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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(▇▇▇▇ ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE YEAR ENDED DECEMBER 31, 1999
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 ▇▇-▇▇▇▇▇▇▇
(State or other jurisdiction of (Employer
incorporation or organization) Identification Number)
ONE DIGEX PLAZA
BELTSVILLE, MD 20705
(Address of principal executive offices)
Registrant's telephone number, including area code: (▇▇▇) ▇▇▇-▇▇▇▇
Securities registered pursuant to Section 12(b) of the Act:
NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, PAR VALUE $.01 PER SHARE
Indicate by check ▇▇▇▇ 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 ▇▇▇▇ 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 Form 10-K or any
amendment in this Form 10-K. [X]
Aggregate market value of the voting stock held by non-affiliates (1) of
the registrant on February 18, 2000: $3,012,712,500.
As of February 18, 2000, there were 24,150,000 shares of the Registrant's
Common Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
DOCUMENT PART OF 10-K INTO WHICH INCORPORATED
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Proxy Statement relating to registrant's Part III
Annual Meeting of Stockholders to be held on
May 19, 2000
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(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.
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DIGEX, INCORPORATED
INDEX
PAGE
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PART I
Item 1 Business.................................................... 1
Item 2 Properties.................................................. 21
Item 3 Legal Proceedings........................................... 22
Item 4 Submission of Matters to a Vote of Security Holders......... 22
PART II
Item 5 Market for Registrant's Common Equity and Related
Stockholder Matters......................................... 23
Item 6 Selected Financial and Other Operating Data................. 24
Item 7 Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 27
Item 7A Quantitative and Qualitative Disclosure..................... 34
Item 8 Financial Statements and Supplementary Data................. 35
Item 9 Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................... 35
PART III
Item 10 Directors and Executive Officers of the Registrant.......... 36
Item 11 Executive Compensation...................................... 36
Item 12 Security Ownership of Certain Beneficial Owners and
Management.................................................. 36
Item 13 Certain Relationships and Related Transactions.............. 36
PART IV
Item 14 Exhibits, Financial Statement Schedules and Reports on Form
8-K......................................................... 37
Signatures.................................................. 40
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PART I
References in this report to "we," "the Company," or "Digex," mean Digex,
Incorporated except where the context otherwise requires. This report contains
certain "forward-looking statements" concerning Digex's operations, economic
performance and financial condition, which are subject to inherent uncertainties
and risks. Actual results could differ materially from those anticipated in this
report. When used in this report, the words "estimate," "plan," "project,"
"anticipate," "expect," "intend," "believe" and similar expressions are intended
to identify forward-looking statements.
ITEM 1. BUSINESS
OVERVIEW
We are a leading provider of managed Web hosting services to businesses
operating mission-critical, multi-functional Web sites. In addition, we offer
Web hosting services to the rapidly growing number of application service
providers, enabling them to more efficiently deliver their application services
to their customers over the Internet. We also offer related value-added
services, such as firewall management, stress testing and consulting services,
including capacity and migration planning and database optimization. From major
corporations to Internet start-ups, our customers leverage our services to
rapidly and cost-effectively deploy secure and reliable business solutions
including on-line banking, on-line procurement and electronic retailing. Our
services include providing the computer hardware, software, network technology,
and systems management necessary to offer our customers comprehensive outsourced
Web site and application hosting solutions.
We believe our singular focus on delivering mission-critical Web site and
application hosting solutions has been the major contributor to our growth. We
currently serve over 550 customers, including American Century Investments,
Forbes, J. Crew, Kraft, Publishers Clearing House and Universal Studios. We
operate two state-of-the-art data centers strategically positioned on the east
and west coasts of the United States. We own and manage approximately 2,300
Windows NT and UNIX-based servers in these data centers. Our revenues grew at a
compounded annual growth rate of 177% between 1996 and 1999, from $2.8 million
in 1996 to $59.8 million in 1999.
The following are among the key factors that we believe will continue to
drive our growth:
- the ability to facilitate the rapid, cost-efficient implementation and
expansion of customers' Web site initiatives;
- an operating platform designed to allow us to scale our operations to
achieve higher revenues, lower marginal unit costs and increased
operating margins;
- strong alliances with Microsoft Corporation ("Microsoft") and Compaq
Computer Corporation ("Compaq"), each of whom have recently invested in
Digex;
- strong working relationships with other technology leaders including Sun
Microsystems, Akamai, Netscape and Cisco Systems;
- an experienced management team and technical experts, who in the
aggregate hold over 200 technical certifications from leading companies
such as Cisco Systems, Microsoft and Sun Microsystems;
- a highly skilled research and development organization dedicated to
identifying the best available tools, technologies and processes;
- a growing, geographically distributed sales force; and
- a network of over 120 business alliances which provide complementary
design, development and integration services for our customers and which
represent a significant source of new customer referrals for Digex.
We believe we have established a reputation for reliable service, prompt
deployment and quality customer service. To meet our customers' evolving
requirements, we continuously seek to identify, test and utilize the
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best available technologies and processes. Scalability is a central element of
our operating strategy. Our architecture was specifically designed to facilitate
the rapid, cost-efficient implementation and expansion of our customers' Web
hosting initiatives.
OUR HISTORY
Our business started in 1996 as the Web site hosting unit of Business
Internet, Inc., previously known as DIGEX, Incorporated, a company that was
principally an Internet access and Web site hosting services provider. Business
Internet went public in October 1996 under the name DIGEX, Incorporated, and was
acquired by Intermedia Communications Inc. in July 1997. In contemplation of our
initial public offering, we were incorporated as Digex, Incorporated in April
1999, and Business Internet contributed our assets to the newly formed Digex,
Incorporated in order to effect a recapitalization of our business.
On July 29, 1999, we announced a 50,000-for-one stock split effective on
August 4, 1999 in the form of a stock dividend to holders of record of our Class
B Common Stock as of July 8, 1999. Share and per share information in this Form
10-K has been adjusted retroactively to reflect this stock split.
RECENT DEVELOPMENTS
On August 4, 1999, we sold 11,500,000 shares of Class A Common Stock in our
initial public offering.
Subsequent to our initial public offering, Business Internet contributed
our Class B Common Stock to its wholly-owned subsidiary, Intermedia Financial
Company.
In January 2000, Microsoft and a subsidiary of Compaq made a $100.0 million
equity investment in our Company, 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 and joint marketing arrangements
with both companies.
We will work together with Microsoft to advance our capabilities to more
rapidly install, manage and upgrade large numbers of Microsoft Windows-based
servers for Web site and application hosting.
We will work jointly with Compaq to streamline the order, delivery and
installation of Compaq's server hardware and storage devices. We have agreed to
use Compaq's server hardware and attached storage exclusively for a period of
18-months for all customer implementations using a Microsoft platform, provided
the equipment meets agreed performance, cost and service delivery requirements.
In January 2000, we were one of the first service providers to complete Sun
Microsystems' SunTone certification for our services, demonstrating our
continued leadership in the UNIX marketplace.
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 Intermedia sold 10,650,000 shares of Class B Common Stock. The Class B
Common Stock sold by Intermedia automatically converted to Class A Common Stock
at the closing of the offering. See "Risk Factors -- Digex is controlled by
Intermedia, which could have multiple risks for you as a stockholder."
INDUSTRY BACKGROUND
Introduction
Use of the Internet, including intranets and extranets, has grown rapidly
in recent years. This growth has been driven by a number of factors, including
the large and growing installed base of personal computers, improvements in
network architectures, increasing numbers of network-enabled applications, the
emergence of compelling content and commerce-enabling technologies, and easier,
faster and cheaper Internet access. As a result of this growing use, the
Internet has become an important new global communications and commerce medium.
The Internet represents an opportunity for enterprises to interact in new and
different ways with both existing and prospective customers, employees,
suppliers and partners. Enterprises are responding to this opportunity by
substantially increasing their investment in Internet sites and services.
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Over the last few years, enterprises that focus solely on distributing
products and services over the Internet have emerged and, more recently,
mainstream businesses have begun to implement Web sites to complement
traditional business models and applications. Among the various factors which
continue to attract these businesses to the Internet is the transformation of
Web sites from being primarily text-based and informational to becoming
interactive, multimedia-enabled and transaction oriented. New technologies and
development tools have also led to the Web-enabling of traditional business
functions and applications such as customer service, procurement, human resource
management and sales force automation. Internet operations and applications are
mission-critical for virtually all Web-centric companies and are becoming
increasingly mission-critical for many mainstream enterprises. At the same time,
these operations and applications are becoming more complex and challenging to
operate. Ensuring the quality, reliability, and availability of these Internet
operations typically requires substantial investments in developing Internet
expertise and infrastructures. However, such a continuing significant investment
of resources is often an inefficient use of an enterprise's limited resources.
As a result, businesses are increasingly seeking collaborative outsourcing
arrangements that can increase performance, provide continuous operation of
their Internet solutions, and reduce Internet operating expenses.
According to ▇▇▇▇▇▇▇▇▇ Research, 44% of the 50 Fortune 1000 firms they
surveyed have outsourced the management of their Web sites. ▇▇▇▇▇▇▇▇▇ reports
that companies outsource Web site management primarily for the following
reasons:
- scarcity of technical skills;
- performance;
- speed of implementation; and
- security.
We believe additional benefits of outsourcing the management of a complex
Web site include lower total costs, higher service level guarantees and reduced
risk of technology obsolescence.
Emergence of Web Hosting Service Providers
In order to establish a high quality, reliable Web site or to run a
Web-based application on the Internet, businesses must, among other things,
procure and integrate sophisticated hardware and software, hire and retain an
operations support staff, develop application specific technical skills, and
have access to a secure, fault-tolerant physical location and redundant Internet
connectivity. While it is possible for a business to assemble all of these
elements in-house, many companies elect to outsource all or a portion of their
Web-site operations to companies offering Web hosting services. Web hosting
companies, in general, provide various infrastructure-related services,
including secure, monitored data centers, uninterrupted power supply and high-
speed network connectivity. We categorize the market for outsourced Web hosting
services into the following:
- Shared Hosting: Customers share server hardware, software and bandwidth
with other customers. Shared hosting provides a price competitive entry
point for individuals and businesses desiring a simple Web site.
- Collocation Hosting: Customers own their hardware, software and network
equipment, which is housed at the Web site hosting company's facilities.
The customers retain responsibility for the installation, management,
upgrading and security of their Web sites. While collocation requires the
customer to assume the majority of the responsibilities for the operation
of its Web site, collocation has been and remains an attractive option
for Web-centric companies with advanced in-house Internet expertise.
- Dedicated Hosting: Customers are provided a complete managed Web site
hosting solution. Unlike collocation, the service provider supplies the
hardware, software, network equipment and support necessary to run the
Web site. In addition, dedicated hosting often includes value-added
services such as firewall management, stress testing and consulting
services. As Web sites have become more complex, even large and
technically astute businesses have found Internet technologies and
solutions a
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challenge to manage. For such companies, including many Fortune 2000
companies, dedicated Web site hosting has become a preferred alternative.
- Application Hosting: Application service providers deliver Web-enabled
business applications to their end-users over the Internet, supporting
such common business processes as customer service, procurement, human
resource management and sales force automation. Often, an application
service provider partners with a dedicated hosting provider to bundle the
services of dedicated web hosting - known as "application hosting" when
targeted at this market -- with their application services and support.
Through this partnership, the application service provider typically
experiences numerous benefits, including faster time-to-market, access to
advanced application skills and significantly lower costs of operations.
A variety of companies, such as ISPs and large systems integrators, offer
products and services that attempt to address enterprises' Internet outsourcing
needs. However, we believe the solutions offered by these companies fail to
address certain elements required to ensure that customers' mission-critical
Internet operations are reliable, scalable and responsive. ISPs have
traditionally focused on providing Internet access and many have not developed
the technical expertise and physical resources to support mission-critical Web
sites and applications. In addition, many large systems integrators focus
primarily on large enterprises and traditional information technologies. These
firms often lack the network and Internet expertise required to provide
mission-critical solutions. As a result, we believe a significant opportunity
exists for a highly-focused company to provide a combination of complex Web site
hosting, outsourced applications management and professional consulting services
that enable businesses to implement reliable, high performance and cost
effective mission-critical Internet solutions.
DIGEX SOLUTION
We focus primarily on providing dedicated Web site and application hosting
services. Our core competency is developing and managing mission-critical Web
solutions for Fortune 2000 companies, Web-centric businesses and application
service providers. We believe we are uniquely positioned to assist such
businesses in optimizing the potential of the Internet and their
Internet-related applications by providing our customers with the following key
advantages:
A Comprehensive Suite of Web Site and Application Hosting Services. We
provide a suite of services that enable companies to conduct business on the
Internet. Using a large, multi-specialized technical staff of certified
engineers, and through the security and reliability of our state-of-the-art data
centers, we provide the services and expertise necessary to ensure secure,
scalable, high-performance operation of mission-critical Web sites and
applications 24 hour a day. These services include:
- Management services such as operating and supporting Windows NT and
UNIX-based dedicated servers and intelligent networking services such as
load balancing and network caching;
- Enterprise services such as firewall management, stress testing,
customized Web site activity reporting, and enhanced security services;
and
- Consulting services including capacity planning, disaster recovery
planning, migration planning and database optimization.
As part of our services, we provide the installation and maintenance of
industry-leading hardware and software, core technical expertise, high-volume
backup and recovery systems and 24 hours a day monitoring by our Server
Operations Center ("SOC").
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High-Performance Internet and Private Network Connectivity. We provide
high performance network connectivity services for our customers' Web sites as
well as direct private networking options for secure "back-end" network
connections to private corporate networks and information systems. Through our
network services agreement with Intermedia, we offer superior Internet
connectivity that provides the following direct benefits to customers:
- connectivity to a diversely redundant high-speed national network via
Intermedia, a tier-one ISP;
- use of all of Intermedia's public and private peering relationships,
permitting direct exchange of traffic with a significantly large number
of carriers and ISPs;
- use of all of Intermedia's regional direct connections to major ISPs,
dial-up carriers and content service providers; and
- service level agreements guaranteeing high availability and performance.
In addition to the Internet connectivity available through Intermedia's
backbone, we provide diversified connectivity from our data centers to other
major Internet backbones. We are also actively establishing and maintaining our
own public and private peering arrangements.
In addition, Digex offers a broad array of intelligent networking services
including products and services from Akamai and Cisco Systems.
Responsive Customer Care and Technical Support. We strive to provide
superior customer service. This includes providing customers with 24-hour a day
direct access to a staff of over 300 customer care and technical support
personnel and our use of a variety of proactive monitoring services from our
state-of-the-art SOC, which allows us to anticipate potential problems or
rapidly identify and remedy service interruptions. We believe this level of
customer support significantly differentiates Digex in the marketplace.
At our SOC, we monitor and report on the health of servers, software,
networks, and security devices managed by us through our centralized server
monitoring platform. The SOC uses a variety of technologies and tools, including
the Computer Associates Unicenter and Micromuse Netcool products, to ensure
highest possible server availability by monitoring a large volume of server
resources such as CPU utilization, system and application processes, log files,
TCP ports and disk space, and security devices, such as firewalls. In addition,
the SOC monitors specific network devices, such as routers, switches and load
balancing equipment that are critical to the successful delivery of our hosting
services.
Secure, Fault-Tolerant Data Centers. Our data centers have been engineered
to meet the highest expectations of our most demanding customers across our
target markets, including the particularly stringent requirements of the
financial services industry.
Our data centers contain multiple, freestanding computer rooms to provide
containment and isolation. Separate mechanical rooms adjacent to each computer
room house cooling and mechanical equipment, eliminating the possible
introduction of liquid into the computer room from equipment leakage. We use
redundant uninterruptible power supply systems and redundant diesel generators
to ensure that the power system is capable of maintaining power to the data
center in the event of any component failure. State-of-the-art physical security
has been implemented through tightly controlled security zones requiring both
card and biometric identification. Over 100 surveillance cameras record movement
through the data centers and security guards provide real-time visibility.
Cooling and environmental controls for each data center are designed to monitor
and ensure proper temperature and humidity levels. Finally, all
telecommunications connections enter the data centers through multiple points
from diverse service arrangements to ensure continued operation of service
without degradation in the unlikely event of a cable cut or local carrier
network outage.
Predictable Monthly Fees. We provide our services for predictable monthly
fees, enabling our customers to accurately budget costs for Web site hosting
services. These fees are typically contracted as part of one, two or three-year
agreements. These agreements often provide service level guarantees and permit
technology upgrades at any time during the life of a contract.
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DIGEX STRATEGY
Our objective is to maintain our leadership position in the industry and
continue to shape and lead the global market for hosting complex Web sites and
applications. We intend to accomplish this by delivering secure, scalable,
high-performance Web site and application hosting solutions. Our business
strategy focuses on the following:
Expand Our Premier Web Hosting Capabilities. We have recently expanded the
capacity of our east and west coast data centers. In addition, we are actively
seeking international expansion opportunities. We intend to continue to add data
center capacity over the next five years as justified by customer demand. We
believe our ability to readily grow and scale our operations while
simultaneously maintaining the highest service levels will allow us to continue
to attain higher revenues, lower marginal unit costs and higher operating
margins. The following are among the key initiatives we have instituted to
maintain the quality and scalability of our operations:
- We have formed alliances with leading technology companies. These
alliances help facilitate continuous innovation particularly in the areas
of Web solution scalability, serviceability and rapid deployment speed.
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.
In January 2000, we were one of the first service providers to receive
SunTone certification for our services, demonstrating our continued
leadership in the UNIX marketplace.
