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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------
Form 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Quarter Ended June 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number: 000-26873
DIGEX, INCORPORATED
(Exact name of registrant as specified in its charter)
Delaware 59-3582217
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
14400 Sweitzer Lane
Laurel, MD 20707
(Address of principal executive offices)
(240) 264-2000
Telephone Number
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days:
Yes [X] No [ ]
As of July 31, 2002, there were 25,519,461 and 39,350,000 shares of the
Registrant's Class A and Class B Common Stock outstanding, respectively.
DIGEX, INCORPORATED
INDEX
Page
No.
----
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements (Unaudited):
Consolidated Statements of Operations--
Three and six months ended June 30, 2002 and 2001 ........... 3
Consolidated Balance Sheets--
June 30, 2002 and December 31, 2001 ......................... 4
Consolidated Statements of Cash Flows--
Six months ended June 30, 2002 and 2001 ..................... 5
Notes to Consolidated Financial Statements ...................... 6
ITEM 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations .................................... 17
ITEM 3. Quantitative and Qualitative Disclosures about Market Risk ...... 35
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings ............................................... 35
ITEM 2. Changes in Securities and Use of Proceeds ....................... 35
ITEM 3. Defaults Upon Senior Securities ................................. 36
ITEM 4. Submission of Matters to a Vote of Security Holders ............. 36
ITEM 5. Other Information ............................................... 36
ITEM 6. Exhibits and Reports on Form 8-K ................................ 37
Signatures ...................................................... 39
2
PART 1: FINANCIAL INFORMATION
Item 1. Financial Statements
DIGEX, INCORPORATED
CONSOLIDATED STATEMENTS OF OPERATIONS
Unaudited (Amounts in thousands, except share and per share data)
Three Months Ended Six Months Ended
June 30, June 30,
----------------------- ----------------------
2002 2001 2002 2001
---------- ---------- ---------- ----------
Revenue:
Revenue ............................................ $ 32,479 $ 49,802 $ 73,347 $ 101,739
Revenue from WorldCom .............................. 16,214 3,989 27,103 5,104
---------- ---------- ---------- ----------
Total revenue ........................................... 48,693 53,791 100,450 106,843
Costs and expenses:
Cost of operations ................................. 3,440 4,375 7,728 9,531
Cost of services ................................... 23,008 26,455 48,078 51,000
Selling, general and administrative ................ 20,860 32,005 48,871 66,287
Provision for doubtful accounts .................... 740 4,601 2,005 7,499
Provision for doubtful accounts for WorldCom ....... 17,670 ---- 18,578 ----
Deferred compensation .............................. 396 734 993 1,806
Impairment loss .................................... 56,990 ---- 56,990 ----
Depreciation and amortization ...................... 42,084 32,401 82,307 61,890
---------- ---------- ---------- ----------
Total costs and expenses ................................ 165,188 100,571 265,550 198,013
---------- ---------- ---------- ----------
Loss from operations .................................... (116,495) (46,780) (165,100) (91,170)
Other income (expense):
Interest expense ................................... (2,143) (747) (4,135) (1,445)
Interest income and other .......................... 135 204 296 1,073
---------- ---------- ---------- ----------
Net loss ................................................ (118,503) (47,323) (168,939) (91,542)
Accretion of preferred stock discount ................... (503) (1,006) (1,509) (2,013)
---------- ---------- ---------- ----------
Net loss available to common stockholders ............... $(119,006) $(48,329) $(170,448) $ (93,555)
========== ========== =========== ==========
Net loss per common share--
basic and diluted .................................. $ (1.83) $ (0.76) $ (2.64) $ (1.47)
========== ========== ========== ==========
Shares used in computing basic and diluted net
loss per share ..................................... 64,869,461 64,075,828 64,505,983 64,013,802
========== ========== ========== ==========
See accompanying notes to consolidated financial statements.
3
DIGEX, INCORPORATED
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except share information)
June 30, December 31,
2002 2001
------------- -------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents ................................................ $ 4,812 $ 12,096
Restricted investments ................................................... 3,215 3,197
Accounts receivable, net of allowance of $3,383 in 2002
and $4,806 in 2001 .................................................... 18,147 25,159
Due from WorldCom, net of allowance of $18,578 in 2002
and $0 in 2001 ........................................................ 3,609 15,179
Deferred costs ........................................................... 6,454 7,302
Prepaid expenses and other current assets ................................ 3,815 7,579
----------- ----------
Total current assets .............................................. 40,052 70,512
Property and equipment, net ................................................... 220,140 327,701
Goodwill, net ................................................................. 11,880 11,880
Intangible assets, net ........................................................ 4,875 7,351
Notes receivable from employees, net .......................................... 6,147 6,825
Other assets .................................................................. 2,647 3,089
----------- ----------
Total assets ...................................................... $ 285,741 $ 427,358
=========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses .................................... $ 45,637 $ 43,491
Due to WorldCom .......................................................... 4,346 4,475
Current portion of deferred liabilities .................................. 6,668 7,572
Current portion of note payable .......................................... 57 56
Current portion of notes payable to Intermedia ........................... 10,900 ----
Current portion of capital lease obligations ............................. 5,670 5,675
----------- ----------
Total current liabilities ......................................... 73,278 61,269
Deferred liabilities .......................................................... 3,879 4,257
Notes payable ................................................................. 3,329 3,208
Notes payable to Intermedia ................................................... 101,300 90,000
Capital lease obligations ..................................................... 27,129 29,477
----------- ----------
Total liabilities ................................................. 208,915 188,211
----------- ----------
Commitments and contingencies
Redeemable preferred stock, $.01 par value; 5,000,000 shares authorized;
100,000 shares designated as Series A Convertible; 50,000 and
100,000 Series A Convertible shares issued and outstanding in 2002
and 2001, respectively (aggregate liquidation preference of $50,000) ..... 44,049 81,503
Stockholders' equity:
Class A common stock, $.01 par value; 100,000,000 shares authorized;
25,519,461 and 24,788,466 shares issued and outstanding in 2002
and 2001, respectively ............................................... 255 248
Class B common stock, $.01 par value; 50,000,000 shares authorized;
39,350,000 shares issued and outstanding in 2002 and 2001 ............ 394 394
Additional capital ....................................................... 588,126 545,020
Accumulated deficit ...................................................... (553,267) (384,328)
Deferred compensation .................................................... (2,610) (3,448)
Accumulated other comprehensive loss ..................................... (121) (242)
----------- ----------
Total stockholders' equity ........................................ 32,777 157,644
----------- ----------
Total liabilities and stockholders' equity ........................ $ 285,741 $ 427,358
=========== ==========
See accompanying notes to consolidated financial statements.
4
DIGEX, INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
Unaudited (Amounts in thousands)
Six Months Ended
June 30,
----------------------------
2002 2001
------------- -------------
Operating activities:
Net loss ............................................................... $ (168,939) $ (91,542)
Adjustments to reconcile net loss to cash used in operating activities:
Depreciation and amortization ........................................ 82,307 61,890
Impairment loss ...................................................... 56,990 ----
Provision for doubtful accounts ...................................... 2,005 7,499
Provision for doubtful accounts for WorldCom ......................... 18,578 ----
Amortization of deferred compensation ................................ 993 1,806
Accretion of interest on note payable and capital lease
obligations ........................................................ 150 56
Changes in operating assets and liabilities:
Accounts receivable .................................................. 5,007 (6,733)
Due from WorldCom, net ............................................... (7,137) 1,310
Deferred costs ....................................................... 848 942
Prepaid expenses and other current assets ............................ 3,764 330
Notes receivable from employees ...................................... 678 ----
Other assets ......................................................... 442 1,407
Accounts payable and accrued expenses ................................ 2,146 3,510
Deferred liabilities ................................................. (1,282) (2,162)
---------- ----------
Net cash used in operating activities .................................. (3,450) (21,687)
Investing activities:
Purchases of property and equipment .................................... (23,046) (62,428)
Purchase of restricted investments ..................................... (18) (1,158)
Proceeds from sale of property and equipment ........................... 261 313
---------- ----------
Net cash used in investing activities .................................. (22,803) (63,273)
Financing activities:
Proceeds from issuances of notes payable ............................... 22,200 15,300
Proceeds from exercises of common stock options ........................ ---- 2,084
Principal payment on long-term note payable and capital lease
obligations .......................................................... (3,352) (922)
---------- ----------
Net cash provided by financing activities .............................. 18,848 16,462
Effect of exchange rate on cash and cash equivalents ...................... 121 (206)
---------- ----------
Net decrease in cash and cash equivalents ................................. (7,284) (68,704)
Cash and cash equivalents at beginning of period .......................... 12,096 83,434
---------- ----------
Cash and cash equivalents at end of period ................................ $ 4,812 $ 14,730
========== ==========
Supplemental disclosures of cash flow information:
Interest paid .......................................................... $ 4,489 $ 1,299
Assets purchased with equipment credits granted in connection with
the issuance of preferred stock ..................................... 5,503 1,087
Assets acquired through capital leases ................................. 995 1,285
See accompanying notes to consolidated financial statements.
5
DIGEX, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Basis of Presentation
The accompanying consolidated financial statements have been prepared by
Digex, Incorporated without audit, pursuant to the rules and regulations of the
Securities and Exchange Commission (the "SEC"). Certain information and footnote
disclosures normally included in financial statements prepared in accordance
with generally accepted accounting principles ("GAAP") have been omitted
pursuant to such rules and regulations. The unaudited consolidated financial
statements should be read in conjunction with the Form 10-K of Digex for the
year ended December 31, 2001, including the audited consolidated financial
statements and related notes and the section entitled "Risk Factors."
The accompanying unaudited consolidated financial statements include the
accounts of Digex and its wholly-owned subsidiaries. All significant
intercompany accounts and transactions have been eliminated in consolidation.
Certain prior period amounts have been reclassified to conform to the current
period presentation. For example, specific line items related to WorldCom, such
as the provision for doubtful accounts and accounts receivable, have been
presented.
The accompanying unaudited consolidated financial statements reflect, in the
opinion of management, all adjustments, which are of a normal and recurring
nature, necessary for a fair presentation of the financial condition and results
of operations and cash flows for the periods presented. The preparation of
financial statements in accordance with GAAP requires management to make
estimates and assumptions. Such estimates and assumptions affect the reported
amounts of assets and liabilities, as well as the disclosure of contingent
assets and liabilities at the date of the financial statements and the reported
amounts of revenue and expenses during the reporting period. Actual results
could differ from those estimates. The results of operations for the interim
periods are not necessarily indicative of the results for the entire year.