- We have designed an innovative architecture, called the Distributed
Internet Server Array ("DISA"), to facilitate Web site operating
scalability. DISA unifies interrelated layers of hardware and software
around industry standard solutions. Our customers are strongly encouraged
to adopt the DISA architecture in implementing their Web initiatives. The
consistency and reliability afforded by our DISA architecture facilitates
rapid and cost-efficient implementation of our customers' Web hosting
initiatives. Other Web hosting companies typically have opted not to
standardize their operating architectures. The resulting multiple
architectures significantly complicate and limit the flexibility of their
operations.
- Our technical staff includes over 40 Microsoft certified engineers, as
well as technical experts certified by Cisco Systems and Sun
Microsystems. We believe this makes our technical staff among the most
highly skilled and trained in the Web hosting industry. Based on comments
by our customers, we believe our technical staff affords us a competitive
advantage and has been instrumental in attracting many of our Fortune
2000 customers. In addition, we believe the depth and scope of our
staff's technical skill base is essential to our ability to maintain our
high quality service levels. To attract and retain these individuals, we
offer competitive financial incentives, including stock options, in-house
and external training programs, and the opportunity to work with
cutting-edge technology.
Develop Next Generation Service Offerings. As the underlying technology
and functionality of Web-based products evolve, we believe customers will
continuously demand new service offerings. We believe the depth of our Web site
management skills positions us to be a leading provider of next generation Web
site and application hosting services. The following are among the new service
initiatives we are currently pursuing:
- Support for Leading Applications and Databases. We have developed
expertise in several of the leading software applications and databases
used by many of today's business oriented Web sites. Over the past six
months, Digex has begun to support Lotus Domino and the Oracle 8i
database. We intend to continue to add new Web site applications and
databases to the list of software that we support.
- Value-added, Recurring Services. We have developed various value-added
services, which we believe significantly enhance the availability and
effectiveness of our customers' Web sites. Examples of these services
are: testing, security, database, reporting and intranet service
offerings. In 1999, we added
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expanded reporting and monthly security scanning and analysis services. We
intend to continue developing services that improve the effectiveness of Web
sites and optimize their performance.
- Enable the Emerging Application Service Provider Market. We believe that
we are well positioned to capitalize on the growth of the application
hosting segment of the Web hosting market by leveraging our experience
and technical expertise in efficiently deploying, managing, and scaling
Web hosting solutions. Digex intends to develop new services,
complementary to its suite of existing Web site hosting services, which
will enable application service providers to rapidly and cost effectively
deliver business applications to their customers' desktops over the
Internet. While the early phase of this emerging application hosting
market has been dominated by traditional software applications, we
believe a substantial number of new business process software products
designed for the Internet environment, and consequently a large number of
new application service providers, will begin to emerge in 2000.
▇▇▇▇▇▇▇▇▇ research, for example, predicts that the market for hosted
business applications will increase to $11.3 billion in 2003. We intend
to work with the various software developers, systems integrators, and
information technology firms that are evolving into application service
providers by providing their managed hosting services.
Expand Capabilities Through Selective Strategic Alliances and
Acquisitions. We currently have business alliances with over 120 Web design and
development companies and interactive media agencies. These businesses typically
partner with us due to our high quality services support and augment, rather
than compete with, their own product and service offerings. Together with our
business partners, we can provide our customers with end-to-end Web site
solutions. In 1998, we created the Digex e-Link Partner Program(TM), which
continues to attract leading interactive media and Web development companies
such as ▇▇▇▇▇▇.▇▇▇, OrderTrust and US Interactive. In addition, in December
1999, we launched the Digex app-Link Partner Program(TM) in order to expand our
alliances to include systems integrators, value-added resellers and consultants
who offer application services to customers over the Internet. Our partnership
programs provide a valuable, cost-effective channel for marketing our services
as well as a highly productive customer referral source. In addition, we may
seek to opportunistically acquire companies which we believe will enable us to
cost-effectively augment our existing products and services, technology,
infrastructure, skill set, geographic presence or customer base.
DIGEX SERVICES
We offer a full range of complementary value-added services designed to
satisfy the rapidly evolving requirements of complex Web sites. Our services
include the following:
- Managed Hosting Services;
- Enterprise Services; and
- Consulting Services.
MANAGED HOSTING SERVICES
Dedicated Web Site and Application Hosting Services. We offer dedicated
Web site and application hosting services designed to enable reliable, scalable,
mission-critical Web solutions. We operate both Windows and UNIX-based servers
exclusively using hardware from Compaq and Sun Microsystems. By standardizing
around the hardware produced by these two vendors, we are able to quickly,
easily and cost-effectively upgrade, configure and implement the new hardware
necessary to accommodate our customers' growing needs for higher computing
speeds and capacity. We offer a number of services to dedicated Web site
management customers and application service providers to ensure ease of
implementation, security, performance and scalability. We offer a comprehensive
package featuring our core managed hosting services under the Digex
SmartServices(SM) brand. Digex SmartServices(SM) include:
- installation and maintenance of Web sites and applications on industry
leading server hardware and storage systems from Compaq or Sun
Microsystems;
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- installation and maintenance of Microsoft Windows NT or Microsoft Windows
2000 and/or the Sun Solaris UNIX operating system tested and configured
by us to ensure optimal Internet performance and security;
- unlimited help desk support available 24 hours a day with access to
certified technical professionals;
- continuous server and network monitoring services;
- substantial inventory of parts on-site for rapid upgrading and
maintenance of hardware and software;
- industry and vendor security alerts and maintenance;
- backup and recovery of system information, user information and customer
content to ensure protection against data loss from disaster, hardware
failure, or administrative errors; and
- secure remote administration capabilities for easy and ubiquitous remote
management.
Intelligent Networking. We offer a variety of intelligent networking
services to our customers. These services include load balancing and
geographical distribution of network traffic using Cisco Systems technology and
high-performance delivery of Internet content using the Akamai network and
technology. We expect demand for these products to increase as more customers
move to multiple server and higher bandwidth solutions.
Private Networking. Our private networking services are primarily used to
securely connect a customer's Web site at our site to their private corporate
network or information system. Today, we offer a private IP connectivity service
and Intermedia's frame relay service.
ENTERPRISE SERVICES
Our enterprise services help companies deploy and maintain effective Web
sites. We believe these value-added, repeatable services will become
increasingly important to our customers as they look to ensure a higher level of
Web site availability, security and reporting. Our enterprise services include
the following:
Testing Services. Our testing services aim to identify problems that could
degrade the expected performance and availability of a customer's Web site. For
example, our stress testing services simulate users accessing a Web site to
provide information for isolating problems, optimizing performance and
accelerating the deployment of Web sites.
Reporting Services. Our reporting services are designed to provide timely,
reliable information about user activity on a customer's Web site. Businesses
can use these reports to assess the effectiveness of their Web sites and to
increase their knowledge of the preferences, habits and demographic
characteristics of their Web site visitors. For example, we offer a custom Web
site usage reporting service to help improve Web server performance for our
customers by off-loading the usage reporting processing to a powerful server
designed specifically for reporting.
Security Services. Our security services are designed to ensure the
security of a customer's Web site or an application service provider's
applications. In December 1999, we introduced monthly security scanning and
vulnerability assessment services to provide our customers with a higher level
of protection and assurance. Other security services offered today include
managed firewalls, encryption software and authentication devices.
Database Services. Our database services provide the installation,
configuration, maintenance and support of leading databases. Today, we provide
enhanced database services for Microsoft SQL Server and Oracle 8i database
technology.
CONSULTING SERVICES
Our consulting services provide customized assistance to customers with
unique architecture, deployment or maintenance requirements. These services
include high-availability design, performance tuning, site architecture
assessment, migration planning, capacity planning, disaster recovery planning
and database
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optimization. Our consulting services typically assist customers with limited
resources or who lack Internet and technical expertise. Our consulting
engagements typically range from a few hours to a few weeks depending on the
complexity and volume of the services needed. We believe our consulting services
will play an increasingly important role in supporting the implementation and
maintenance of complex Web sites and Web-based applications.
CUSTOMERS
We have a large and diverse customer base ranging from Fortune 50 companies
to small and medium size businesses that rely heavily on the Internet. Our
customers are primarily located within the United States. We serve over 550
customers, covering most major industries. Our customer contracts typically
range in duration from one to three years. Our customers include the following
well-known companies:
FINANCIAL SERVICES
AND INSURANCE MEDIA AND ENTERTAINMENT MANUFACTURING RETAIL AND DISTRIBUTION
------------------ ----------------------- ------------- -----------------------
American Century Investments BBC America Kraft Foods American Eagle Outfitters
Ernst & Young LLP The Economist Liz Claiborne Authentic Fitness
Lending Tree Edmund's Nissan Campmor
Northwestern Mutual Forbes ▇▇▇▇ ▇▇▇ Corporation J. Crew
Life Insurance ▇▇▇▇▇▇ ▇▇▇▇▇▇▇ ▇▇▇▇▇▇ ▇▇▇▇▇▇
Progressive Insurance Publishers Clearing House ▇. ▇. ▇▇▇▇▇▇▇▇
Companies Universal Studios
TECHNOLOGY AND
GOVERNMENT COMMUNICATIONS HEALTHCARE TRAVEL & HOSPITALITY
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U.S. Department of Agriculture Compaq Association of Budget Rent-A-Car
Microsoft American The Travel Company
Medical Colleges
Bally Total Fitness
Claimsnet
DuPont Pharmaceuticals
In the past few years, our growth has come from new customers, as well as
existing customers whose Web sites have become increasingly more strategic to
their overall business goals and objectives.
In addition, an increasing number of our customers are application service
providers, commonly referred to as ASPs, who use our hosting services to deliver
their applications to their customers. Our application service provider clients
include:
ASP CLIENT HOSTED APPLICATION
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Encentris -- customer relationship management application
Continuity -- project management application
Celarix -- global logistics management application
Pandesic -- e-commerce application
Quick Arrow -- consulting and professional services office management
application
SALES AND MARKETING
Our sales objective is to achieve broad market penetration by focusing on
market segments that, we believe, have both a high propensity to outsource and
to deploy complex, mission-critical Web sites. We sell our services directly
through a highly skilled professional sales force and receive referrals through
an extensive network of business partners.
Direct Sales. As of December 31, 1999, our direct sales force consisted of
70 experienced, quota-bearing sales representatives. We have organized the sales
force into three units: major accounts, mid-market/Web-centric, and alternate
channel. The major accounts unit focuses on Fortune 2000 companies. The
mid-market/ Web-centric unit addresses the large and growing number of mid-size
businesses requiring mission-critical hosting services. Our alternate channel
sales group works closely with our extensive network of business alliance
partners, which includes systems integrators, Web site developers and
application service providers. Supporting each of these units is a site
engineering team that provides pre-sales technical support, including
requirements gathering, configuration support, site architecture, and project
management.
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Business Alliance Partners -- The Digex e-Link Partner Program(TM) and
Digex app-Link Partner Program(TM). In 1998, we created the Digex e-Link Partner
Program(TM) which, we believe, has attracted some of the leading interactive
media and Web site development companies to partner with us. To date, our
business partners include companies such as ▇▇▇▇▇▇.▇▇▇, Order Trust and US
Interactive. We currently have over 120 business alliances that are a
significant source of sales leads and opportunities. These business partners
include Web site developers, Web site designers, interactive and new media
agencies, and systems integrators. We collaborate, instead of compete, with our
partners and complement each other's skills in an effort to bring the best
overall solution to our customers. Typically, in these collaborative
relationships, we focus on Web site hosting, while our strategic partners
concentrate on Web site design, development and systems integration.
In November 1999, we launched our second comprehensive partner program, the
Digex app-Link Partner Program(TM). The Digex app-Link Partner Program(TM)
targets application service providers, including consultants, systems
integrators and software developers. We currently host Web-based applications
for a variety of application service providers who specialize in providing a
broad range of Web-based business solutions.
Marketing. Our marketing organization is responsible for building our
brand awareness, identifying key target markets and developing innovative
programs to communicate our products and services to the marketplace. Another
objective of our marketing efforts is to stimulate the demand for our services
through a broad range of marketing communications and public relations
activities. Our primary communication vehicles include advertising, trade shows,
direct response programs, event sponsorship, our Web sites and the distribution
channels of our technology vendors such as Microsoft, Compaq and Sun
Microsystems. Through our alliances with Microsoft and Compaq, we intend to
develop joint marketing activities promoting Windows-based solutions to Web site
and application service provider customers.
COMPETITION
The market served by Digex is highly competitive. There are few substantial
barriers to entry, and we expect to face additional competition from existing
competitors and new market entrants in the future. The principal competitive
factors in this market include:
- quality of services and scalability of infrastructure;
- network capacity, reliability, security and adaptability to new
technologies;
- Internet system engineering expertise;
- quality of customer service and support;
- relationships with marketing partners and vendors;
- number and geographic presence of sales and technical support personnel;
- variety of services offered;
- price;
- product innovation;
- financial resources; and
- brand name.
Our current and potential competitors in the market include:
- Web hosting service providers;
- local, regional, national and international ISPs;
- local, regional, national and international telecommunications companies;
and
- large information technology outsourcing firms.
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Our competitors may operate in one or more of these areas and include
companies such as AT&T, Cable & Wireless, Concentric Network, Data Return, EDS,
Exodus Communications, Frontier/GlobalCenter, Globix, GTE, IBM, Intel, Level 3
Communications, MCI WorldCom, Navisite, PSINet, Qwest Communications
International, and USinternetworking.
We believe our experience and reputation for delivering high quality,
managed Web site and application hosting services differentiates us from our key
competitors. We focus on our core competency of Web site and application hosting
as opposed to offering hosting as a complement to a wide range of communication
services. We believe we have defined and offer the industry's most complete set
of functions required to configure, engineer, implement and maintain complex,
transactional Web sites and applications. We believe our DISA architecture, data
centers, and technical team distinguish us from our competition and enable us to
provide among the highest quality end-to-end managed Web site and application
hosting solutions.
INTELLECTUAL PROPERTY RIGHTS
We rely on a combination of copyright, trademark, service ▇▇▇▇ and trade
secret laws and contractual restrictions to establish and protect certain
proprietary rights in our data, applications and services. We have no patented
technology that would bar competitors from our market. We also rely on certain
technologies we license from third parties, such as Microsoft, Netscape and
Micromuse. There can be no assurance these third-party technology licenses will
continue to be available to us on commercially reasonable terms. The loss of
such technology could require us to obtain substitute technology of lower
quality or performance standards or at greater cost, which could harm our
business. However, other than our trademarks and service marks, we do not
believe that the loss of any particular one of our intellectual property rights
would harm our business.
GOVERNMENT REGULATION
We are not currently subject to direct federal, state or local government
regulation, other than regulations applicable to businesses generally. There is
currently only a small body of laws and regulations directly applicable to
access to or commerce on the Internet.
In October 1998, Congress enacted the Digital Millennium Copyright Act,
which includes a limitation on liability of on-line service providers for
copyright infringement for transmitting, routing, or providing connections,
transient storage, caching or storage at the direction of a user. This
limitation on liability applies if the service provider had no actual knowledge
or awareness that the transmitted or stored material was infringing and if
certain other conditions are met. Since this law is relatively new, we are
unsure of how it will be applied to limit any liability we may face in the
future for any possible copyright infringement or copyright-related issues. This
law also requires ISPs to follow certain "notice and take-down" procedures in
order to be able to take advantage of the limitation on liability. We have not
yet implemented such procedures nor evaluated the cost of complying with them.
However, our customers are subject to an acceptable use policy which prohibits
them from posting, transmitting or storing material on or through any of our
services which, in our sole judgment, is (1) in violation of any local, state,
federal or foreign law or regulation, (2) threatening, obscene, indecent or
defamatory or that otherwise could adversely affect any individual, group or
entity or (3) in violation of the intellectual property rights or other rights
of any person. Although this policy is designed to promote the security,
reliability and privacy of our systems and network, there is no assurance that
our policy will accomplish this goal or shield us from liability under the
Digital Millennium Copyright Act.
Despite enactment of the Digital Millennium Copyright Act, the law relating
to the liability of on-line services companies and Internet access providers for
information carried on or disseminated through their networks remains largely
unsettled. It is possible claims could be made against on-line services
companies and Internet access providers under both United States and foreign law
for defamation, obscenity, negligence, copyright or trademark infringement, or
other theories based on the nature and content of the materials disseminated
through their networks. Several private lawsuits seeking to impose such
liability upon on-line services companies and Internet access providers are
currently pending.
Although the sections of the Communications Decency Act of 1996 that
proposed to impose criminal penalties on anyone distributing indecent material
to minors over the Internet were held to be unconstitutional
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by the U.S. Supreme Court, similar laws may be proposed, adopted and upheld. The
nature of future legislation and the manner in which it may be interpreted and
enforced cannot be fully determined and, therefore, legislation similar to the
Communications Decency Act could subject us and/or our customers to potential
liability, which in turn could harm our business. The adoption of any of these
types of laws or regulations might decrease the growth of the Internet, which in
turn could decrease the demand for our services or increase our cost of doing
business or in some other manner harm our business.
Due to the increasing popularity and use of the Internet, it is likely a
number of additional laws and regulations may be adopted at the federal, state
and local levels with respect to the Internet, covering issues such as user
privacy, freedom of expression, pricing, characteristics and quality of products
and services, taxation, advertising, intellectual property rights, information
security and the convergence of traditional telecommunications services with
Internet communications. The adoption of any such laws or regulations might
decrease the growth of the Internet, which in turn could decrease the demand for
our services or increase the cost of doing business or in some other manner harm
our business. In addition, applicability to the Internet of existing laws
governing issues such as property ownership, copyrights and other intellectual
property issues, taxation, libel, obscenity and personal privacy is uncertain.