On July 1, 2001, pursuant to the terms of the agreement and plan of merger,
dated September 1, 2000, and the amendments thereto, a wholly-owned subsidiary
of WorldCom, Inc. was merged with and into Intermedia Communications Inc. with
Intermedia continuing as the surviving corporation and as a subsidiary of
WorldCom (the "Intermedia - WorldCom Merger"). As a result of the Intermedia -
WorldCom Merger, WorldCom now owns all of the capital stock of Intermedia, other
than the 13-1/2% series B preferred stock, and approximately 90.0% of the voting
securities of Intermedia. Therefore, WorldCom has acquired an indirect
controlling interest of Digex through Intermedia as Intermedia continues to own
approximately 60.7% of Digex's equity interests and controls 93.9% of Digex's
voting interests, calculated based on total common stock outstanding, as of June
30, 2002.
In connection with the Intermedia - WorldCom Merger and the settlement of
related litigation, WorldCom and Digex have entered into a series of operating
and funding agreements under which Digex sells hosting services to WorldCom, may
borrow to satisfy cash requirements, and purchases certain telecommunication
services from WorldCom. These agreements are discussed in more detail in Note 7
"Related Party Agreements" to the consolidated financial statements.
Refer also to Note 2 "Recent Events related to WorldCom and Digex."
6
DIGEX, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)
2. Recent Events related to WorldCom and Digex
There have been a number of internal and external events which have
impacted Digex in the last three months. Some of the significant events include:
o On June 21, the Board replaced the Digex President and Chief Executive
Officer (CEO), naming George L. Kerns, the former Senior Vice
President of Service Delivery & Operations as the new President and
CEO.
o On June 24, T. Scott Zimmerman was named Digex Chief Financial Officer
(CFO), after having served as interim CFO for approximately 6 months.
o On June 25, WorldCom announced that it had fired its CFO and would have
to restate certain financial statements from 2001 and the first
quarter of 2002 to reflect as operating expenditures approximately
$3.9 billion of expenses previously accounted for as capital
expenditures.
o On June 27, Digex announced a reduction of 86 positions, or
approximately 7.0% of the overall workforce. The initiative resulted
from an overall long-term effort to align expenses with revenues,
focusing on the ability to leverage efficiencies and eliminate
functions not core to the business.
o On July 12, the three non-WorldCom members of the Digex board of
directors resigned.
o On July 21, WorldCom and many of its domestic affiliates, but not
including Digex, filed a petition for reorganization in the federal
bankruptcy court in New York.
o On July 22, the bankruptcy court approved an interim credit agreement
between WorldCom and certain banks, which allows WorldCom to continue
to make investments in Digex up to $10.0 million per month.
o On August 6, Digex announced a reduction of approximately 200 positions
or about 20.0% of its workforce. These efforts are part of an overall
plan for Digex to become financially self-sustaining, and to align and
focus resources on servicing its customer base.
o On August 8, WorldCom announced that it would have further
multi-billion dollar restatements of its financial statements for
prior years.
7
DIGEX, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)
Throughout these events, Digex has been focusing on three top
priorities--financial independence by becoming self-sustaining from an operating
and capital expenditures perspective, a renewed focus on its customers, and
expansion of the Digex value proposition for current and prospective customers.
The workforce reductions of June and August were part of Digex's efforts to
bring expenses into line with revenues in the present economic environment. At
the same time, Digex is taking steps to minimize the amount of capital required
to deliver customer solutions by implementing customer furnished equipment
offerings along with third party leasing options. Digex remains committed to
retaining its market position and providing quality hosting solutions and
services, and believes that the plan provides Digex with the best opportunity to
succeed in the marketplace. Since June 25, Digex has been making efforts to
obtain insurance coverages that are separate from any coverage available through
WorldCom. Such coverages may be critical to Digex's prospects, and there can be
no assurances that Digex will be successful in obtaining the necessary
coverages. Digex is also making efforts to replace its independent directors.
Since WorldCom's bankruptcy filing on July 21, 2002, it loaned to Digex through
Intermedia an amount of $5.9 million through August 14, 2002. Although WorldCom
has permission under its interim credit agreement to loan Digex up to $10.0
million per month, there can be no assurance that WorldCom will continue making
loans to Digex.
With respect to Digex's cash requirements, Digex currently projects
continued significant losses and operating cash flow deficits. Digex remains
dependent on WorldCom to fund its operating cash flow deficits and capital
expenditures. Actual funding through June 30, 2002 was $22.2 million,
substantially less than forecasted under the Digex original 2002 business plan.
The ultimate amount of borrowings can be affected by WorldCom's bankruptcy,
changes in the economy, and Digex's ability to execute its business plan, among
other factors. Further, as of June 30, 2002, approximately $52.8 million in
notes payable and capital lease obligations come due in 2003. Digex currently
believes that some or all of these obligations will need to be restructured.
There can be no assurance that these obligations will be restructured or that
WorldCom will provide Digex with any additional funding. Digex believes that
funding from any source other than WorldCom on appropriate or commercially
acceptable terms is currently unavailable.
The impact of the above events on Digex remains unclear. Digex cannot
predict what will happen at WorldCom, nor can it predict the impact of events at
WorldCom on Digex. Further, it cannot predict how its customers, vendors,
employees and strategic partners, will react to the unfolding events. If any of
those entities react negatively to the events or perceptions generated from
those events, whether accurate or not, then Digex may be significantly and
negatively impacted, and its ability to execute on its plans may be
substantially impaired.
Although no assurances can be given, management believes that Digex has the
ability to continue as a going concern unless WorldCom's bankruptcy filing
impacts any necessary future borrowings to fund Digex's business operations. The
preparation of the Digex business plan for 2003 is currently underway and is
expected to be submitted to the WorldCom and Digex's boards of directors for
approval, as described in Note 7 "Related Party Agreements" to the consolidated
financial statements. Nonetheless, because of recent events surrounding
WorldCom, and the lack of certainty that WorldCom will be able to continue to
fund Digex, there is substantial doubt about Digex's ability to continue as a
going concern over the next twelve months, unless the above referenced events
stabilize. A substantial doubt about an entity's ability to continue as a going
concern exists when the entity is unable to continue to meet its obligations as
they become due without substantial disposition of assets outside the ordinary
course of business, restructuring of debt, externally forced revisions of its
operations, or similar actions for a reasonable period of time, not to exceed
one year beyond the date of the financial statements. The accompanying financial
statements do not reflect any adjustments to the carry value of its net assets
or the amount and classification of its liabilities in the event Digex is not
able to continue as a going concern.
8
DIGEX, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)
3. Recent Accounting Pronouncements
Goodwill and Other Intangible Assets
In June 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and Other
Intangible Assets. Under the new rules, goodwill and intangible assets deemed to
have indefinite lives are no longer amortized but are subject to impairment
tests at least once a year based upon estimated fair value. Digex adopted the
provisions of SFAS No. 142, effective January 1, 2002, and ceased amortization
of amounts assigned to goodwill and acquired workforce. Depreciation and
amortization expense, excluding the amortization of goodwill and acquired
workforce, in the second quarter of 2001 was $31.9 million. The net book value
of goodwill and acquired workforce at June 30, 2002 was approximately $11.9
million.
The following table reconciles reported net loss available to common
stockholders and loss per share to adjusted net loss available to common
stockholders and loss per share, excluding the goodwill and acquired workforce
amortization previously recognized (in thousands):
Three months ended Six months ended
June 30, June 30,
----------------------------- -------------------------------
2002 2001 2002 2001
------------ ------------- ------------ ---------------
Net loss available to common stockholders, as
reported ....................................... $ (119,006) $ (48,329) $ (170,448) $ (93,555)
Add: Goodwill and acquired workforce
amortization ................................... ---- 540 ---- 1,080
------------ ------------- ------------ ---------------
Adjusted net loss ................................ $ (119,006) $ (47,789) $ (170,448) $ (92,475)
============ ============= ============ ===============
Loss per common share--basic and diluted:
Net loss available to common stockholders, as
reported ....................................... $ (1.83) $ (0.76) $ (2.64) $ (1.47)
Add: Goodwill and acquired workforce
amortization ................................... ---- 0.01 ---- 0.02
------------ ------------- ------------ ---------------
Adjusted net loss ................................ $ (1.83) $ (0.75) $ (2.64) $ (1.45)
============ ============= ============ ===============
9
DIGEX, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)
Digex completed its fair value assessment of goodwill as of January 1, 2002
and determined that goodwill was not impaired. However, given the decrease in
Digex's market capitalization since January 1, 2002 and the uncertainty created
by WorldCom's recent announcements of its intention to restate its financial
statements, as described above, management reassessed the recoverability of its
goodwill as of June 30, 2002 pursuant to SFAS No. 142. Pursuant to an
independent appraisal, Digex determined that goodwill was not impaired as of
June 30, 2002. Digex has elected to assess impairment of goodwill annually as of
July 1st, unless events or changes in circumstances indicate a more frequent
review is necessary. Any impairment then identified would be recorded in
operations in the period in which the impairment is identified.
Impairment of Long-Lived Assets
In August 2001, the FASB issued SFAS No. 144, Impairment or Disposal of
Long-Lived Assets, which supercedes both No. 121, Impairment of Long-Lived
Assets for Long-Lived Assets to be Disposed Of, and the accounting and reporting
provisions for the disposal of a segment of a business contained in Accounting
Principle Board (APB) Opinion No. 30, Reporting the Results of Operations -
Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary,
Unusual and Infrequently Occurring Events and Transactions. Digex has adopted
the provisions of SFAS No. 144 as of January 1, 2002.
Under SFAS No. 144, Digex reviews its long-lived assets for impairment when
events or changes in circumstances indicate the carrying value of such assets
may not be recoverable. The review consists of a comparison of the carrying
value of the assets with the assets' 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 undiscounted cash flow exceeds the carrying
value of the asset, no impairment indicator is considered present. If the
carrying value exceeds the future undiscounted cash flow, an impairment
indicator is considered present. The amount of impairment may be measured using
discounted cash flows or other means of determining fair value.
The events surrounding WorldCom, as described above, resulted in management
revising its estimates of future financial projections. Digex has also performed
an undiscounted cash flow analysis related to its long-lived assets. The result
of that analysis indicates that an impairment to the carrying value of its fixed
assets and other intangible assets may exist as of June 30, 2002. Based upon an
independent appraisal, Digex has adjusted its long-lived assets down to fair
value. An impairment loss related to its property and equipment of $55.4 million
and identifiable intangible assets of $1.6 million has been included in the
results of operations for the three months and six months ended June 30, 2002.
Should Digex fail to meet its operating budget during the balance of 2002,
management's estimates of future cash flows may be further adjusted downward.
Such downward adjustments could trigger a further impairment of Digex's
long-lived assets.
10
DIGEX, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)
Accounting for Costs Associated with Exit or Disposal Activities
In July 2002, the FASB has issued SFAS No. 146, Accounting for Costs
Associated with Exit or Disposal Activities, which supercedes Emerging Issues
Task Force (EITF) Issue No. 94-3, Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring), to be applied prospectively to exit or
disposal activities initiated after December 31, 2002, with early adoption
permitted.