The vast majority of such laws were adopted prior to the advent of the Internet
and related technologies and, as a result, do not contemplate or address the
unique issues of the Internet and related technologies.
EMPLOYEES
As of January 1, 2000, we employed approximately 595 full-time employees.
None of our employees are covered by a collective bargaining agreement. We
believe that our employee relations are good.
RISK FACTORS
WE HAVE A LIMITED OPERATING HISTORY AND OUR BUSINESS MODEL IS STILL EVOLVING,
WHICH MAKES IT MORE DIFFICULT FOR YOU TO EVALUATE OUR COMPANY AND ITS PROSPECTS.
We were established in January 1996 to provide Web site hosting services
for businesses deploying complex, mission-critical Web sites, which remains our
primary focus. Our range of service offerings has changed since 1996 and our
business model is still new and developing. Because some of our services are
new, we cannot be sure that businesses will buy them. As a result, the revenue
and income potential of our business is unproven. Our limited operating history
makes predicting future results difficult. Our prospects must be considered in
light of the risks, expenses and difficulties encountered by companies in the
new and rapidly evolving market for Web site and application hosting services.
To address these risks, among other things, we must:
- provide reliable, technologically current and cost-effective services;
- continue to upgrade and expand our infrastructure;
- market our brand name and services effectively;
- maintain and develop our business alliances; and
- retain and attract qualified personnel.
WE HAVE A HISTORY OF SIGNIFICANT LOSSES AND EXPECT THESE LOSSES TO CONTINUE IN
THE FORESEEABLE FUTURE.
We have experienced operating losses and negative cash flows from
operations in each annual period from inception. As of December 31, 1999, our
accumulated losses since January 1, 1996 amounted to approximately $112.9
million. We had net losses of $65.0 million for the year ended December 31,
1999. While our revenues have grown in recent periods, we cannot assure you this
growth will continue. In connection with our expansion plans, we anticipate
making significant investments in sales, marketing, technical and customer
support personnel, as well as in our data center infrastructure. As a result of
our expansion plans, we expect our net losses and negative cash flows from
operations to continue for the foreseeable future. We cannot assure you that we
will ever become or remain profitable or that we will generate positive cash
flows from operations.
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OUR QUARTERLY AND ANNUAL RESULTS MAY FLUCTUATE, RESULTING IN FLUCTUATIONS IN THE
PRICE OF OUR CLASS A COMMON STOCK.
Our results of operations fluctuate on a quarterly and annual basis. We
expect to continue experiencing significant fluctuations in our future quarterly
and annual results of operations due to a variety of factors, many of which are
outside our control, including:
- demand for and market acceptance of our services;
- introductions of new services by us and our competitors;
- capacity utilization of our data centers;
- timing of customer installations;
- the mix of services we sell;
- customer retention;
- the timing and magnitude of our capital expenditures;
- changes in our pricing policies and those of our competitors;
- fluctuations in bandwidth used by customers;
- our retention of key personnel; and
- other general economic factors.
For these and other reasons, in some future quarters, our results of
operations may fall below the expectations of securities analysts or investors,
which could negatively affect the market price of our Class A Common Stock.
WE CANNOT PREDICT THE OUTCOME OF OUR JOINT DEVELOPMENT EFFORT WITH MICROSOFT AND
COMPAQ.
Working closely with Microsoft and Compaq, we expect to invest significant
resources to advance our ability to more rapidly install, manage and upgrade
large numbers of Microsoft Windows-based servers for Web site and application
hosting. While Microsoft and a subsidiary of Compaq have each made a $50.0
million equity investment in our company, neither has an obligation to
contribute additional equity, whether or not the costs associated with this
development project exceed our expectations. Our alliance agreements also do not
prevent Microsoft and/or Compaq from working with other service providers to
develop similar capabilities. In addition, because this alliance is for a
research and development project, we cannot assure you that any commercially
successful products will be developed as a result of our agreements with
Microsoft and Compaq. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Liquidity and Capital Resources."
WE OPERATE IN A RELATIVELY NEW AND EVOLVING MARKET WITH UNCERTAIN PROSPECTS FOR
GROWTH.
The market for Web site and application hosting and related services has
only recently begun to develop and is evolving rapidly. Although certain
industry analysts project significant growth for this market, their projections
may not be realized. Our future growth, if any, will depend on the continued
trend of businesses outsourcing their Web site and application hosting and our
ability to market our services effectively. There can be no assurance that the
market for our services will grow, that our services will be adopted, or that
businesses will use these Internet-based services to the degree or in the manner
that we expect. It is possible that at some point businesses may find it
cheaper, more secure or otherwise preferable to host their Web sites and
applications internally and decide not to outsource the management of their Web
sites and applications. If we are unable to react quickly to changes in the
market, if the market fails to develop, or develops more slowly than expected,
or if our services do not achieve market acceptance, then we are unlikely to
become or remain profitable.
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WE MAY BE UNABLE TO ACHIEVE OUR OPERATING AND FINANCIAL OBJECTIVES DUE TO
SIGNIFICANT COMPETITION IN THE WEB SITE AND APPLICATION HOSTING INDUSTRY.
The market for hosting Web sites and applications is highly competitive.
There are few substantial barriers to entry and many of our current competitors
have substantially greater financial, technical and marketing resources, larger
customer bases, more data centers, longer operating histories, greater name
recognition and more established relationships in the industry than we possess.
Our current and potential competitors in the market include Web hosting service
providers, Internet service providers, commonly known as ISPs,
telecommunications companies and large information technology outsourcing firms.
Our competitors may operate in one or more of these areas and include companies
such as AT&T, Cable & Wireless, Concentric Network, Data Return, EDS, Exodus
Communications, Frontier/GlobalCenter, Globix, GTE, IBM, Intel, Level 3
Communications, MCI WorldCom, Navisite, PSINet, Qwest Communications
International, and USinternetworking.
Our competitors may be able to expand their network infrastructures and
service offerings more quickly. They may also bundle other services with their
Web site hosting or application hosting services, which could allow them to
reduce the relative prices of their Web site hosting and/or application hosting
services beyond levels that we could compete with, and generally adopt more
aggressive pricing policies. In addition, some competitors have entered and will
likely continue to enter into joint ventures or alliances to provide additional
services which may be competitive with those we provide. We also believe the Web
site hosting and application hosting markets are likely to experience
consolidation in the near future, which could result in increased price and
other competition that would make it more difficult for us to compete. See
"Business -- Competition."
OUR DATA CENTERS AND THE NETWORKS WE RELY ON ARE SENSITIVE TO HARM FROM HUMAN
ACTIONS AND NATURAL DISASTERS. ANY RESULTING DISRUPTION COULD SIGNIFICANTLY
DAMAGE OUR BUSINESS AND REPUTATION.
Our reputation for providing reliable service largely depends on the
performance and security of our data centers and equipment, and of the network
infrastructure of our connectivity providers. In addition, our customers often
maintain confidential information on our servers. However, our data centers and
equipment, the networks we use, and our customers' information are subject to
damage and unauthorized access from human error and tampering, breaches of
security, natural disasters, power loss, capacity limitations, software defects,
telecommunications failures, intentional acts of vandalism, including computer
viruses, and other factors that have caused, and will continue to cause,
interruptions in service or reduced capacity for our customers, and could
potentially jeopardize the security of our customers' confidential information
such as credit card and bank account numbers. Despite precautions we have taken
and plan to take, the occurrence of a security breach, a natural disaster,
interruption in service or other unanticipated problems could seriously damage
our business and reputation and cause us to lose customers. Additionally, the
time and expense required to eliminate computer viruses and alleviate other
security problems could be significant and could impair our service quality. We
also often provide our customers with service level agreements. If we do not
meet the required service levels, we may have to provide credits to our
customers, which could significantly reduce our revenues. Additionally, in the
event of any resulting harm to customers, we could be held liable for damages.
Awards for such damages might exceed our liability insurance by an unknown but
significant amount and could seriously harm our business.
WE COULD NOT PROVIDE ADEQUATE SERVICE TO OUR CUSTOMERS IF WE WERE UNABLE TO
SECURE SUFFICIENT NETWORK CAPACITY TO MEET OUR FUTURE NEEDS ON REASONABLE TERMS
OR AT ALL.
We must continue to expand and adapt our network arrangements to
accommodate an increasing amount of data traffic and changing customers'
requirements. We have entered into several network services agreements with
Intermedia to provide us with certain network transit capacity which we believe
to be adequate for our capacity requirements. However, if our future network
capacity requirements exceed the capacity Intermedia has committed to provide to
us, we may have to pay higher prices for such additional network capacity or
such capacity might not be available at all. Our failure to achieve or maintain
high capacity data transmission could negatively impact service levels to our
existing customers and limit our ability to attract new customers, which would
harm our business.
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OUR BUSINESS, IN LARGE PART, DEPENDS ON NETWORK SERVICES WE RECEIVE FROM
INTERMEDIA. ANY DISRUPTION OF THESE SERVICES OR INTERMEDIA'S INABILITY TO
MAINTAIN ITS PEERING RELATIONSHIPS COULD BE COSTLY AND HARMFUL TO OUR BUSINESS.
We currently rely primarily on Intermedia for network services. Intermedia
operates its own coast-to-coast Internet Protocol network, which qualifies it as
a tier-one service provider of Internet connectivity services. If our network
services agreements with Intermedia were to be terminated, we would need to
rapidly secure an alternative provider of these services. As a result, we could
incur transition costs and our monthly costs of operations could increase. In
addition, such a transition could have a detrimental effect on our customer
service levels.
The Internet is composed of many ISPs that operate their own networks and
interconnect with other ISPs at various peering points. Peering relationships
are arrangements that permit ISPs to exchange traffic with one another without
having to pay for the cost of transit services. Peering relationships are a
competitive factor that allow some Web hosting companies to provide faster data
transmission than others. We believe Intermedia's tier-one status and numerous
peering relationships enable it to provide us faster data transmission than many
other ISPs provide. If Intermedia fails to adapt its network infrastructure to
meet industry requirements for peering or loses its peering relationships for
any other reason, then our transmission rates could be reduced, resulting in a
decrease in the service quality we provide to our customers.
PROVIDING SERVICES TO CUSTOMERS WITH MISSION-CRITICAL WEB SITES AND WEB-BASED
APPLICATIONS COULD POTENTIALLY EXPOSE US TO LAWSUITS FOR CUSTOMERS' LOST PROFITS
OR OTHER DAMAGES.
Because our Web site and application hosting services are critical to many
of our customers' businesses, any significant interruption in our services could
result in lost profits or other indirect or consequential damages to our
customers. Our customers are required to sign server order forms which
incorporate our standard terms and conditions. Although these terms disclaim our
liability for any such damages, a customer could still bring a lawsuit against
us claiming lost profits or other consequential damages as the result of a
service interruption or other Web site or application problems that the customer
may ascribe to us. There can be no assurance a court would enforce any
limitations on our liability, and the outcome of any lawsuit would depend on the
specific facts of the case and legal and policy considerations. We also believe
we would have meritorious defenses to any such claims, but there can be no
assurance we would prevail. In such cases, we could be liable for substantial
damage awards. Such damage awards might exceed our liability insurance by
unknown but significant amounts, which would seriously harm our business.
DIGEX IS CONTROLLED BY INTERMEDIA, WHICH COULD INVOLVE MULTIPLE RISKS FOR YOU AS
A STOCKHOLDER.
Intermedia controls a majority of our voting power, and Intermedia's
interests in us may conflict with your interests as a stockholder. Intermedia,
indirectly through its wholly-owned subsidiary, Intermedia Financial Company,
owns all of the issued and outstanding shares of our Class B Common Stock.
Intermedia currently owns 39,350,000 shares of Class B Common Stock or
approximately 62.0% of the outstanding capital stock of Digex. Each share of
Class B Common Stock is entitled to 10 votes, as compared to one vote for each
share of Class A Common Stock. As a result, Intermedia controls approximately
94.2% of our voting interests, and will be able to control the management and
affairs of Digex, and all matters submitted to our stockholders for approval,
including the election and removal of directors, and any merger, consolidation
or sale of all or substantially all of our assets. As a result, the price of our
Class A Common Stock may be affected.
We depend on Intermedia to fund our working capital and operating losses,
but Intermedia's ability to fund these needs is limited by its own substantial
indebtedness. Because we are subject to the restrictions under Intermedia's
indentures, we are required to use all of the net proceeds of our recent equity
offerings to purchase Telecommunications Related Assets within 270 days of the
offering date. We will not be able to use the proceeds of these offerings
directly to fund operating losses, working capital or other uses that are not
purchases of Telecommunications Related Assets. Because we anticipate operating
losses and a significant need for working capital for the foreseeable future, we
expect we will have to obtain funds for such purposes from Intermedia or other
sources which are significantly restricted. See "Market for Registrant's Common
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Equity and Related Stockholder Matters -- Use of Proceeds from a Sale of
Registered Securities" for a description of certain arrangements we made with
Intermedia relating to our use of a portion of the proceeds of our recent
offering.
Even though Intermedia has indicated that it may use a portion of the
proceeds from the shares it sold in the recent offering to reduce Intermedia's
indebtedness, Intermedia is and will continue to be highly leveraged and may
incur additional indebtedness in the future. 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. In addition, because of the restrictions in the Intermedia indentures,
Intermedia has only a limited amount of cash that may be used for working
capital purposes and to fund operating losses. Consequently, Intermedia may not
be able to provide us with a source of funds for our working capital or
operating losses. Our dependence on Intermedia and the degree to which
Intermedia is leveraged could, among other things, increase our vulnerability to
general adverse economic and industry conditions, limit our ability to fund
future working capital, operating losses, capital expenditures, acquisitions and
other requirements, and limit our flexibility in reacting to changes in our
business and industry. We strongly urge you to read "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Liquidity and
Capital Resources."
We may require additional funds to finance our business but our ability to
raise funds is significantly limited by agreements that are binding on
Intermedia. Intermedia has issued debt securities to the public under seven
indentures. In addition, as of December 31, 1999, Intermedia borrowed $50.0
million under a $100.0 million credit facility. The credit facility borrowing
was repaid in February 2000. In addition, Intermedia recently received a
commitment from the banks to increase the size of its facility, although it is
under no obligation to do so. As a subsidiary of Intermedia, we are subject to a
number of restrictions under the Intermedia indentures and the credit facility.
These restrictions will, among other things, limit our ability to make certain
restricted payments, incur indebtedness and issue preferred stock, pay dividends
or make other distributions, engage in sale and leaseback transactions, create
liens, sell our assets, issue or sell our equity interests, or enter into
certain mergers and consolidations. As a result, our future financing sources
will be significantly limited and our use of any proceeds of any future
financing will be significantly restricted.
We, along with Intermedia's other subsidiaries, have guaranteed
Intermedia's obligations under its credit facility which could make us more
vulnerable to changes in Intermedia's financial condition and make it more
difficult for us to raise capital to expand our business. As security for our
guarantee, we have granted the banks a security interest in a substantial
portion of our assets. If Intermedia were unable to meet its obligations under
the credit facility, we could be obligated to repay the debt. In addition, the
banks' liens on a substantial portion of our assets could make it more difficult
for us to obtain additional financing.
Our ability to issue additional capital stock is constrained by
Intermedia's ownership of the Class B Common Stock, which could make it more
difficult for us to raise capital to expand our business. In the future,
Intermedia may elect to sell additional shares of our Class B Common Stock to
the public or to distribute these shares to its own stockholders. If as a result
of a sale or distribution, Intermedia would no longer hold more than 50% of the
total voting power of our capital stock, the consent of the majority in
principal amount of the noteholders under the Intermedia indentures would be
required for the sale or distribution. In addition, if we decide in the future
to issue and sell additional shares of our capital stock and, as a result, the
voting power represented by the Class B Common Stock held by Intermedia would no
longer be greater than 50% of the total voting power of our capital stock, the
consent of the majority in principal amount of the noteholders under the
Intermedia indentures would be required for the sale. We would be free of the
restrictions in the Intermedia indentures only if either Intermedia's voting
power was reduced to below 50% as described above or Intermedia designated us as
an "unrestricted subsidiary," which would also require a consent of a majority
in principal amount of the noteholders under the Intermedia indentures.
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Digex and Intermedia have the same legal counsel, and therefore contractual
relationships between Digex and Intermedia might be less advantageous to Digex
than if Digex had separate legal representation. Kronish ▇▇▇▇ ▇▇▇▇▇▇ & ▇▇▇▇▇▇▇
LLP, counsel to Digex, is also counsel to Intermedia. In addition, ▇▇▇▇▇ ▇.
▇▇▇▇▇▇▇▇▇, a partner of Kronish ▇▇▇▇ ▇▇▇▇▇▇ & ▇▇▇▇▇▇▇ LLP, has recently been
appointed as a director of Intermedia. Consequently, Digex does not have legal
representation independent from Intermedia.
IF WE DO NOT RESPOND EFFECTIVELY AND ON A TIMELY BASIS TO RAPID TECHNOLOGICAL
CHANGE AND EVOLVING INDUSTRY STANDARDS, OUR BUSINESS COULD SUFFER.
Internet and networking technology is changing rapidly. Our future success
will depend largely on our ability to:
- offer services that incorporate leading technologies;
- address the increasingly sophisticated and varied needs of our current
and prospective customers;
- respond to technological advances and emerging industry standards on a
timely and cost-effective basis; and
- continue offering services that are compatible with products and services
of other vendors.
Although we often work with various vendors in testing newly developed
products, there can be no assurance such products will be compatible with our
infrastructure or such products will adequately address changing customer needs.