SFAS No. 146 requires companies to recognize costs associated with exit or
disposal activities when they are incurred rather than at the date of a
commitment to an exit or disposal plan. Costs covered by the standard include
lease termination costs and certain employee severance costs that are associated
with a restructuring, discontinued operation, plant closing, or other exit or
disposal activity. Digex does not expect the adoption of SFAS No. 146 to have a
material impact on its consolidated results of operations or financial position.
4. Comprehensive Loss
The following table reflects the calculation of comprehensive loss (in
thousands):
Three months ended Six months ended
June 30, June 30,
----------------------------- ----------------------------
2002 2001 2002 2001
------------ ------------- ------------ ------------
Net loss available to common stockholders ........ $ (119,006) $ (48,329) $ (170,448) $ (93,555)
Other comprehensive loss:
Foreign currency translation adjustments ....... 99 (121) 121 (206)
------------ ------------- ------------ ------------
Comprehensive loss available to common
stockholders ................................... $ (118,907) $ (48,450) $ (170,327) $ (93,761)
============ ============= ============ ============
5. Commitments and Contingencies
In 2001, Digex entered into master lease and financing agreements with two
vendors for lines of credit to facilitate the leasing of computer hardware and
software. The terms of the associated schedules range from 12 months for
financing a maintenance contract to 36 months for leasing computer equipment.
Digex will have an option to purchase the equipment at the end of the initial
lease term. Interest and principal are payable monthly with interest rates
ranging from 7.2% to 12.3% per annum. As of June 30, 2002 and December 31, 2001,
Digex had acquired $11.9 million and $11.0 million of computer equipment and
maintenance services under these leasing and financing arrangements,
respectively.
11
DIGEX, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)
Digex is also indebted to Intermedia as discussed in Note 7 "Related Party
Agreements" to the consolidated financial statements.
On August 1, 2002, the law firm of Richards Layton & Finger ("Richards
Layton") requested that the Delaware Chancery Court enter judgment against Digex
for payment of success bonuses of $500,000 apiece to Richards Layton and a
second law firm, Cahill Gordon & Reindel ("Cahill Gordon"), in connection with
their representation of the Special Committee of the Digex board of directors in
In re Digex, Inc. Shareholders Litigation, Consolidated Civil Action No. 18336
(Del. Ch.) (the "Shareholder Action"). The requested order would modify the
court's order of July 29, 2002 (the "Order"), which requires WorldCom to pay
approximately $1.9 million to reimburse certain expenses approved by the Special
Committee pursuant to the settlement of the Shareholder Action, including the
success bonuses for Richards Layton and Cahill Gordon. Insofar as the bankruptcy
of WorldCom prevents immediate enforcement of the Order against WorldCom,
Richards Layton has sought the requested modification to obtain payment directly
from Digex. Digex opposes Richards Layton's request on the grounds that (i) the
court has not conclusively decided whether Digex is independently liable for the
fees approved by the Special Committee in the absence of reimbursement by
WorldCom and (ii) the proceedings relating to enforcement of WorldCom's
settlement obligations do not present the appropriate context or forum to
resolve that issue. Counsel for the plaintiffs in the Shareholder Action also
opposes the request. The court currently has the matter under advisement.
It cannot be determined at this time when the court will rule on Richards
Layton's request or what its ruling will be. Because the pendency of the
WorldCom bankruptcy makes it unlikely that WorldCom will be able to honor its
obligation to pay the $1.0 million in fees, an order that requires Digex to pay
that $1.0 million directly would impose a significant additional cash burden on
Digex. In order to meet that burden, Digex would be required to seek additional
borrowings from WorldCom under its debtor-in-possession financing of Digex.
There is no assurance that debtor-in-possession financing will continue to be
available from WorldCom to fund any payments that Digex might be ordered to make
to the law firms.
6. Restructuring Charges
In June 2002, Digex terminated the employment of 86 employees, or
approximately 7.0% of its overall workforce, in an effort to streamline
expenses. In connection with the reduction in its employee base, Digex also
vacated certain excess office space. Digex recognized a liability for the
estimated amount of future rent payments for permanently vacated properties and
the estimated amount of lease termination fees. During the three months ended
June 30, 2002, Digex recorded a restructuring charge of $1.4 million in its
results of operations. The restructuring charge represents severance benefits
for terminated employees of $0.9 million and exit costs related to early
terminated real property leases of $0.5 million. These amounts have not been
paid as of June 30, 2002.
7. Related Party Agreements
WorldCom
In connection with the Intermedia - WorldCom Merger and the settlement of
related litigation, Digex and certain subsidiaries of WorldCom have entered into
four commercial agreements, including a sales channel agreement, funding
agreement, facilities agreement, and network agreement. Except for the funding
agreement, these agreements run through December 31, 2003 and permit either
party to request for a 12-month extension from the initial term, provided that
written notice be given to the other party by December 31, 2002 for the initial
extension. The four agreements are also subject to termination by either party
upon insolvency of the other. There can be no assurance that changes to the
commercial agreements will not be made, or that WorldCom will be in a position
to honor the terms of the commercial agreements, as WorldCom's bankruptcy filing
progresses. The principal terms of the agreements are as follows:
Sales Channel Agreement. Effective January 1, 2001, WorldCom agreed to
purchase the Digex portfolio of managed Web hosting products for resale to
WorldCom customers. If Digex satisfies certain service level and data center
capacity commitments, WorldCom has agreed to purchase up to a total of $500.0
million during the period from 2001 through 2003. WorldCom has agreed to
purchase $50.0
12
DIGEX, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)
million and $192.0 million of managed hosting services in 2001 and 2002,
respectively. WorldCom has agreed to purchase, in 2003, a minimum amount of
managed hosting services equal to the lesser of $260.0 million or an amount
equal to four times the actual services purchased by WorldCom for resale in the
fourth quarter of 2002 ("the Minimum Annual Commitment"). WorldCom also agreed
to compensate Digex, on a quarterly basis, for the full amount of operating
losses before depreciation and amortization incurred in servicing WorldCom
customers under the sales channel agreement, during 2001. However, in 2001 and
thereafter, to the extent that Digex generates operating income before
depreciation and amortization in servicing WorldCom customers under the sales
channel agreement, Digex has agreed to share such operating income with
WorldCom. WorldCom's participation in operating results is recognized as
adjustments to revenue recognized under the sales channel agreement.