Although we currently intend to support emerging standards, there can be no
assurance industry standards will be established or, if they become established,
that we will be able to conform to these new standards in a timely fashion and
maintain a competitive position in the market. Our failure to conform to the
prevailing standards, or the failure of common standards to emerge, could harm
our business. In addition, products, services or technologies developed by
others may render our services no longer competitive or obsolete.
OUR BUSINESS WILL NOT GROW UNLESS INTERNET USAGE GROWS AND INTERNET PERFORMANCE
REMAINS ADEQUATE.
The increased use of the Internet for retrieving, sharing and transferring
information among businesses and consumers has only recently begun to develop.
Our success will depend on the continued growth in Internet usage. In addition,
our business plan anticipates extensive growth in the Web site hosting and
application hosting markets. The growth of the Internet, including the Web site
hosting and application hosting markets, is subject to a high level of
uncertainty and depends on a number of factors, including the growth in consumer
and business use of new interactive technologies, the development of
technologies that facilitate interactive communications, security concerns and
increases in data transport capacity. If the Internet as a commercial medium
fails to grow or develops more slowly than expected, then our business is
unlikely to grow.
The recent growth in the use of the Internet in general has caused frequent
periods of performance degradation, requiring the upgrade of routers and
switches, telecommunications links and other components forming the
infrastructure of the Internet by ISPs and other organizations with links to the
Internet. Any perceived degradation in the performance of the Internet as a
whole could undermine the benefits of our services. The performance of our Web
site and application hosting services is ultimately limited by and relies on the
speed and reliability of the networks operated by third parties. Consequently,
the growth of the market for our services depends on improvements being made to
the entire Internet infrastructure to alleviate overloading and congestion.
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WE MAY BE UNABLE TO ACHIEVE OUR OPERATING AND FINANCIAL OBJECTIVES IF WE CANNOT
MANAGE OUR ANTICIPATED GROWTH EFFECTIVELY.
Our business has grown rapidly, and our future success depends in large
part on our ability to manage the recent and anticipated growth in our business.
For us to manage this growth, we will need to:
- expand and enhance our operating and financial procedures and controls;
- replace or upgrade our operational and financial management information
systems; and
- attract, train, manage and retain key employees.
These activities are expected to place a significant strain on our
financial and management resources. If we are unable to manage growth
effectively, our business could suffer.
WE HAVE HAD DIFFICULTY COLLECTING A PORTION OF OUR ACCOUNTS RECEIVABLE.
During the first three quarters of 1999, we encountered difficulties
establishing appropriate procedures to avoid billing errors and increasing our
financial staffing to accommodate our rapid growth. This resulted in disputes
and delayed payments on certain of our accounts receivable, as a consequence of
which our allowance for doubtful accounts was approximately 24% of our accounts
receivable at September 30, 1999. As of December 31, 1999, our allowance for
doubtful accounts has decreased to approximately 22% of our accounts receivable.
We believe we have remedied the deficiencies in our billing procedures and
staffing. Audit tests conducted by Intermedia's and Digex's internal audit staff
has confirmed the effectiveness of the remedial actions taken. We are in the
process of resolving with our customers existing disputes with respect to
outstanding accounts receivable. We expect our allowance for doubtful accounts
will be significantly reduced as a percentage of total accounts receivable over
time, commencing with the first quarter of 2000, as these disputes are resolved,
since customers typically withhold payment of the entire account receivable even
though the dispute ordinarily only relates to a modest portion of that account
receivable. There can be no assurance we will not encounter billing problems in
the future as our rapid growth continues or that we will be able to collect all
of our past due accounts receivable.
OUR GROWTH DEPENDS ON OUR ABILITY TO EXPAND DATA CENTER CAPACITY TO MEET
ANTICIPATED DEMAND.
Continuing to expand capacity is critical to achieving our business
strategy. This expansion is likely to include the need to add new hardware and
software, and may include the opening of additional data centers both in the
United States and globally. We recently expanded the capacity of our east and
west coast data centers. We intend to add data center capacity over the next
five years as justified by customer demand. Our ability to do so successfully
depends on:
- anticipating and planning for future demand levels;
- having access to sufficient capital; and
- locating and securing satisfactory data center sites and implementing the
build-out of these sites, all of which may require significant lead time.
If we cannot expand capacity effectively, our growth will suffer and we may
not be able to adequately meet the demands of existing customers.
OUR BUSINESS COULD BE HARMED IF OUR MANAGEMENT TEAM, WHICH HAS WORKED TOGETHER
FOR ONLY A BRIEF TIME, IS UNABLE TO WORK TOGETHER EFFECTIVELY, OR IF WE ARE
UNABLE TO RETAIN AND ATTRACT KEY PERSONNEL.
We have recently hired key employees and officers, including our President
and Chief Executive Officer and our President, Product Management, Engineering
and Marketing Group, who joined us in the beginning of July 1999, our President,
Sales and Service Delivery Group, who joined us in December 1998, and our Chief
Financial Officer, who joined us in January 2000. As a result, our management
team has worked
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together for only a brief time. Our success in significant part depends on the
continued services of our senior management personnel, as well as of our key
technical and sales personnel.
We believe our short and long-term success also depends largely on our
ability to attract and retain highly skilled technical, managerial and marketing
personnel, particularly additional management personnel in the areas of
application integration and technical support. Competition for such personnel is
intense. We may not be able to hire or retain the necessary personnel to
implement our business strategy, or we may need to pay higher compensation for
employees than we currently expect. Our inability to attract and retain such
personnel would limit our growth and harm our business.
WE COULD FACE ADDITIONAL COSTS AND OPERATIONAL DISRUPTIONS IN THE FUTURE IF
INTERMEDIA DISCONTINUES PROVIDING GENERAL AND ADMINISTRATIVE SERVICES TO US.
Intermedia has provided and is expected to continue to provide many of our
financial, administrative and operational services and related support
functions, including treasury, legal, human resources and information management
services. Our General and Administrative Services Agreement with Intermedia has
an initial two year term which expires in July 2001. Should Intermedia's
provision of these services no longer meet our needs or if Intermedia
unexpectedly stops providing these services for any reason, we could face
significant challenges and costs in transitioning to our own or alternative
general and administrative functions. Such a transition and any resulting
impairment of our operations could harm our financial results.
REGULATORY AND LEGAL UNCERTAINTIES COULD HAVE SIGNIFICANT COSTS OR OTHERWISE
HARM OUR BUSINESS.
The law in the United States relating to the liability of on-line and
Internet service providers for information disseminated through their systems
remains largely unsettled. It may also take years to determine whether and how
existing laws, such as those governing intellectual property, privacy, libel and
taxation, apply to the Internet. The growth and development of the market for
on-line commerce may also prompt calls for more stringent consumer protection
laws that may impose additional burdens on companies conducting business
on-line. The application of existing laws or promulgation of new laws could
require us to expend substantial resources to comply with such laws or
discontinue certain service offerings. Increased attention to liability issues
could also divert management attention, result in unanticipated expenses and
harm our business. Regulation of the Internet may also harm our customers'
businesses, which could lead to reduced demand for our services. We are not
currently subject to direct regulation by the Federal Communications Commission
("FCC") or any other government agency, other than as to regulations applicable
to business in general. However, in the future we may be subject to regulation
by the FCC or other federal or state agencies, which could increase our costs
and harm our business. See "Business -- Government Regulation."
OUR BUSINESS PLAN CONTEMPLATES FUTURE INTERNATIONAL OPERATIONS BUT THERE ARE
NUMEROUS RISKS AND UNCERTAINTIES IN OFFERING SERVICES OUTSIDE OF THE UNITED
STATES.
We intend to expand into international markets and may build data centers
internationally. We cannot be sure that we will be able to successfully sell our
services or adequately maintain operations outside the United States. In
addition, there are certain risks inherent in conducting business
internationally. These include:
- unexpected changes in regulatory requirements;
- ability to secure and maintain the necessary physical and
telecommunications infrastructure;
- challenges in staffing and managing foreign operations; and
- employment laws and practices in foreign countries.
Any of these could adversely affect our international operations.
Furthermore, some foreign governments have enforced laws and regulations on
content distributed over the Internet that are more restrictive than those
currently in place in the United States. Any one or more of these factors could
adversely affect our contemplated future international operations and
consequently, our business.
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WE MAY BE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS OR TO CONTINUE
USING INTELLECTUAL PROPERTY THAT WE LICENSE FROM OTHERS.
We rely on a combination of copyright, trademark, service ▇▇▇▇ and trade
secret laws and contractual restrictions to establish and protect certain of our
proprietary rights. We have no patented technology that would bar competitors
from our market. Despite our efforts to protect our proprietary rights,
unauthorized parties may attempt to copy or otherwise obtain and use our data or
technology.
We also rely on certain technologies licensed from third parties. We cannot
be sure these licenses will remain available to us on commercially reasonable
terms or at all. The loss of such technology could require us to obtain
substitute technology of lower quality or performance standards or at greater
cost which could harm our business.
WE DID NOT OBTAIN THIRD PARTY CONSENTS IN CONNECTION WITH OUR RECAPITALIZATION,
WHICH MAY ALLOW CERTAIN THIRD PARTIES, INCLUDING SOME OF OUR CUSTOMERS, TO
ASSERT A BREACH OF A CONTRACT.
In connection with our initial public offering, Business Internet, our
indirect parent company, contributed the Web hosting business to us. This
contribution included an assignment of all of the contracts that were part of
our business on the date of assignment, including our customer contracts. We
elected not to seek consents in connection with this assignment. While the
failure to obtain required third party consents could give a third party the
ability to assert a breach of the acquired contract, we believe this would be
unlikely in the case of the restructuring because all of the assigned contracts
were transferred as part of the entire Web hosting business. Nevertheless, we
cannot be sure that one or more third parties will not assert a breach of our
contracts with them because of our failure to seek or obtain their consents to
assignment.
THE MARKET PRICE OF THE SHARES WILL FLUCTUATE.
The stock markets, and in particular the Nasdaq National Market, have
experienced extreme price and volume fluctuations that have particularly
affected the market prices of equity securities of many technology companies and
that often have been unrelated or disproportionate to the operating performance
of such companies. The trading prices of many technology companies' stocks are
at or near historical highs and reflect price to earnings ratios substantially
above historical levels which may not be sustained. These broad market factors
may adversely affect the market price of our Class A Common Stock. In the past,
following periods of volatility in the market price of a company's securities,
securities class action litigation has often been instituted against such
companies. Such litigation, if instituted, could result in substantial costs and
a diversion of management's attention and resources, which could harm our
business.
FUTURE SALES OF OUR COMMON STOCK COULD ADVERSELY AFFECT THE PRICE OF OUR CLASS A
COMMON STOCK.
24,150,000 shares of our Class A Common Stock are currently issued and
outstanding. All of the outstanding shares of Class A Common Stock are freely
tradable under the Securities Act unless held by our "affiliates," as that term
is defined in the Securities Act. Additional shares of Class A Common Stock that
may be issued on conversion or exercise of outstanding securities may be sold in
the future. In connection with our recent public offering and subject to certain
exceptions, our executive officers and directors and Intermedia have agreed to
refrain from selling any shares of Common Stock until May 11, 2000. The market
price of our Class A Common Stock could drop due to sales of a large number of
shares of our Class A Common Stock in the market or the perception that such
sales could occur. Historically, market prices of start-up and Internet
companies' stocks have been particularly susceptible to such fluctuations. These
factors could also make it more difficult to raise funds through future
offerings of common stock.
THE GREATER VOTING POWER OF OUR CLASS B COMMON STOCK, AS WELL AS SOME PROVISIONS
OF THE DELAWARE ANTI-TAKEOVER LAW AND OF OUR CERTIFICATE OF INCORPORATION AND
BYLAWS, COULD DISCOURAGE A TAKEOVER OF DIGEX AND ADVERSELY AFFECT THE PRICE OF
THE CLASS A COMMON STOCK.
Our board of directors has the authority to issue up to 4,900,000 shares of
preferred stock and to determine the price, rights, preferences, privileges and
restrictions, including voting rights, of those shares
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without any further vote or action by the stockholders. The rights of the
holders of any of our common stock may be adversely affected by the rights of
the holders of any preferred stock that may be issued in the future. The
issuance of preferred stock, while providing flexibility in connection with
possible acquisitions and other corporate purposes, could have the effect of
making it more difficult for a third party to acquire a majority of our
outstanding voting stock. We have no current plans to issue additional shares of
preferred stock and any issuance of preferred stock is subject to restrictions
under the Intermedia indentures. We are also subject to certain provisions of
Delaware law which could have the effect of delaying, deterring or preventing a
change in control of Digex, including Section 203 of the Delaware General
Corporation Law, which prohibits us from engaging in any business combination
with any interested stockholder for a period of three years from the date the
person became an interested stockholder unless certain conditions are met. In
addition, our certificate of incorporation and bylaws contain certain provisions
that, together with Intermedia's voting power and ownership of Class B Common
Stock, could discourage potential takeover attempts and make attempts by
stockholders to change management more difficult.
THIS REPORT INCLUDES FORWARD-LOOKING STATEMENTS, WHICH COULD DIFFER FROM ACTUAL
RESULTS.
Some of the statements in this Form 10-K that are not historical facts are
"forward-looking statements" (as such term is defined in the Private Securities
Litigation Reform Act of 1995). Forward-looking statements can be identified by
the use of words such as "estimates," "projects," "anticipates," "expects,"
"intends," "believes" or comparable terminology, the negative thereof or other
variations thereon or by discussions of strategy that involve risks and
uncertainties. Examples of forward-looking statements include discussions
relating to:
- plans to expand our existing Web site hosting services and application
hosting services;
- introductions of new products and services;
- proposals to build new data centers in various geographic areas;
- estimates of market sizes and addressable markets for our services and
products; and
- Statements regarding the future course of our relationship with
Intermedia.
We wish to caution you that all the forward-looking statements contained in
this document are only estimates and predictions. Our actual results could
differ materially from those anticipated in the forward-looking statements due
to risks, uncertainties or actual events differing from the assumptions
underlying these statements. Such risks, uncertainties and assumptions include,
but are not limited to, those discussed in this Form 10-K.
ITEM 2. PROPERTIES
We currently lease office space for our corporate headquarters,
administrative offices, and regional sales office in Beltsville, Maryland. We
also lease space for our east coast data center in Beltsville and our west coast
data center in northern California.
As of December 31, 1999, our total property and equipment in service
consisted of buildings (7%), electronic and computer equipment (54%), computer
software (12%), furniture and fixtures (1%), and leasehold improvements (26%).
Such properties do not lend themselves to description by character and location
of principal units. Substantially all of our telecommunications equipment is
housed in multiple leased facilities on the east and west coast. We believe that
our properties are adequate and suitable for their intended purposes.
DATA CENTER INFRASTRUCTURE
We presently operate highly secure, fault-tolerant data centers
specifically designed for the non-stop 24-hour a day hosting of Web sites and
Web-based applications. Our east coast data center is strategically located near
major network access points in the Washington, D.C. metropolitan area. Our west
coast data center is situated near the western network access points and the
headquarters of many of our strategic technology
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providers. We recently expanded our total data center capacity and expect to add
additional data center capacity over the next five years as appropriate to meet
anticipated customer and market demand.
Our data centers combine the predictability and control of traditional
mainframe-based data centers with the network access and capacity required for
today's Internet-based computing. Our data centers are designed to provide
consistently high service levels while permitting customers to rapidly deploy
new and strategic applications without substantially increasing cost or
incurring risk.
The physical infrastructure and security controls of our data centers have
been designed to support rigorous requirements for secure data storage and
processing. Specifically, our data centers offer the following major physical
benefits to our customers:
- state-of-the-art physical security;
- multi-redundant mechanics, utilities and environmental controls;
- high-performance multi-network points of presence (WebPOPs); and
- fully-integrated customer work areas.
State-of-the-art physical security. Our data centers include multiple
separate computer rooms offering customers a high degree of containment and
isolation from accidents or disasters occurring within or outside of each data
center. Physical security has been implemented through tightly controlled
security zones requiring both access card and biometric identification. Each
data center has five security zones that require separate access levels to gain
entry. Our highest security zones include computer rooms physically constructed
as a building-within-a-building, with fire suppression and other controls
separate from the remainder of the data center. Fencing above the ceiling and
below the raised floor isolate each security zone. Over 100 surveillance cameras
record movement through the data centers and security guards provide real-time
visibility. Our cooling towers are surrounded by security fences and monitored
by cameras. Our dual 20,000 gallon diesel fuel tanks are safely buried
underground.
Multi-redundant mechanics, utilities and environmental controls. Within
each data center, separate mechanical rooms exist adjacent to each computer
room. These mechanical rooms house all cooling and mechanical equipment,
eliminating the possible introduction of liquid into the computer rooms from
equipment leakage. We use redundant uninterruptible power supply systems and
redundant diesel generators, to ensure the power system is capable of
maintaining power to the data center in the event of any component failure.
Cooling and environmental controls for each data center are designed to monitor
and ensure proper temperature and humidity.
High-performance WebPOPs. Our data centers include physically separated
WebPOPs, which are network points of presence within our data centers. These
WebPOPs provide high-performance, reliable networking connectivity to multiple
national Internet backbone carriers for our customers. Telecommunications
circuits enter the data centers through multiple points from diverse service
providers. Multiple points of presence ensure continued operation of service
without degradation in the unlikely event of a cable cut or local carrier
network outage.
Fully integrated customer work areas. Our data centers include separate,
private customer work areas. These work areas are isolated from the security
zones that house our servers, permitting customers to work on-site as necessary.
These work areas provide computing and personal resources, such as customer
breakrooms and wash areas.
ITEM 3. LEGAL PROCEEDINGS
We do not believe there are any pending or threatened legal proceedings
that, if adversely determined, would have a material adverse effect on us.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
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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, 1999, based upon 39 holders of record and an estimate
of the number of individual participants represented by security position
listings, there are approximately 8,603 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 prices for our Class A Common
Stock are as reported by The Nasdaq Stock Market and represent inter-dealer
quotations which do not include retail ▇▇▇▇-ups, ▇▇▇▇-▇▇▇▇▇ or commissions. Such
prices do not necessarily represent actual transactions.
BID PRICE
-------------------
HIGH LOW
-------- --------
Third quarter (from July 29, 1999).......................... $33.6250 $14.6250
Fourth quarter.............................................. 90.0000 21.1880
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.
Recent Sales of Unregistered Securities.
On January 12, 2000, Digex issued 50,000 shares of Series A Preferred Stock
and warrants to purchase 532,500 shares of Class A Common Stock, with an
exercise price of $57.00 per share, to Microsoft Corporation for an aggregate
consideration of $50.0 million. On January 12, 2000, Digex also issued 50,000
shares of Series A Preferred Stock and warrants to purchase 532,500 shares of
Class A Common Stock, with an exercise price of $57.00 per share, to CPQ
Holdings, Inc., a subsidiary of Compaq Computer Corporation, for an aggregate
consideration of $50.0 million of which $35.0 million was paid in cash and $15.0
million was paid in the form of equipment credits granted to Digex. The 100,000
shares of Series A Preferred Stock are convertible into an aggregate of
approximately 1,462,000 shares of Class A Common 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.
Use of Proceeds from a Sale of Registered Securities
On July 29, 1999, the Registration Statement relating to our initial public
offering (Commission 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 Intermedia, which could involve multiple risks
for you as a stockholder," we are required to use all of the net proceeds of our
recent 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 recent offerings. Intermedia is expected to pay us for these
Telecommunications Related Assets to the extent necessary with funds not subject
to restrictions under the Intermedia indentures that we will use for working
capital purposes and to fund operating losses. The amounts actually expended for
such
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capital expenditures and working capital purposes may vary significantly,
depending on a number of factors, including our future revenues and Intermedia's
availability of funds.
At December 31, 1999, the end of the period covered by this report, we used
$80.8 million of the proceeds of our initial public offering to purchase
Telecommunications Related Assets held by us and $25.3 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.
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 and 1999 and 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 which have been audited by Ernst &
Young LLP, independent certified public accountants.
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
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.
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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 financial statements and related notes, included
elsewhere in this report.
PREDECESSOR DIGEX
------------------------------ ------------------------------------------------------------
HISTORICAL HISTORICAL PRO FORMA(1) HISTORICAL
------------------------------ --------------- ------------ ---------------------------
PERIOD FROM
JULY 7, 1997
(DATE OF
YEAR ENDED PERIOD FROM ACQUISITION) TO YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, JANUARY 1, 1997 DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
1996 TO JULY 6, 1997 1997 1997 1998 1999
------------ --------------- --------------- ------------ ------------ ------------
(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
Costs and expenses:
Cost of operations.... 2,002 4,149 1,739 2,808 6,710 9,656
Cost of services...... 684 1,817 1,611 3,428 7,044 21,750
Selling, general and
administrative...... 3,194 7,001 6,087 13,088 17,512 70,213
Deferred
compensation........ -- -- -- -- -- 1,299
Depreciation and
amortization........ 591 519 2,753 4,850 8,109 29,070
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
----------- ----------- ----------- ----------- ----------- -----------
Loss from operations.... (3,668) (9,066) (19,998) (27,562) (16,740) (72,202)
Other income (expense):
Interest expense...... -- -- -- -- -- (1,094)
Interest and other
income................ -- -- -- -- -- 3,458
----------- ----------- ----------- ----------- ----------- -----------
Net loss before income
tax benefit........... (3,668) (9,066) (19,998) (27,562) (16,740) (69,838)
Income tax benefit...... -- -- 1,440 4,710(4) 159 4,839
----------- ----------- ----------- ----------- ----------- -----------
Net loss................ $ (3,668) $ (9,066) $ (18,558) $ (22,852) $ (16,581) $ (64,999)
=========== =========== =========== =========== =========== ===========
Net loss per common
share:
Basic................. $ -- $ -- $ (0.37) $ (0.46) $ (0.33) $ (1.19)
=========== =========== =========== =========== =========== ===========
Diluted............... $ -- $ -- $ (0.37) $ (0.46) $ (0.33) $ (1.19)
=========== =========== =========== =========== =========== ===========
Shares used in computing
pro forma basic and
diluted net loss per
share................. -- -- 50,000,000 50,000,000 50,000,000 54,726,027
OTHER DATA:
EBITDA before certain
charges(3)............ $ (3,077) $ (8,547) $ (2,245) $ (7,712) $ (8,631) $ (41,833)
Net cash used in
operating
activities............ (2,565) (7,172) (6,079) (13,251) (10,930) (20,515)
Net cash used in
investing
activities............ (1,445) (1,004) (55,237) (56,241) (30,969) (170,193)
Net cash provided by
financing
activities(4)......... 4,010 8,176 61,316 69,492 41,899 279,486
Capital expenditures.... 1,445 1,004 8,016 9,020 30,969 170,396
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PREDECESSOR DIGEX
------------ ------------------------------------------
DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
1996 1997 1998 1999
------------ ------------ ------------ ------------
(IN THOUSANDS)
BALANCE SHEET DATA:
Cash and cash equivalents(5)........................ $ -- $ -- $ -- $ 88,778
Working capital..................................... (1,237) (351) 1,231 74,778
Property and equipment, net......................... 2,599 12,930 39,059 205,903
Total assets........................................ 3,173 49,693 77,739 344,309
Long-term note payable, including current portion... -- -- -- 3,712
Capital lease obligations, including current
portion........................................... 1,745 1,980 2,089 16,567
Total Stockholders'/Owner's equity.................. 342 45,527 70,845 290,189
---------------
(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 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:
- A decrease in cost of operations of $3,080 which represents reduced
network expenses.
- An increase in depreciation and amortization of $1,578 which represents
amortization of intangible assets arising from the acquisition.
- 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, 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.
(4) Net cash provided by financing activities includes capital contributions of
$4,010, $7,626, $64,085, $41,899 and $102,007 for the year ended December
31, 1996, the period from January 1, 1997 to July 6, 1997, the period from
July 7, 1997 to December 31, 1997, and the years ended December 31, 1998 and
1999, respectively.
(5) 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.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
We are a leading provider of managed Web hosting services to businesses
operating mission-critical, multi-functional Web sites. In addition, we provide
Web hosting services to the rapidly growing number of application service
providers enabling them to more efficiently deliver their application services
to their customers over the Internet. We provide the computer hardware,
software, network technology, and systems management necessary to provide our
customers comprehensive, managed Web site 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 550 customers. As of December
31, 1999, we managed approximately 2,300 Windows NT 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.
Our revenues grew at a compounded annual growth rate of 177% between 1996
and 1999, from $2.8 million in 1996 to $59.8 million in 1999. We believe our
singular focus on delivering mission-critical Web site and application hosting
solutions has been the major contributor to our growth.
Revenue. Our revenues consist primarily of monthly fees from our managed
Web site and application hosting services. Contracts for these services are
typically between one and three years in length. In addition to Web site 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.
Cost and Expenses. Cost and expenses include:
- cost of operations;
- cost of services;
- selling, general and administrative expenses;
- deferred compensation; and
- 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 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 and other miscellaneous
expenses. We expect selling, general and administrative expenses in the future
to increase in dollar amount but to decline as a percentage of revenue.
Deferred compensation expense is recorded to amortize the resulting
deferred compensation cost over the four-year vesting period of the options.
Stock options were granted by us 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 expand our data center capacity.
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PLAN OF OPERATION
We plan to expand our Web site 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 completed the expansion of our state-of-the-art data
centers on the east and west coasts of the United States. We anticipate that
these expanded data centers, when operating at full capacity, will support
servers generating approximately $500 million in annualized revenue. In
addition, we believe that the new data centers will place us in a stronger
competitive position to successfully provide outsourced solutions of scalable
Web site 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.
RESULTS OF OPERATIONS
The following table presents certain information derived from our audited
financial statements for the years ended December 31, 1997, 1998, and 1999
expressed as a percentage of revenue. For the purposes of the following
discussion and analysis, the results of operations of the Predecessor for the
period from January 1, 1997 to July 6, 1997, have been adjusted to reflect the
acquisition of Business Internet by Intermedia as if the acquisition had
occurred at the beginning of 1997 and have been combined with the results of our
operations for the period from July 7, 1997 (date of acquisition) to December
31, 1997. This computation was done to permit useful, complete year comparisons
between the results for 1997, 1998, and 1999. However, this pro forma
information is not necessarily indicative of the operating results we would have
achieved if the Predecessor had been acquired on January 1, 1997.
DIGEX
------------------------------------------
PRO FORMA HISTORICAL
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31,
1997 1998 1999
------------ ------------ ------------
(UNAUDITED)
Revenues.................................................. 100.0% 100.0% 100.0%
Costs of expenses:
Cost of operations...................................... 24.2 29.6 16.2
Cost of services........................................ 29.5 31.1 36.4
Selling, general and administrative..................... 112.7 77.5 117.4
Deferred compensation................................... -- -- 2.2
Depreciation and amortization........................... 41.8 35.8 48.6
Charge off of purchased in-process research and
development.......................................... 129.2 -- --
------ ----- ------
Total costs and expenses........................ 337.4 174.0 220.8
------ ----- ------
Loss from operations...................................... (237.4) (74.0) (120.8)
Other income (expense):
Interest expense..................................... -- -- (1.8)
Interest and other income............................ -- -- 5.8
------ ----- ------
Net loss before income tax benefit........................ (237.4) (74.0) (116.8)
Income tax benefit........................................ 40.6 .7 8.1
------ ----- ------
Net loss........................................ (196.8)% (73.3)% (108.7)%
------ ----- ------
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
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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.
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.
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.
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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.
Net 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.
YEAR ENDED DECEMBER 31, 1998 COMPARED TO THE PRO FORMA YEAR ENDED DECEMBER 31,
1997
Revenue
Revenues were $22.6 million for the year ended December 31, 1998, compared
to $11.6 million for the year ended December 31, 1997, an increase of 94.9%. The
$11.0 million increase in revenue was a result of our increased marketing
efforts, and market acceptance of our new products, resulting in growth in our
number of customers. We also experienced increases in revenue from existing
customers through upgrades and value-
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added services. This translated into higher average revenues per server.
Additionally, during 1998 we increased the number of quota-bearing sales
representatives.
Cost of Operations
Our cost of operations was $6.7 million for the year ended December 31,
1998, compared to $2.8 million for the year ended December 31, 1997. The $3.9
million increase was due to increased network capacity requirements necessary to
support our growing business. In addition, we also experienced an increase in
the average network bandwidth per server. As a percentage of revenue, the cost
of operations increased to 29.6% in 1998 from 24.2% in 1997 primarily as a
result of our purchasing added network capacity per server in 1998 as compared
to 1997 to improve customer Web site performance.
Cost of Services
Our cost of services was $7.0 million for the year ended December 31, 1998,
compared to $3.4 million for the year ended December 31, 1997. The $3.6 million
increase was due primarily to the hiring of additional engineering and
operations staff to support our expanded customer base. As a percentage of
revenue, the cost of services increased to 31.1% in 1998 from 29.5% in 1997.
Selling, General and Administrative
Our selling, general and administrative expenses increased to $17.5 million
for the year ended December 31, 1998, compared to $13.1 million for the year
ended December 31, 1997. The $4.4 million increase was due to higher commission
expenses associated with our increased sales levels as well as increases in our
administrative headcount. As a percentage of revenue, the expenses decreased to
77.5% in 1998 from 112.7% in 1997 due to economies of scale.
Depreciation and Amortization
Depreciation and amortization increased to $8.1 million for the year ended
December 31, 1998, compared to $4.9 million for the year ended December 31,
1997. The $3.2 million increase was largely due to increased capital
expenditures for servers and other data center related equipment.
Income Tax Benefit
Our income tax benefit decreased to $159,000 for the year ended December
31, 1998, compared to $4.7 million for the year ended December 31, 1997. The
1998 income tax benefit represents the recognition of a portion of the benefits
associated with 1998 tax net operating loss. Benefits were recognized in 1998 to
the extent of unused deferred tax credits originating in previous periods.
Net Loss
Net losses decreased to $(16.6) million for the year ended December 31,
1998, compared to $(22.9) million for the year ended December 31, 1997.
EBITDA Before Certain Charges
EBITDA before certain charges, as defined below, decreased 11.9% to
negative $8.6 million in 1998 compared to negative $7.7 million in 1997. The
decrease is primarily attributable to costs associated with the Company's growth
strategy. In addition, the Company expects 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
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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.
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. Such contributions amounted to $24.5 million, $41.9
million and $148.3 million in 1997 (pro forma), 1998 and 1999, respectively.
Since the date of our initial public offering, there have been no permanent
capital contributions made by Intermedia.
Net cash used in operating activities in 1997 (pro forma), 1998, and 1999
was $13.3 million, $10.9 million and $20.5 million, 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 in 1997 (pro forma), 1998 and 1999
was $56.2 million, $31.0 million and $170.2 million, respectively. Net cash used
for investing activities in each of these periods was primarily the result of
capital expenditures for data center infrastructure, as well as leasehold
improvements, furniture and fixtures and computers and other equipment.
Additionally, in July of 1997, goodwill and other intangible assets were
allocated to us for separate reporting purposes, and shown as a use of cash.
Although we have plans to invest significantly in property and equipment, we
have no material commitments for such items at this time.
We anticipate we will have significant cash requirements for several years
as we expand our data center capacity, increase our employee base 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 Compaq.
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 Series A Preferred Stock
and warrants to purchase 1,065,000 shares of Class A Common Stock to Microsoft
and a subsidiary of Compaq for aggregate gross proceeds of $100.0 million, of
which $85.0 million was paid in cash and $15.0 million was paid in the form of
equipment credits from Compaq. The Series A Preferred Stock has an aggregate
liquidation preference of $100,000,000 and is convertible into approximately
1,462,000 shares of Class A Common Stock. The warrants can be exercised at any
time over their three-year term at a price of $57.00 per share (the fair value
of our Class A Common Stock on the transaction commitment date). The proceeds
from the offering will be allocated between the Series A Preferred Stock and the
Warrants based upon their relative fair values, which have not yet been
determined by us. Following the allocation, the Series A Preferred Stock will be
accreted up to its liquidation preference through charges to retained earnings.
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
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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 $171.7 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 must be 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 have made arrangements
with Intermedia to sell to Intermedia certain Telecommunications Related Assets
that are purchased by Digex with the net proceeds of these offerings. The assets
are sold to Intermedia for cash at our cost. As of December 31, 1999, we had
received approximately $25.3 million from Intermedia related to the sale of
Telecommunications Related Assets. These 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."
Cash payments for capital assets for the year ended December 31, 1999 were
approximately $170.4 million. As more fully discussed in the footnotes to the
financial statements, Digex was capitalized by Intermedia's contribution of
assets and certain liabilities amounting to approximately $115.1 million on
April 30, 1999. Additionally, beginning May 1, 1999 and through the date of the
initial public offering, Intermedia contributed additional capital of $48.1
million to Digex, principally by way of contributions of telecommunications
assets. Finally, Intermedia assigned two capital leases for data centers with a
value of $17.1 million to Digex in the second quarter of 1999.
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. Subject to the limitations discussed under the caption "Market for
Registrant's Common Equity and Related Stockholder Matters -- Use of Proceeds
from a Sale of Registered Securities", we believe we have sufficient capital to
sustain our current operations and capital expenditure plans into the first half
of 2001. We intend to continue to seek funding from external sources to meet our
cash needs subsequent to that date. There can be no assurance that such funding
will be available on terms satisfactory to us.
In addition, we have from time to time held, and continue to hold,
preliminary discussions with (a) potential investors (i.e. strategic investors
in the same or a related business and financial investors) who have expressed an
interest in making an investment in or acquiring us, (b) potential joint venture
partners looking toward the formation of strategic alliances that would expand
our product offerings or improve our services without necessarily requiring an
additional investment in or by us and (c) companies that represent potential
acquisition opportunities for us. We cannot assure you that any agreement with
any potential strategic or financial investor, joint venture partner or
acquisition target will be reached nor does management believe that any such
transaction is necessary to successfully implement our strategic plans.
Alternatively, Intermedia may be able to advance funds to us to meet our
requirements, but it has no obligation to do so. Although Intermedia has advised
us that it intends to use most of the proceeds from its sale of shares in our
recent offering to reduce its outstanding debt, Intermedia is and will continue
to be highly leveraged. At December 31, 1999, Intermedia had outstanding
approximately $3.2 billion of debt and other liabilities including trade
payables, and a total of approximately $916.8 million of obligations with
respect to four outstanding series of preferred stock. In addition, as of
December 31, 1999, Intermedia borrowed $50.0 million under its $100.0 million
credit facility. The credit facility borrowing was repaid in February 2000. In
addition, Intermedia recently received a commitment from the banks to increase
the size of its facility, although it is under no obligation to do so.
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 year ended December 31, 1999,
Intermedia's
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earnings were insufficient to cover combined fixed charges and dividends on
preferred stock. Because of the restrictions in the Intermedia indentures,
Intermedia has only a limited amount of cash that may be used to fund working
capital and operating losses. Consequently, Intermedia may not be able to
provide us with a source of funds for our working capital or operating losses.