Total revenues from WorldCom under the sales channel agreement include (1)
actual managed hosting services purchased for resale by WorldCom and (2) for
each three month period ended December 31 during the term of the sales channel
agreement, the difference, if any, between actual managed hosting services
purchased by WorldCom and WorldCom's Minimum Annual Commitment. These amounts
are further adjusted for compensation due to or due from WorldCom as discussed
above based upon the net results of activity under the sales channel agreement.
Digex recognized revenue from WorldCom of $16.2 million and $27.1 million
for the three and six months ended June 30, 2002, respectively, under the sales
channel agreement. All revenue recognized under the sales channel agreement in
2002 resulted from actual managed hosting services purchased for resale by
WorldCom. Digex expects to recognize revenue from WorldCom using cash basis
accounting in the foreseeable future, which could have a material impact on
future reported revenue. Deferred revenue will reflect that which has been
billed to WorldCom for those underlying customers but not yet received in cash.
Amounts due from WorldCom as of June 30, 2002 have been reflected net of a
reserve for doubtful accounts. Digex has reserved all receivables due from
WorldCom which were not collected subsequent to June 30, 2002 as a result of
WorlCom's filing for bankruptcy. Revenues from the sales channel agreement may
be adversely affected by WorldCom's bankruptcy filing.
Funding Agreement. Refer to "Borrowings from Related Parties" below.
Facilities Agreement. Effective January 1, 2001, managed Web hosting
facilities for Digex were built and may continue to be built in several WorldCom
data centers in the United States and around the world. Digex has leased space
from WorldCom at these data centers based on customer demand. The expense for
the data center space and connections from the space to a WorldCom Internet
Protocol network hub amounted to $1.0 million and $1.6 million for the three and
six months ended June 30, 2002, respectively. Expenses were not incurred for
these services until the third quarter of 2001.
Network Agreement. This agreement, effective January 1, 2001, provides
terms for Digex to purchase bandwidth and connectivity from WorldCom in the
United States to support its managed Web hosting activities. The expense for the
dedicated Internet connections and WorldCom network services amounted to $1.1
million and $1.7 million for the three and six months ended June 30, 2002,
respectively, and $1.4 million and $3.0 million for the three and six months
ended June 30, 2001, respectively.
13
DIGEX, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)
WorldCom also provides certain operational services to Digex under vendor
contracts or agreements in the ordinary course of business, such as facilities,
telephone, software maintenance, and other circuit related services. The
following table reflects charges related to services provided by WorldCom in the
ordinary course of business to Digex (in thousands):
Three months ended Six months ended
June 30, June 30,
----------------------------- -----------------------------
2002 2001 2002 2001
------------ ------------- ------------ -------------
Other circuit related expense ...... $ 1,601 $ 2,175 $ 3,301 $ 3,837
Telephone expense .................. 1,034 332 1,768 1,325
Rent expense ....................... 332 ---- 787 ----
Network maintenance expense ........ 525 ---- 1,050 ----
------------ ------------- ------------ -------------
$ 3,492 $ 2,507 $ 6,906 $ 5,162
============ ============= ============ =============
In January 2002, Digex entered into an affiliates facilities agreement,
effective July 1, 2001, with WorldCom, which permits Digex to rent general
office space from WorldCom at certain facilities. The agreement expires when
Digex ceases to be an affiliate of WorldCom, unless earlier terminated by either
party. Rent expense for office space attributed to this agreement is included in
the rent expense for 2002 presented above.
Borrowings from Related Parties
On July 31, 2001, Digex entered into a note purchase agreement with
WorldCom whereby WorldCom agreed to provide funding for the Digex business
plans for 2001 and 2002 as approved by the Digex and WorldCom boards of
directors. The Digex and WorldCom boards of directors have approved the Digex
business plans for 2001 and 2002. The preparation of the Digex business plan for
2003 is currently underway and is expected to be submitted to the WorldCom and
Digex's boards of directors for approval no later than December 1, 2002. Subject
to the terms and conditions of the agreement, Digex will issue and WorldCom will
purchase (or cause an affiliate to purchase) a series of senior notes up to an
aggregate principal amount sufficient to satisfy Digex's net cash requirements
under the approved business plan. Given WorldCom's bankruptcy filing, there can
be no assurance that WorldCom will honor its contractual commitments to Digex.
See Note 2 "Recent Events related to WorldCom and Digex." Interest on the unpaid
principal balance is payable monthly at a rate equal to LIBOR plus 300 basis
points. Repayment of principal is due on December 31, 2002, but may be extended
to December 31, 2006 upon the election of Digex by written notice. Management
intends to make this election by December 2002, at which time amounts then
outstanding will be repaid in equal monthly straight-line amortization payments
of principal through December 31, 2006. As a result, all payments after the
election due in periods after June 30, 2003 have been classified as long-term.
Any changes to its business plans that require increased funding would require
the WorldCom board of directors' approval before WorldCom would be obligated to
fund any such increase.
14
DIGEX, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)
As of June 30, 2002 and December 31, 2001, Digex issued and WorldCom caused
Intermedia to purchase a series of senior notes totaling $87.2 million and $65.0
million, respectively, to satisfy Digex's net cash requirements under its
approved 2002 and 2001 business plans. Through June 30, 2002, variable interest
on the unpaid principal balance was paid monthly at an interest rate of 300
basis points over LIBOR rate (weighted average interest rate of 5.05%). Interest
cost incurred and charged to expense related to the funding agreement with
WorldCom was $1.1 million and $1.9 million for the three and six months ended
June 30, 2002, respectively. Interest cost incurred and charged to expense
related to the funding agreement with WorldCom was $0.04 million for the three
and six months ended June 30, 2001.
On January 14, 2002, Digex entered into a note purchase agreement, dated
July 31, 2001, with Intermedia to refinance the $13.0 million intercompany loan
and $12.0 million promissory note to Intermedia under a series of senior notes
totaling $25.0 million. The terms of the agreement are substantially the same as
the original note purchase agreement, dated July 31, 2001 between Digex and
WorldCom, with the repayment of principal due on December 31, 2003. There is no
option to extend the maturity date of the notes. Through June 30, 2002, variable
interest on the unpaid principal balance was paid monthly at an interest rate of
300 basis points over LIBOR rate (weighted average interest rate of 5.29%).
Interest cost incurred and charged to expense related to the funding agreement
with Intermedia was $0.3 million and $0.6 million for the three and six months
ended June 30, 2002, respectively.
Management intends to seek to renegotiate the maturity dates of the note
purchase agreements with WorldCom and Intermedia as a result of WorldCom's
filing for reorganization. There can be no assurance that management will be
able to do so.
Notes Receivable from Employees
Digex made personal loans to various executive officers and employees in
November 2001 and February 2002. Amounts outstanding, net of reserves for
doubtful accounts, are $6.1 million and $6.8 million as of June 30, 2002 and
December 31, 2001, respectively. Interest accrues on these loans at a rate of
3.82% per annum. Principal and accrued interest on the loan is payable in full
on the earlier of (1) November 1, 2003 and (2) the termination of employment of
such officer or employee with Digex for any reason, including termination by
Digex with or without cause, termination as a result of death or disability,
resignation for any reason or termination resulting from constructive discharge.
Since March 31, 2002, personal loans to officers have not occurred
and are not permitted.
Digex also entered into retention bonus agreements with certain of its
executive officers and employees. Under the agreements, each such officer or
employee (or his or her estate) is entitled to receive the amounts (1) if he or
she is actively employed with Digex through and including November 1, 2003 or
(2) if prior to that time Digex terminates his or her employment without cause
or his or her employment is terminated as a result of death or permanent
disability. No officer or employee is entitled to the retention bonus under this
agreement, or any pro rata portion thereof, if his or her employment terminates
prior to November 1, 2003 by reason of termination for cause, resignation for
any reason or termination resulting from constructive discharge by Digex. As of
June 30, 2002, the potential retention bonus pool payable in 2003 under these
agreements totaled $12.3 million.
15
DIGEX, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)
8. Stockholders' Equity
On April 1, 2002, Microsoft converted its 50,000 shares of Series A
convertible preferred stock into 730,995 shares of Digex Class A common stock.
Subsequent to the conversion, Microsoft has given some indication that it may
seek to rescind the conversion. Digex believes that the conversion was proper in
all respects.
Prior to conversion into common stock on April 1, 2002, Microsoft's
redeemable preferred stock, was classified outside of stockholders' equity. Upon
conversion into common stock, the then carrying amount of the redeemable
preferred stock of approximately $44.5 million was recorded as a component of
stockholders' equity. A component of the then carrying value of Microsoft's
redeemable preferred stock was a discount that had been recorded upon the
original issuance of the preferred stock. That discount was being accreted into
net loss available to common stockholders through additional capital on the
consolidated balance sheets. After the conversion, neither further accretion of
the preferred stock discount will be recorded nor will the preferred stock be
subject to future redemption or conversion.
Digex does not anticipate paying any dividends on any of its common stock
in the foreseeable future. Moreover, Digex is subject to restrictions under the
Intermedia indentures, which restrict any subsidiary of Intermedia from paying
dividends unless Intermedia meets certain financial tests. Intermedia does not
currently meet and is not expected to meet these financial tests in the
foreseeable future. Therefore, Digex is effectively prohibited from paying
dividends. Digex may also incur indebtedness in the future, which may prohibit
or effectively restrict the payment of dividends.
9. Subsequent Events
In accordance with the Digex Long-Term Incentive Plan, all stock options
granted to participants who were employed by Digex as of July 1, 2001, the
consummation date of the Intermedia - WorldCom Merger, will become fully vested
on July 1, 2002 through a provision for accelerated vesting upon a change of
control of Digex. Accordingly, deferred compensation of $2.6 million as of June
30, 2002 for options granted with exercise prices at less than fair market value
will be expensed in the third quarter of 2002.
In July 2002, WorldCom caused Intermedia to purchase a series of senior
notes totaling $10.0 million from Digex under the note purchase agreement.
Through June 30, 2002, variable interest on the unpaid principal balance was
paid monthly at an average interest rate of 5.05% per annum. Repayment of
principal is due on December 31, 2002, unless otherwise extended at the election
of Digex.