An affiliate of Kohlberg Kravis ▇▇▇▇▇▇▇ & Co. has recently made a $200.0 million
equity investment in Intermedia. The proceeds of that equity investment may be
used by Intermedia, at its discretion, to fund our working capital and operating
losses.
Intermedia has from time to time held, and continues to hold, preliminary
discussions with (a) potential investors (i.e. strategic investors in the same
or a related business and financial investors) who have expressed an interest in
making an investment in or acquiring Intermedia, (b) potential joint venture
partners looking toward the formation of strategic alliances that would expand
the reach of Intermedia's network or services without necessarily requiring an
additional investment in or by Intermedia and (c) companies that represent
potential acquisition opportunities for Intermedia. We cannot assure you that
any agreement with any potential strategic or financial investor, joint venture
partner or acquisition target will be reached. In addition, we cannot predict
the impact of any possible transaction on the ability of Intermedia to purchase
Telecommunications Related Assets from us to fund our operating expenses or the
future cost of services we currently purchase from Intermedia
IMPACT OF YEAR 2000
The Year 2000 issue is the result of computer-controlled systems using two
digits rather than four to define the applicable year. For example, computer
programs that have date-sensitive software may recognize a date ending in "00"
as the year 1900 rather than the year 2000. To date, we have not experienced any
significant Year 2000 problems.
As of December 31, 1999, we had spent $2.3 million on external costs, $1.7
million on internal costs, and $0.6 million on hardware and software costs
pursuant to our compliance program. The internal costs are comprised of employee
hours, and external costs are comprised of outside consultant costs. The costs
presented do not include system upgrades that would otherwise result as part of
our capital expenditure program.
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. See "Risk
Factors -- This report includes forward-looking statements which could differ
from actual results."
INCOME TAXES
We account for income taxes under the Statement of Financial Accounting
Standards No. 109, "Accounting for Income Taxes." For the period ended December
31, 1999, we recorded a deferred tax benefit of $4.8 million. At December 31,
1999, a full valuation allowance was provided on net deferred tax assets of
$18.5 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 7 to the financial statements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE
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.
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The 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.
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PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item 10 is incorporated by reference from
the information captioned "Proposal One: Election of Directors" and "Executive
Officers" to be included in the Company's proxy statement to be filed in
connection with the annual meeting of stockholders, to be held on May 19, 2000
(the "Proxy Statement").
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item 11 is incorporated by reference from
the information captioned "Executive Compensation," "Compensation Committee
Interlocks and Insider Participation," and "Comparative Stock Performance" to be
included in the Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item 12 is incorporated by reference from
the information captioned "Beneficial Ownership" to be included in the Proxy
Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by the Item 13 is incorporated by reference from
the information captioned "Certain Relationships and Related Transactions" to be
included in the Proxy statement.
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PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
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 certified public
accountants, and financial statement schedules, are filed pursuant to Item 8 of
this Report:
INDEX TO FINANCIAL STATEMENTS
PAGE
----
Report of Independent Auditors -- The Company............... F-1
Report of Independent Auditors -- Predecessor............... F-2
Balance Sheets as of December 31, 1998 and 1999............. F-3
Statements of Operations for the Period from January 1, 1997
to July 6, 1997, the Period from July 7, 1997 (Date of
Acquisition) to December 31, 1997, and the Years Ended
December 31, 1998 and 1999................................ F-4
Statements of Changes in Stockholders'/Owner's Equity
(Deficit) for the Period from January 1, 1997 to July 6,
1997, the Period from July 7, 1997 (Date of Acquisition)
to December 31, 1997, and the Years Ended December 31,
1998 and 1999............................................. F-5
Statements of Cash Flows for the Period from January 1, 1997
to July 6, 1997, the Period from July 7, 1997 (Date of
Acquisition) to December 31, 1997, and the Years Ended
December 31, 1998 and 1999................................ F-6
Notes to Financial Statements............................... F-7
FINANCIAL STATEMENT SCHEDULES
Schedule II -- Valuation and Qualifying Accounts............ F-21
All other financial statement schedules for which provision is made in the
applicable accounting regulations of the Securities and Exchange Commission (the
"Commission") are not required pursuant to the instructions to Item 8 or are
inapplicable and therefore have been omitted.
37
40
REPORTS ON FORM 8-K
The following Current Report on Form 8-K was filed during the fourth
quarter of 1999:
Digex filed a Current Report on Form 8-K, dated November 3, 1999, reporting
under Item 5 the issuance of a press release discussing the Company'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.
EXHIBIT EXHIBIT INDEX
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 -- ▇▇▇▇ of Sale to the Contribution Agreement, dated as of
April 30, 1999.*
3.1 -- Certificate of Incorporation of Digex, as amended to date.**
3.2 -- Bylaws of Digex.*
3.3 -- Certificate of Designation for the Series A Preferred
Stock.**
4.1 -- See the Certificate of Incorporation of Digex, as amended to
date, filed as Exhibit 3.1.
4.2 -- Warrant Agreement, dated as of January 12, 2000, among
Digex, Microsoft Corporation and CPQ Holdings, Inc.**
4.3 -- 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.*
10.4 -- Lease by and between Intermedia and ▇▇▇▇ ▇▇▇▇ ▇▇▇▇▇▇
Associates, dated as of July 23, 1998.*
10.5 -- Contract for Construction by and between Intermedia and ▇.▇.
▇▇▇▇▇▇ Company, d/b/a The ▇▇▇▇▇▇ Company, dated as of
February 19, 1999.*
10.6 -- Contract for Construction by and between Intermedia and ▇.▇.
▇▇▇▇▇▇ Company, d/b/a The ▇▇▇▇▇▇ 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 ▇▇▇▇▇▇▇▇ 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.(1)*
10.11 -- Internet Transit Services Agreement (West Coast) between
Digex and Business Internet, Inc., dated as of April 30,
1999.(1)*
10.12 -- Managed Firewall Services Agreement between Digex and
Business Internet, Inc., dated as of April 30, 1999.(1)*
38
41
EXHIBIT INDEX
EXHIBITS
NUMBERS DESCRIPTION
-------- -----------
10.13 -- Employment Letter dated June 29, 1999 between Digex and ▇▇▇▇
▇. ▇▇▇▇▇, and amendments thereto.(2)**
10.14 -- Employment Letter dated December 14, 1998 between Digex and
▇▇▇▇▇ ▇. ▇▇▇▇▇▇, and amendments thereto.(2)**
10.15 -- Employment Letter dated July 9, 1999 between Digex and
▇▇▇▇▇▇▇ ▇▇▇▇, and amendments thereto.(2)**
10.16 -- Employment Letter dated July 9, 1999 between Digex and ▇▇▇▇▇
▇. ▇▇▇▇▇▇, and amendments thereto.(2)**
10.17 -- Employment Letter dated December 15, 1999 between Digex and
▇▇▇▇▇▇▇ ▇. ▇▇▇▇▇, and amendments thereto.(2)**
10.18 -- Employment Letter dated September 11, 1996 between Digex and
▇▇▇▇▇▇ ▇. ▇▇▇▇▇▇▇, and amendments thereto.(2)**
10.19 -- Digex Long-Term Incentive Plan.(2)**
10.20 -- Intermedia 1996 Long-Term Incentive Plan.(2)**
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.**
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.**
23.1 -- Consent of Ernst & Young LLP.
27.1 -- Financial Data Schedule (for SEC use only).
---------------
(1) Confidential treatment of certain provisions of this exhibit was requested
and granted by the Commission in connection with the filing of Digex's
registration statement on Form S-1 (Commission File #333-77105).
(2) Management contract or compensatory plan or arrangement.
* Filed as an exhibit to Digex's registration statement on Form S-1
(Commission File #333-77105) and incorporated herein by reference.
** Filed as an exhibit to Digex's registration statement on Form S-1
(Commission File #333-94879) and incorporated herein by reference.
39
42
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.
DIGEX, INCORPORATED
(Registrant)
By: /s/ ▇▇▇▇ ▇. ▇▇▇▇▇
------------------------------------
▇▇▇▇ ▇. ▇▇▇▇▇
President and Chief Executive
Officer
Dated: March 10, 2000.
Pursuant to the requirements of the Securities and Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
PRINCIPAL EXECUTIVE OFFICER:
/s/ ▇▇▇▇ ▇. ▇▇▇▇▇ Director, President and Chief March 10, 2000
----------------------------------------------------- Executive Officer
▇▇▇▇ ▇. ▇▇▇▇▇
PRINCIPAL FINANCIAL AND ACCOUNTING OFFICERS:
/s/ ▇▇▇▇▇▇▇ ▇. ▇▇▇▇▇ Chief Financial Officer March 10, 2000
-----------------------------------------------------
▇▇▇▇▇▇▇ ▇. ▇▇▇▇▇
/s/ T. ▇▇▇▇▇ ▇▇▇▇▇▇▇▇▇ Vice President and Controller March 10, 2000
-----------------------------------------------------
T. ▇▇▇▇▇ ▇▇▇▇▇▇▇▇▇
DIRECTORS:
/s/ ▇▇▇▇▇ ▇. ▇▇▇▇▇▇ Chairman of the Board March 10, 2000
-----------------------------------------------------
▇▇▇▇▇ ▇. ▇▇▇▇▇▇
/s/ ▇▇▇▇ ▇. ▇▇▇▇▇ Director March 10, 2000
-----------------------------------------------------
▇▇▇▇ ▇. ▇▇▇▇▇
Director March , 2000
-----------------------------------------------------
▇▇▇▇▇▇ ▇. ▇▇▇▇▇▇▇▇
/s/ ▇▇▇▇▇▇▇ ▇. ▇▇▇▇▇▇ Director March 10, 2000
-----------------------------------------------------
▇▇▇▇▇▇▇ ▇. ▇▇▇▇▇▇
/s/ ▇▇▇▇▇▇ ▇. ▇▇▇▇▇ Director March 10, 2000
-----------------------------------------------------
▇▇▇▇▇▇ ▇. ▇▇▇▇▇
/s/ ▇▇▇▇▇▇ ▇. ▇▇▇▇▇▇▇ Director March 10, 2000
-----------------------------------------------------
▇▇▇▇▇▇ ▇. ▇▇▇▇▇▇▇
/s/ ▇▇▇▇ ▇. ▇▇▇▇▇ Director March 10, 2000
-----------------------------------------------------
▇▇▇▇ ▇. ▇▇▇▇▇
40
43
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Digex, Incorporated
We have audited the accompanying balance sheets of Digex, Incorporated
(formerly the Web site hosting unit of Business Internet, Inc.) as of December
31, 1998 and 1999, and the related statements of operations, changes in
stockholders'/owner's equity and cash flows for the period from July 7, 1997
(date of acquisition) to December 31, 1997, and the years ended December 31,
1998 and 1999. Our audits included the financial statement schedule listed in
the index at Item 14. These financial statements and this 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 financial statements referred to above present fairly,
in all material respects, the financial position of Digex, Incorporated at
December 31, 1998 and 1999, and the results of its operations and its cash flows
for the period from July 7, 1997 (date of acquisition) to December 31, 1997 and
the years ended December 31, 1998 and 1999, 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.
/s/ ERNST & YOUNG LLP
Tampa, Florida
February 2, 2000
F-1
44
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Digex, Incorporated
We have audited the accompanying statements of operations, changes in
owner's equity, and cash flows of the Web site hosting unit of Business
Internet, Inc. for the period from January 1, 1997 to July 6, 1997. Our audits
included the financial statement schedule listed in the index at Item 14. 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 financial statements referred to above present fairly,
in all material respects, the results of operations and cash flows of the Web
site hosting unit of Business Internet, Inc. for the period from January 1, 1997
to July 6, 1997, 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.
/s/ ERNST & YOUNG LLP
Tampa, Florida
April 23, 1999
F-2
45
DIGEX, INCORPORATED
BALANCE SHEETS
(AMOUNTS IN THOUSANDS, EXCEPT SHARE INFORMATION)
DECEMBER 31,
-------------------
1998 1999
-------- --------
ASSETS
Current assets:
Cash and cash equivalents................................. $ -- $ 88,778
Accounts receivable, net of allowance of $719 and $4,362
in 1998 and 1999, respectively......................... 6,127 17,271
Due from parent........................................... -- 3,110
Prepaid expenses and other current assets................. 890 1,496
-------- --------
Total current assets........................................ 7,017 110,655
-------- --------
Property and equipment, net................................. 39,059 205,903
Intangible assets, net...................................... 31,204 27,213
Other assets................................................ 459 538
-------- --------
Total assets...................................... $ 77,739 $344,309
======== ========
LIABILITIES AND STOCKHOLDERS'/OWNER'S EQUITY
Current liabilities:
Accounts payable.......................................... $ 3,341 $ 24,623
Accrued expenses.......................................... 843 8,996
Deferred revenue.......................................... 621 222
Current portion of note payable........................... -- 1,235
Current portion of capital lease obligations.............. 981 801
-------- --------
Total current liabilities................................... 5,786 35,877
Note payable................................................ -- 2,477
Capital lease obligations................................... 1,108 15,766
-------- --------
Total liabilities................................. 6,894 54,120
-------- --------
Stockholders'/Owner's Equity:
Preferred stock, $.01 par value; 5,000,000 shares
undesignated as to series; no shares issued............ -- --
Class A common stock, $.01 par value; 100,000,000 shares
authorized; 11,500,000 shares outstanding.............. -- 115
Class B common stock, $.01 par value; 50,000,000 shares
authorized; issued and outstanding..................... -- 500
Additional paid-in capital................................ -- 354,553
Accumulated deficit....................................... -- (52,768)
Deferred compensation..................................... -- (12,211)
Owner's net investment.................................... 70,845 --
-------- --------
Total stockholders'/owner's equity................ 70,845 290,189
-------- --------
Total liabilities and stockholders'/owner's
equity........................................... $ 77,739 $344,309
======== ========
See accompanying notes to financial statements.
F-3
46
DIGEX, INCORPORATED
STATEMENTS OF OPERATIONS
(AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
PREDECESSOR THE COMPANY
--------------- ---------------------------------------------------
PERIOD FROM
JULY 7, 1997
(DATE OF
PERIOD FROM ACQUISITION) TO YEAR ENDED YEAR ENDED
JANUARY 1, 1997 DECEMBER 31, DECEMBER 31, DECEMBER 31,
TO JULY 6, 1997 1997 1998 1999
--------------- --------------- --------------- ---------------
Revenues................................ $ 4,420 $ 7,192 $ 22,635 $ 59,786
Costs and expenses:
Cost of operations.................... 4,149 1,739 6,710 9,656
Cost of services...................... 1,817 1,611 7,044 21,750
Selling, general and administrative... 7,001 6,087 17,512 70,213
Deferred compensation................. -- -- -- 1,299
Depreciation and amortization......... 519 2,753 8,109 29,070
Charge off of purchased in-process
research and development........... -- 15,000 -- --
------- ----------- ----------- -----------
Total costs and expenses...... 13,486 27,190 39,375 131,988
------- ----------- ----------- -----------
Loss from operations.................... (9,066) (19,998) (16,740) (72,202)
Other income (expense):
Interest expense...................... -- -- -- (1,094)
Interest and other income............. -- -- -- 3,458
------- ----------- ----------- -----------
Net loss before income tax benefit...... (9,066) (19,998) (16,740) (69,838)
Income tax benefit...................... -- 1,440 159 4,839
------- ----------- ----------- -----------
Net loss................................ $(9,066) $ (18,558) $ (16,581) $ (64,999)
------- ----------- ----------- -----------
Net loss per common share -- basic and
diluted:.............................. $ (0.37) $ (0.33) $ (1.19)
=========== =========== ===========
Shares used in computing basic and
diluted net loss per share............ 50,000,000 50,000,000 54,726,027
=========== =========== ===========
See accompanying notes to financial statements.
F-4
47
DIGEX, INCORPORATED
STATEMENTS OF CHANGES IN STOCKHOLDERS'/OWNER'S EQUITY
(AMOUNTS IN THOUSANDS)
COMMON STOCK
----------------------------------- OWNER'S
CLASS A CLASS B ADDITIONAL RETAINED NET
---------------- ---------------- PAID-IN DEFERRED EARNINGS INVESTMENT
SHARES AMOUNT SHARES AMOUNT CAPITAL COMPENSATION (DEFICIT) (DEFICIT) TOTAL
------- ------ ------- ------ ---------- ------------ --------- ---------- --------
PREDECESSOR
BALANCE AT DECEMBER 31,
1996...................... -- $ -- -- $ -- $ -- $ -- $ -- $ 342 $ 342
Stock options exercised..... -- -- -- -- -- -- -- 550 550
Total allocated costs....... -- -- -- -- -- -- -- 6,105 6,105
Funding for working
capital................... -- -- -- -- -- -- -- 517 517
Funding for purchases of
property, plant and
equipment................. -- -- -- -- -- -- -- 1,004 1,004
Net loss.................... -- -- -- -- -- -- -- (9,066) (9,066)
------- ---- ------- ---- -------- -------- -------- -------- --------
BALANCE AT JULY 6, 1997..... -- $ -- -- $ -- $ -- $ -- $ -- $ (548) $ (548)
======= ==== ======= ==== ======== ======== ======== ======== ========
THE COMPANY
BALANCE AT JULY 7, 1997..... -- $ -- -- $ -- $ -- $ -- $ -- $ -- $ --
Contribution from Parent for
Acquisition............... -- -- -- -- -- -- -- 47,221 47,221
Total allocated costs....... -- -- -- -- -- -- -- 2,698 2,698
Funding for working
capital................... -- -- -- -- -- -- -- 6,150 6,150
Funding for purchases of
property, plant and
equipment................. -- -- -- -- -- -- -- 8,016 8,016
Net loss.................... -- -- -- -- -- -- -- (18,558) (18,558)
------- ---- ------- ---- -------- -------- -------- -------- --------
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
Parent.................... -- -- 50,000 500 114,566 -- -- (115,066) --
Contributions from Parent
following
recapitalization.......... -- -- -- -- 47,689 -- -- (48,106) (417)
Initial public offering of
common stock, net of
issuance cost............. 11,500 115 -- -- 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...................... 11,500 $115 50,000 $500 $354,553 $(12,211) $(52,768) $ -- $290,189
======= ==== ======= ==== ======== ======== ======== ======== ========
See accompanying notes to financial statements.
F-5
48
DIGEX, INCORPORATED
STATEMENTS OF CASH FLOWS
(AMOUNTS IN THOUSANDS)
PREDECESSOR THE COMPANY
--------------- ----------------------------------------------
PERIOD FROM
JULY 7, 1997
PERIOD FROM (DATE OF
JANUARY 1, ACQUISITION) TO YEAR ENDED YEAR ENDED
1997 DECEMBER 31, DECEMBER 31, DECEMBER 31,
TO JULY 6, 1997 1997 1998 1999
--------------- ---------------- ------------ ------------
OPERATING ACTIVITIES:
Net loss................................. $ (9,066) $ (18,558) $ (16,581) $ (64,999)
Adjustments to reconcile net loss to cash
used in operating activities:
Depreciation and amortization......... 519 2,753 8,109 29,070
Deferred income taxes................. -- (1,440) (159) (4,839)
Provision for doubtful accounts....... 352 498 1,491 4,265
Amortization of deferred
compensation........................ -- -- -- 1,299
Charge off of purchased in-process
research and development............ -- 15,000 -- --
Loss on sale of telecommunications
equipment........................... -- -- -- 52
Changes in operating assets and
liabilities net of the effects of
the acquisition:
Accounts receivable................. (890) (1,466) (5,559) (15,409)
Prepaid expenses and other current
assets........................... (54) (265) (550) (606)
Other assets........................ -- -- (459) (79)
Accounts payable, accrued expenses
and other liabilities............ 1,967 (2,601) 2,778 33,619
Due from parent..................... -- -- -- (3,110)
Advanced ▇▇▇▇▇▇▇▇................... -- -- -- 222
--------- --------- --------- ------------
Net cash used in operating activities.... (7,172) (6,079) (10,930) (20,515)
INVESTING ACTIVITIES:
Acquisition of business.................. -- (47,221) -- --
Proceeds from sale of telecommunication
assets................................ -- -- -- 203
Purchases of property and equipment...... (1,004) (8,016) (30,969) (170,396)
--------- --------- --------- ------------
Net cash used in investing activities.... (1,004) (55,237) (30,969) (170,193)
FINANCING ACTIVITIES:
Principal payments on long-term debt and
capital leases........................ -- (2,769) -- (1,424)
Proceeds from initial public offering.... -- -- -- 178,903
Exercise of stock options................ 550 -- -- --
Net contributions from Parent............ 7,626 64,085 41,899 102,007
--------- --------- --------- ------------
Net cash provided by financing
activities............................ 8,176 61,316 41,899 279,486
Net increase(decrease) in cash and cash
equivalents........................... -- -- -- 88,778
Cash and cash equivalents at beginning of
the year.............................. -- -- -- --
--------- --------- --------- ------------
Cash and cash equivalents at end of
year.................................. $ -- $ -- $ -- $ 88,778
========= ========= ========= ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION:
Noncash investing and financing
activities:
Assets purchased under capital
leases.............................. $ 829 $ 846 $ 958 $ 17,111
Asset purchased by issuance of note
payable............................. -- -- -- 4,672
Interest Paid......................... -- -- -- 1,010
See accompanying note to financial statements.
F-6
49
DIGEX, INCORPORATED
NOTES TO FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE INFORMATION)
1. ORGANIZATION, BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION
Digex, Incorporated ("Digex" or the "Company") was incorporated on April
26, 1999, under the laws of the State of Delaware. The Company's business was
operated as the Web site hosting unit of Intermedia Communications, Inc.
("Intermedia" or "the Parent") 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 (the
"Predecessor"), 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 the Company on April 26,
1999. Prior to April 30, 1999, the Registrant had no assets or liabilities. See
also Note 11, which discloses the contribution of assets on April 30, 1999 by
Business Internet, Inc. to the Registrant.
The Company's operations began in January 1996 to provide managed Web
hosting services, principally to Fortune 2000 companies. The Company's services
include implementing and maintaining secure, scaleable, high-performance Web
sites on the Internet 24 hours a day. In addition, the Company 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.
BASIS OF PRESENTATION
The accompanying financial statements of the Company reflect the carved-out
operations and financial position of the Web site hosting unit of Intermedia for
all periods between July 7, 1997 and April 26, 1999. The accompanying financial
statements of the Predecessor reflect its operations and financial position from
January 1, 1997 to July 6, 1997. As more fully discussed in Note 2, "Related
Party Transactions and Corporate Allocations," the financial statements for all
periods presented include allocations of network costs and corporate expenses.
In addition, for financial reporting purposes, the equity activity of the
Company, prior to its incorporation, and the Predecessor 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 conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
Cash Equivalents
The Company considers all highly liquid investments with a maturity of
three months or less when purchased to be cash equivalents.
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 are recognized upon the customer-approved
completion of the managed Web hosting solution. Monthly service fees are
recognized in the month the service is rendered over the contract period.
Certain customer payments for managed Web
F-7
50
DIGEX, INCORPORATED
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE INFORMATION)
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.
Property and Equipment
Property and equipment is stated at cost. Depreciation is computed using
the straight-line method over estimated useful lives of the property and
equipment, generally five years for equipment and up to twenty years for
leasehold improvements. 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, generally five years. The cost of license
agreements with software vendors is amortized over five years.
Intangible Assets
Intangible assets include assets that arose in connection with the purchase
of Business Internet 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 on Accounting Standards No. 121, Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
Of, the Company 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 the Company's financial instruments, including cash
and cash equivalents, accounts receivable, accounts payable, note payable and
capital lease obligation approximate their fair market values.
Advertising Costs
The Company expenses advertising costs as incurred. Advertising expense
amounted to $2,016, $2,076, $2,544 and $6,782 the period from January 1, 1997 to
July 6, 1997, the period from July 7, 1997 to December 31, 1997, the years ended
December 31, 1998 and 1999, respectively.
Stock-Based Compensation
The Company's employees participated in the stock option plans of
Intermedia prior to August 4, 1999 and subsequently in the Digex plan. The
Company accounts for employee stock-based compensation in accordance with
Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees, and related interpretations, because the alternative fair value
accounting model provided under Statement of Financial Accounting Standards No.
123, Accounting for Stock-Based Compensation (SFAS 123), is not required.
Accordingly, in cases where exercise prices equal or exceed fair market value of
the underlying Intermedia or Digex common stock, the Company recognizes no
compensation expense. In cases where
F-8
51
DIGEX, INCORPORATED
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE INFORMATION)
exercise prices are less than the fair value, compensation is recognized over
the period of performance or vesting period.
Income Taxes
The operations of the Company and of the Predecessor were included in the
consolidated income tax returns of Intermedia and Business Internet,
respectively. For reporting purposes, the Company has used the asset and
liability method in accounting for income taxes prescribed in Statement of
Financial Accounting Standards No. 109, Accounting for Income Taxes, except that
the presentation reflects the parent companies as if they were the taxing
jurisdictions. 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. The income
tax provision is calculated on a separate return basis.
Comprehensive Income
In June 1997, the FASB issued Statement of Financial Accounting Standards
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. The
Company and the Predecessor adopted this standard in 1998 and implemented the
standard for all years presented herein. The Company's and Predecessor's
comprehensive losses were equal to net losses for all periods presented.
Segment Reporting
The Company and the Predecessor operated during all periods in a single
segment when applying the management approach defined in Statement of Financial
Accounting Standards No. 131, Disclosures about Segments of an Enterprise and
Related Information.
Loss Per Share
The Company has applied the provisions of Statement of Financial Accounting
Standards No. 128, Earnings Per Share (SFAS 128), 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. The calculation of
diluted earnings per share includes the effect of dilutive common stock
equivalents. No dilutive common stock equivalents existed in any year presented.
Concentrations of Credit Risk
The Company's cash and cash equivalents and accounts receivable are
financial instruments that expose the Company to credit risk, as defined by
Statement of Financial Accounting Standards No. 105, Disclosure of Information
About Financial Instruments with Off-Balance Sheet Risk and Financial
Instruments with Concentrations of Credit Risk.
The Company places its cash and temporary cash investments with
high-quality institutions. As of December 31, 1998 and 1999, cash and cash
equivalents totaling $0 and approximately $88.8 million, respectively, were held
by certain financial institutions.
Accounts receivable are due from commercial entities to whom credit is
extended based on evaluation of the customer's financial condition, and
generally collateral is not required. Anticipated credit losses are
F-9
52
DIGEX, INCORPORATED
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE INFORMATION)
provided for in the financial statements and have been within management's
expectations for all periods presented.
2. RELATED PARTY TRANSACTIONS AND CORPORATE ALLOCATIONS
The Predecessor and, prior to August 4, 1999, the Company utilized the
central cash management systems of Business Internet and Intermedia,
respectively. Cash requirements during these periods were satisfied by cash
transactions and transfers that were accounted for through an intercompany
account. In addition, the parent companies charged the Company for identifiable
corporate and operating expenses, such as network cost and corporate overhead
cost. Intercompany account balances for all periods presented have been treated
as permanent contributions and have been reflected as a component of owner's net
investment in the accompanying financial statements.
The following table summarizes corporate charges and allocations included
in the accompanying financial statements:
PREDECESSOR THE COMPANY
--------------- ------------------------------------------
JULY 7, 1997
(DATE OF
ACQUISITION)
JANUARY 1, 1997 TO YEAR ENDED YEAR ENDED
TO JULY 6, DECEMBER 31, DECEMBER 31, DECEMBER 31,
STATEMENT OF OPERATIONS CAPTION 1997 1997 1998 1999
------------------------------- --------------- ------------ ------------ ------------
Cost of operations................... $4,001 $1,624 $ 6,494 $ 9,190
Cost of services..................... 344 103 1,320 494
Selling, general and
administrative..................... 1,760 971 2,204 18,123
------ ------ ------- -------
$6,105 $2,698 $10,018 $27,807
====== ====== ======= =======
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 the Company 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.
F-10
53
DIGEX, INCORPORATED
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE INFORMATION)
On December 22, 1999, Intermedia entered into a $100,000 credit facility
under which the Company and Intermedia's subsidiaries are the guarantors.
As of December 31, 1999, unexercised options to purchase 155,000 shares of
its Class A Common Stock were granted by the Company to members of its Board of
Directors. The options were granted at fair market value on the date of
issuance.
Refer to Note 11 for additional related party transactions and agreements.
Software, Equipment and Services Purchased from Microsoft and Compaq
In January 2000, the Company entered into strategic development agreements
and joint marketing arrangements with Microsoft and Compaq. Digex and Microsoft
will work together to advance the Company'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 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 the Company, 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 the Company. Digex paid $209 in
1997, $1,120 in 1998, and $3,085 million in 1999 for products and services
provided by Microsoft. For products and services provided by Compaq, the Company
paid $2,365 in 1997, $7,487 in 1998, and $18,669 in 1999.
Sale of Telecommunications Related Assets to Intermedia
The Company entered into agreements with Intermedia to sell to Intermedia
certain telecommunications related assets that are purchased by the Company with
the net proceeds of the recent offerings. The assets are sold to Intermedia at
the Company's cost. The proceeds from the sale of telecommunications related
assets to Intermedia were approximately $25.3 million during the year ended
December 31, 1999. These proceeds are considered unrestricted and are used to
fund the Company's operating expenses.
3. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following:
DECEMBER 31, DECEMBER 31,
1998 1999
------------ ------------
Buildings................................................... $ -- $ 17,344
Electronics and computer equipment.......................... 36,245 126,389
Computer software........................................... 8,153 29,053
Furniture and office equipment.............................. 297 2,427
Leasehold improvements...................................... 488 61,981
------- --------
45,183 237,194
Less accumulated depreciation............................... (6,124) (31,291)
------- --------
$39,059 $205,903
======= ========
Property and equipment included buildings, electronics and computer
equipment of $3,009 and $20,338 at December 31, 1998 and 1999, respectively,
that were capitalized pursuant to the terms of capital lease agreements.
Accumulated amortization of assets recorded under capital leases amounted to $0
and $1,295 at
F-11
54
DIGEX, INCORPORATED
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE INFORMATION)
December 31, 1998 and 1999, respectively. Amortization of these assets is
included in depreciation expense for the years ended December 31, 1998 and 1999.
Depreciation expense amounted to $519 for the period from January 1, 1997
to July 6, 1997, $1,175 for the period from July 7, 1997 to December 31, 1997,
$4,949 and $25,079 for the years ended December 31, 1998 and 1999, respectively.
4. INTANGIBLE ASSETS
Intangible assets consisted of the following:
DECEMBER 31, DECEMBER 31,
1998 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............................... (4,738) (8,729)
------- -------
$31,204 $27,213
======= =======
Amortization expense amounted to $1,578 for the period from July 7, 1997 to
December 31, 1997, $3,160 and $3,991 for the years ended December 31, 1998 and
1999, respectively. At the date of acquisition, the trade name was valued at
$11,000. The Company and another operating unit of Intermedia shared the value
of this trade name during the period from July 7, 1997 through December 31,
1998.
5. STOCKHOLDERS' EQUITY
On August 4, 1999, the Company 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 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 $178,903 and can be used only to purchase
telecommunications related assets due to restrictions in Intermedia's debt
instruments.
Under the provisions of the Intermedia 1996 Long-Term Incentive Plan (1996
Plan), certain employees and directors of the Company have been granted options
to buy shares of Intermedia common stock, generally at market value with terms
of five to ten years. Under the provisions of Business Internet's equity
participation plan, employees were awarded stock options, generally at market
value with terms of five years. Options in Business Internet that were held by
employees of the Predecessor were converted into 456,632 Intermedia options upon
the purchase of Business Internet, applying the same terms and conditions as
existed under the Business Internet Equity Participation Plan.
The Digex Long-Term Incentive Plan adopted on July 23, 1999 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 our subsidiaries or of any
person that owns over 50% of the voting power of our authorized and outstanding
voting shares.
F-12
55
DIGEX, INCORPORATED
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE INFORMATION)
The following table summarizes the stock option activity related to
employees of the Predecessor, Intermedia, and the Company:
NUMBER PER SHARE
OF SHARES OPTION PRICE
--------- ------------
Outstanding Business Internet options at December 31,
1996...................................................... 482,433 $ 0.13- 5.19
Granted................................................... 478,451 1.50- 5.12
Exercised................................................. 4,778 0.13- 5.00
Canceled.................................................. 3,326 0.13- 5.00
--------- ------------
Outstanding Business Internet options at July 6, 1997....... 952,780 $ 0.13- 5.19
========= ============
Outstanding Intermedia options at July 7, 1997.............. 456,632 $ 0.26-10.82
Granted................................................... -- --
Exercised................................................. 95,364 0.26-10.82
Canceled.................................................. 1,280 8.99-10.82
--------- ------------
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
========= ============
As of December 31, 1999, the Board has 3,295,980 shares of Common Stock
reserved for issuance to employees, officers, directors, and consultants of the
Company pursuant to the Plan.
As of December 31, 1999, unexercised options to purchase 1,088,400 shares
of Class A Common Stock (included in the total above) were granted by the
Company to employees of the Parent. The Financial Accounting Standards Board
recently issued an Exposure Draft, Accounting for Certain Transactions involving
Stock Compensation, an interpretation of APB Opinion No. 25, that addresses the
accounting for such option grants. The final interpretation of APB Opinion No.
25 has not been issued, and therefore, the Company is unable to discuss the
potential impact relative to these stock option grants.
Pro forma net loss and net loss per share, assuming that the Predecessor
and Digex had applied the fair value model (Black-Scholes Pricing Model)
required by SFAS 123, is as follows:
PREDECESSOR THE COMPANY
------------ ------------------------------------------
JANUARY 1, JULY 7, 1997
1997 TO TO YEAR ENDED YEAR ENDED
JULY 6, DECEMBER 31, DECEMBER 31, DECEMBER 31,
1997 1997 1998 1999
------------ ------------ ------------ ------------
Net loss....................................... $(9,645) $(18,558) $(16,828) $(71,800)
Net loss per share............................. -- $ (0.37) $ (0.34) $ (1.31)
F-13
56
DIGEX, INCORPORATED
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE INFORMATION)
The following table summarizes the significant assumptions used in
developing the information:
PREDECESSOR THE COMPANY
----------- ------------------------------------------
JANUARY 1, JULY 7,
1997 TO 1997 TO YEAR ENDED YEAR ENDED
JULY 6, DECEMBER 31, DECEMBER 31, DECEMBER 31,
1997 1997 1998 1999
----------- ------------ ------------ ------------
Risk-free interest rate................. 6.1% 6.1% 5.4% 5.6%
Volatility factor....................... 58.0% 58.0% 53.0% 60.0%
Dividend yield.......................... -- -- -- --
Weighted average life................... 5 years 5 years 5 years 5 years
The following table summarizes the weighted average exercise prices of
option activity:
PREDECESSOR THE COMPANY
----------- ------------------------------------------
JANUARY 1, JULY 7,
1997 TO 1997 TO YEAR ENDED YEAR ENDED
JULY 6, DECEMBER 31, DECEMBER 31, DECEMBER 31,
1997 1997 1998 1999
----------- ------------ ------------ ------------
Balance at beginning of period.......... $ 6.28 $ 5.83 $ 5.83 $ --
Granted............................... 5.36 -- 26.69 18.92
Exercised............................. 7.45 5.28 6.94 --
Canceled.............................. 8.29 10.02 6.73 22.76
------- -------- -------- --------
Balance at end of period................ $ 5.83 $ 5.83 $ 20.60 $ 18.45
======= ======== ======== ========
As of December 31, 1999, the weighted average exercise price of exercisable
options was $17.00. Outstanding options as of December 31, 1999 were not
convertible into shares of the Company and had a weighted average remaining
contractual life of 9.6 years. The per share weighted average fair value of
options granted during the period from January 1, 1997 to July 6, 1997, the
period from July 7, 1997 to December 31, 1997, and the years ended December 31,
1998 and 1999 were $1.44, $0, $14.84 and $12.67.
6. DEFERRED COMPENSATION
The Company granted options to purchase 1,067,500 shares of Class A Common
Stock under the Digex Long Term Incentive Plan to certain employees of the
Company at exercise prices below market value. During the year ended December
31, 1999, the Company recorded approximately $13,510 of deferred compensation, a
separate component of stockholders' equity, to be expensed over the four-year
vesting period of the options. Deferred compensation expense of $1,299 was
expensed during the year ended December 31, 1999.
7. INCOME TAX INFORMATION
The Company's income tax benefit for the period from July 7, 1997 to
December 31, 1997, and the years ended December 31, 1998 and 1999 are comprised
of the following:
PERIOD FROM
JULY 7, 1997 TO YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31,
1997 1998 1999
--------------- ------------ ------------
Current.......................................... $ -- $ -- $ --
Deferred:
Federal........................................ 1,306 144 4,244
State.......................................... 134 15 595
------ ---- ------
$1,440 $159 $4,839
====== ==== ======
F-14
57
DIGEX, INCORPORATED
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE INFORMATION)
The following table reconciles the assumed statutory tax rate with the
effective rate to income tax expense of the Predecessor and the Company:
PREDECESSOR THE COMPANY
----------- ------------------------------------------
PERIOD
FROM PERIOD FROM
JANUARY 1, JULY 7, 1997
1997 TO TO YEAR ENDED YEAR ENDED
JULY 6, DECEMBER 31, DECEMBER 31, DECEMBER 31,
1997 1997 1998 1999
----------- ------------ ------------ ------------
Tax benefit at statutory rate........... (34.0)% (34.0)% (34.0)% (34.0)%
Reconciling items:
State income taxes, net............... (3.5) (0.7) (3.1) (3.2)
Charge off of purchased in-process
research and development........... -- 25.5 -- --
Non-deductible items.................. -- -- -- 3.3
Change in valuation allowance......... 37.1 0.0 32.0 19.1
Other items........................... 0.4 2.0 4.1 7.8
----- ----- ----- -----
Effective tax rate...................... --% (7.2)% (1.0)% (7.0)%
===== ===== ===== =====
At December 31, 1998 and 1999, the Company 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 Company's deferred tax assets and liabilities as of December 31, 1998 and
1999 were as follows:
DECEMBER 31,
1998 1999
------- --------
Deferred tax liabilities:
Identifiable intangible assets............................ $(5,216) $ (4,299)
------- --------
Total deferred tax liabilities.................... (5,216) (4,299)
------- --------
Deferred tax assets:
Net operating loss carryforwards.......................... 10,268 18,449
Allowance for bad debts................................... 186 1,636
Depreciation.............................................. -- 1,867
Contingent tax accrual.................................... -- 352
Stock-based compensation.................................. 111 487
------- --------
Total deferred tax assets......................... 10,565 22,791
Less: valuation allowance................................. (5,349) (18,492)
------- --------
Net deferred tax asset.................................... 5,216 4,299
------- --------
Net deferred tax asset (liability)................ $ -- $ --
======= ========
As a result of the recapitalization of the Company on April 30, 1999, the
net operating loss carryforwards of the Company as of December 31, 1998 did not
transfer to the Company after the recapitalization. Accordingly, the Company
recorded a net deferred tax liability of $4,839 relating to identifiable
intangible assets as a result of the recapitalization on April 30, 1999. The
Company 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, the Company
recorded a $4,839 deferred tax benefit during the year ended December 31, 1999.
F-15
58
DIGEX, INCORPORATED
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE INFORMATION)
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 $18,492 valuation allowance at December 31, 1999 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
$13,143. At December 31, 1999, the Company's net operating loss carryforward for
federal income tax purposes is approximately $49,198, with expiration periods
beginning in 2011 through 2019.
8. LEASE COMMITMENTS AND NOTE PAYABLE
The Company leases office space under capital lease arrangements. The
Company also leases office space and office equipment under operating leases.
Future noncancelable lease payments under the Company's lease commitments at
December 31, 1999 are as follows:
CAPITAL OPERATING
LEASES LEASES
------- ---------
Future minimum lease payments:
Year ended December 31:
2000...................................................... $ 2,179 $1,233
2001...................................................... 2,502 823
2002...................................................... 2,568 546
2003...................................................... 2,637 499
2004...................................................... 2,708 463
Thereafter.................................................. 11,607 73
------- ------
24,201 3,637
======= ======
Less amount representing interest........................... (7,634)
-------
Present value of lease payments............................. 16,567
Current portion of capital leases........................... (801)
-------
Noncurrent portion of capital leases........................ $15,766
=======
Rent expense amounted to $117 for the period from January 1, 1997 to July
7, 1997, $170 for the period from July 7, 1997 to December 31, 1997, and $829
and $2,031 for the years ended December 31, 1998 and 1999, respectively. Lease
payments under operating leases include certain rent allocated to the Company in
1999.
Note payable of $4,672 was issued in 1999 in connection with the purchase
of software. The note accrues at an effective interest rate of 10.54% per annum
and matures in January 2002. Principal repayments until maturity are as follows:
Year ended December 31:
2000...................................................... $1,235
2001...................................................... 1,170
2002...................................................... 1,307
2003...................................................... --
2004...................................................... --
Thereafter................................................ --
------
Total............................................. $3,712
======
Interest cost incurred and charged to expense related to the note payable
was $166 in 1999.
F-16
59
DIGEX, INCORPORATED
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE INFORMATION)
9. LOSS PER SHARE
On April 30, 1999, the Company issued 1,000 shares of Class B Common Stock
to the Parent in connection with the contribution of assets to the Company. Loss
per share is presented on a pro forma basis assuming that the common shares
issued in connection with our 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 the computation of basic and diluted loss
per share of common stock:
PERIOD FROM
JULY 1, 1997
TO YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31,
1997 1998 1999
------------ ------------ ------------
Net loss, as reported........................... $ (18,558) $ (16,581) $ (64,999)
=========== =========== ===========
Weighted average common shares.................. 50,000,000 50,000,000 54,726,027
=========== =========== ===========
Loss per share:
Basic......................................... $ (0.37) $ (0.33) $ (1.19)
=========== =========== ===========
Diluted....................................... $ (0.37) $ (0.33) $ (1.19)
=========== =========== ===========
Unexercised options to purchase 5,704,020 shares of Class A Common Stock
were not included in the computation of diluted loss per share because assumed
conversion would be anti-dilutive.
10. BUSINESS COMBINATION
On July 7, 1997, Intermedia purchased the outstanding common stock of
Business Internet, a nationwide Internet services provider and Web site
management company in a business combination accounted for as a purchase. The
purchase price was allocated to the fair values of assets acquired and
liabilities assumed, with the difference recorded as goodwill, which is being
amortized over ten years.
The following table summarizes the allocation of the purchase price to the
acquired assets and assumed net liabilities of the Company:
Estimated net fair values of operating assets and
liabilities............................................... $(3,721)
Purchased intangible assets:
Trade name................................................ 9,750
Customer list............................................. 3,120
Acquired workforce........................................ 1,253
Developed technologies.................................... 2,720
Goodwill.................................................. 19,099
In-process research and development......................... 15,000
-------
$47,221
=======
The amount allocated to in-process research and development ("IPR&D") of
$15,000 was recorded as a one-time charge to operations in 1997 because the
technology was not fully developed and had no alternative future use. Management
is primarily responsible for estimating the fair value of the purchased IPR&D.
F-17
60
DIGEX, INCORPORATED
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE INFORMATION)
The fair value of the IPR&D was estimated by management using an income
approach. The value allocated to IPR&D was determined by estimating the costs to
develop the purchased technology into commercially viable services, estimating
the resulting net cash flows, excluding the cash flows related to the portion
that was incomplete at the acquisition date, and discounting the net cash flows
to the present value. The forecast was based upon future discounted cash flows,
taking into account the stage of development of the IPR&D, the costs to develop
the IPR&D, the expected income stream, the life cycle of the technology
ultimately developed, and the associated risks. The selection of the applicable
discount rate was based on consideration of the costs of capital of the Company
and Intermedia, as well as other factors including the useful life of the
technology, profitability levels, the uncertainty of technology advances that
were known at the time, and the stage of completion related to the technology.
The IPR&D involved development, engineering, and testing activities
associated with the completion of next generation Web site management services.
The primary effort involved the development of an additional Web site management
facility on the West Coast. The development of technology related to this
project was considered critical to alleviating capacity constraints and adding
significant new service capabilities. Upon completion, the new Web site
management facility was expected to result in faster and easier installation of
customers' servers as well as efficient traffic management with significantly
less overhead. Related efforts involved the development and integration of next
generation routers to support greater transmission capacity, as well as a new
software architecture to assist in balancing traffic loads. Another critical
element involved the development of site mirroring, the ability to create exact
replicas of Web sites at each of the Company's two sites for greater service
reliability.
At the valuation date, the Company had completed 75% of the development of
its next generation Web site management services, and substantial progress had
been made in the areas of specification, design, and implementation. In
particular, engineers had made significant progress in the areas of architecture
development as well as the development of site mirroring capabilities. The
Company anticipated that the R&D would be completed in phases by the end of
1998, after which the Company expected to begin generating economic benefits
from the value of the IPR&D. Total costs to complete were to be $100 for the
remainder of 1997 and $400 in 1998. Projected future cash flows attributable to
Digex's IPR&D, assuming successful development of such technologies, were
discounted to the present value using a discount rate of 24%. The project was
completed as of December 31, 1999.
Intermedia management expected to continue development of the IPR&D efforts
at the valuation date, and believed there was a reasonable chance of
successfully completing such development. However, there was risk associated
with the completion of the IPR&D and there was no assurance that any of the
projects would meet with either technological or commercial success. Failure to
successfully develop and commercialize the IPR&D would result in the loss of the
expected economic return inherent in the fair value allocation.
As a result of the above, on an unaudited pro forma basis, assuming the
purchase had occurred at the beginning of the 1997 year, total revenues would
have been $11,612, net loss would have been $(22,852) and net loss per share
(basic and diluted) would have been $(0.46), assuming that the recapitalization
discussed in Note 11 had been in effect for that period. However, pro forma
results do not purport to be indicative of the results that would have occurred
if the acquisition had occurred at the beginning of year.
11. RECAPITALIZATION
In connection with the recapitalization, the Company 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
F-18
61
DIGEX, INCORPORATED
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE INFORMATION)
is entitled to ten votes for each share. In addition, on April 30, 1999,
Business Internet contributed the Company's assets to the newly formed
corporation.
Network Services Agreements
Pursuant to several network services agreements between Intermedia and the
Company, Intermedia will provide Internet network access, as well as
network-related services. These Agreements have an initial term of two years
which expires in July 2001. Rates charged to the Company will generally be
consistent with rates incurred during the periods presented in the accompanying
financial statements.
General and Administrative Services Agreement
Pursuant to a General and Administrative Services Agreement, entered into
in April 1999, between Intermedia and the Company, Intermedia will provide the
back office and administrative services listed below:
- Corporate Human Resources, including labor relations, payroll and
training
- Finance, accounting and administration
- Tax services, including tax return preparation
- Accounting and back office support services
- Investor relations
- Information management services
The General and Administrative Services Agreement has an initial term of
two years. Rates charged to the Company for these services are believed to be
consistent with the allocations in the accompanying financial statements. Rates
for services not previously provided to the Company (e.g. investor relations)
are based upon Intermedia and the Company's best estimate of the fair value of
those services.
12. SEGMENT INFORMATION
As a provider of Web site and application hosting services, the Company has
one reportable operating segment. The revenue of this single segment is derived
from service offerings as reported in the Company's statement of operations.
Substantially all of the Company's revenue is attributable to customers in the
United States. Additionally, all of the Company's assets are located within the
United States.
13. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
The following is a summary of unaudited quarterly results of operations for
the years ended December 31, 1998 and 1999:
FIRST QUARTER SECOND QUARTER THIRD QUARTER FOURTH QUARTER
----------------- ------------------ ------------------ ------------------
1998 1999 1998 1999 1998 1999 1998 1999
------- ------- ------- -------- ------- -------- ------- --------
Revenues................................... $ 3,869 $ 9,392 $ 4,752 $ 12,629 $ 6,242 $ 16,111 $ 7,772 $ 21,654
Operating expenses......................... 7,658 17,987 9,724 30,482 9,812 37,803 12,181 45,716
------- ------- ------- -------- ------- -------- ------- --------
Loss from operations....................... (3,789) (8,595) (4,972) (17,853) (3,570) (21,692) (4,409) (24,062)
Other income (expense)..................... -- -- -- (239) -- 920 -- 1,683
------- ------- ------- -------- ------- -------- ------- --------
Net loss before income tax benefit......... (3,789) (8,595) (4,972) (18,092) (3,570) (20,772) (4,409) (22,379)
Income tax benefit......................... -- -- -- 4,839 -- -- 159 --
------- ------- ------- -------- ------- -------- ------- --------
Net loss................................... $(3,789) $(8,595) $(4,972) $(13,253) $(3,570) $(20,772) $(4,250) $(22,379)
======= ======= ======= ======== ======= ======== ======= ========
LOSS PER COMMON SHARE:
Net loss per common share.................. $ (0.08) $ (0.17) $ (0.10) $ (0.27) $ (.07) $ (0.36) $ (0.09) $ (0.36)
======= ======= ======= ======== ======= ======== ======= ========
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62
DIGEX, INCORPORATED
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE INFORMATION)
14. EMPLOYEE BENEFIT PLAN
The Company has established a 401(k) profit-sharing 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 during the taxable year. The
Company will match one-half of a participant's contribution, up to a maximum of
7% of the participant's compensation. The Company's matching contribution fully
vests after three years of service. The Company's contributions to the plan were
$46 for the period from January 1, 1997 through July 6, 1997, $61 for the period
from July 7, 1997 through December 31, 1997, $241 in 1998, and $473 in 1999.
15. CONTINGENCIES
The Company is a party to various litigation arising from the normal course
of its business operations. In the opinion of management, the ultimate liability
for these matters, if any, will not have a material adverse effect on the
Company's results of operations, cash flows, or financial position. There were
no other contingencies in existence as of December 31, 1999.
16. SUBSEQUENT EVENTS
On January 12, 2000, the Company sold 100,000 shares of its preferred
stock, designated as Series A Convertible Preferred Stock (the "Preferred
Stock"), with detachable warrants to purchase 1,065,000 shares of its Class A
Common Stock (the "Warrants"), for an aggregate of $100,000, of which $15,000
was in the form of equipment purchase credits. The Preferred Stock has an
aggregate liquidation preference of $100,000, and is convertible into
approximately 1,462,000 shares of Class A Common Stock. The Warrants can be
exercised at any time over their three-year term at a price of $57.00 per share
(the fair value of the Company's Class A Common Stock on the transaction
commitment date). The proceeds from the offering will be allocated between the
Preferred Stock and the Warrants based upon their relative fair values, which
have not yet been determined by the Company. Following the allocation, the
Preferred Stock will be accreted up to its liquidation preference through
charges to retained earnings.
On February 16, 2000, the Company completed a public offering of 12,650,000
shares of its Class A Common Stock. The Company sold 2,000,000 shares of Class A
Common Stock and received net proceeds of approximately $171,718. 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 62.0% of our equity interests, it controls
approximately 94.2% of our voting interest.
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63
DIGEX, INCORPORATED
SCHEDULE II
VALUATION 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
----------- ----------- ----------- ----------- ----------- -----------
THE PREDECESSOR
For the year ended December 31, 1996:
Deducted from asset accounts:
Allowance for doubtful accounts.... $ -- $ 233 $ -- $ -- $ 233
======= ======= ======= ======= =======
Allowance for deferred tax
accounts......................... -- 1,358 -- -- 1,358
======= ======= ======= ======= =======
For the period from January 1, 1997 to
July 6, 1997:
Deducted from asset accounts:
Allowance for doubtful accounts.... 233 352 -- 278(1) 307
======= ======= ======= ======= =======
Allowance for deferred tax
accounts......................... 1,358 3,359 -- -- 4,717
======= ======= ======= ======= =======
THE COMPANY
For the period from July 7, 1997 to
December 31, 1997:
Deducted from asset accounts:
Allowance for doubtful accounts.... 307 498 -- 436(1) 369
======= ======= ======= ======= =======
Allowance for deferred tax
accounts......................... -- -- -- -- --
======= ======= ======= ======= =======
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
======= ======= ======= ======= =======
---------------
(1) Uncollectible accounts written off, net of recoveries.
F-21