On August 6, 2002, Digex announced a reduction of approximately 200
positions or about 20% of its workforce. These efforts are part of an overall
plan for Digex to become financially self-sustaining, and to align and focus
resources on servicing its customer base by eliminating certain positions
primarily in its non-service delivery organizations. Severance costs and related
benefits for these terminated employees are approximately $1.5 million. No
formal plans have been adopted by management for any additional
restructuring activities.
16
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion should be read in conjunction with the unaudited
consolidated financial statements and related notes herein, and with the
Management's Discussion and Analysis of Financial Condition and Results of
Operations and audited consolidated financial statements and related notes
included in Digex's Form 10-K, as filed with the SEC on April 1, 2002.
Overview
We are a provider of advanced hosting services for companies conducting
business on the Internet. Our services include server management, application
support, managed networking services, and customer care and support services. We
also offer value-added IT services, such as enhanced security, database
services, high-availability and application optimization services, stress
testing, and consulting services. As part of our services, we provide the
installation and maintenance of computer hardware and software, network
technology, and systems management to offer our customers a broad range of
managed hosting solutions. From major corporations to Internet-based businesses,
our customers use our services to rapidly deploy their business solutions
including on-line financial services, on-line procurement, electronic retailing,
and customer self-service applications.
Recent Events
There have been a number of internal and external events which have
impacted us in the last three months. Some of the significant events include:
o On June 21, the Board replaced the Digex President and Chief Executive
Officer (CEO), naming George L. Kerns, the former Senior Vice
President of Service Delivery & Operations as the new President and
CEO.
o On June 24, T. Scott Zimmerman was named Digex Chief Financial Officer
(CFO), after having served as interim CFO for approximately 6 months.
o On June 25, WorldCom announced that it had fired its CFO and would have
to restate certain financial statements from 2001 and the first quarter
of 2002 to reflect as operating expenditures approximately $3.9 billion
of expenses previously accounted for as capital expenditures.
o On June 27, we announced a reduction of 86 positions, or approximately
7.0% of the overall workforce. The initiative resulted from an overall
long-term effort to align expenses with revenues, focusing on the
ability to leverage efficiencies and eliminate functions not core to
the business.
o On July 12, the three non-WorldCom members of our board of directors
resigned.
o On July 21, WorldCom and many of its domestic affiliates, but not
including Digex, filed a petition for reorganization in the federal
bankruptcy court in New York.
o On July 22, the bankruptcy court approved an interim credit agreement
between WorldCom and certain banks, which allows WorldCom to continue
to make investments in Digex up to $10.0 million per month.
o On August 6, we announced a reduction of approximately 200 positions
or about 20.0% of our workforce. These efforts are part of an overall
plan for us to become financially self-sustaining, and to align and
focus resources on servicing our customer base.
o On August 8, WorldCom announced that it would have further
multi-billion dollar restatements of its financial statements for
prior years.
17
Throughout these events, we have been focusing on three top
priorities--financial independence by becoming self-sustaining from an operating
and capital expenditures perspective, a renewed focus on our customers, and
expansion of the Digex value proposition for current and prospective customers.
The workforce reductions of June and August were part of our efforts to bring
expenses into line with revenues in the present economic environment. At the
same time, we are taking steps to minimize the amount of capital required to
deliver customer solutions by implementing customer furnished equipment
offerings along with third party leasing options. We remain committed to
retaining our market position and providing quality hosting solutions and
services, and believe that the plan provides us with the best opportunity to
succeed in the marketplace. Since June 25, we have been making efforts to obtain
insurance coverages that are separate from any coverage available through
WorldCom. Such coverages may be critical to our prospects, and there can be no
assurances that we will be successful in obtaining the necessary coverages. We
are also making efforts to replace our independent directors. Since its
bankruptcy filing on July 21, 2002, WorldCom has loaned to Digex through
Intermedia an amount of $5.9 million through August 14, 2002. Although WorldCom
has permission under its interim credit agreement to loan Digex up to $10.0
million per month, there can be no assurance that WorldCom will continue making
loans to Digex.
With respect to our cash requirements, we currently project continued
significant losses and operating cash flow deficits. We remain dependent on
WorldCom to fund our operating cash flow deficits and capital expenditures.
Actual funding through June 30, 2002 was $22.2 million, substantially less than
forecasted under the Digex original 2002 business plan. The ultimate amount of
borrowings can be affected by WorldCom's bankruptcy, changes in the economy, and
our ability to execute our business plan, among other factors. Further, as of
June 30, 2002, approximately $52.8 million in notes payable and capital lease
obligations come due in 2003. We currently believe that some or all of these
obligations will need to be restructured. There can be no assurance that these
obligations will be restructured or that WorldCom will provide us with any
additional funding. We believe that funding from any source other than WorldCom
on appropriate or commercially acceptable terms is currently unavailable.
The impact of the above events on Digex remains unclear. We cannot predict
what will happen at WorldCom, nor can we predict the impact of events at
WorldCom on Digex. Further, we cannot predict how our customers, vendors,
employees and strategic partners, will react to the unfolding events. If any of
those entities react negatively to the events or perceptions generated from
those events, whether accurate or not, then we may be significantly and
negatively impacted, and our ability to execute on our plans may be
substantially impaired.
Although no assurances can be given, management believes that we have the
ability to continue as a going concern unless WorldCom's bankruptcy filing
impacts any necessary future borrowings to fund our business operations. The
preparation of the Digex business plan for 2003 is currently underway and is
expected to be submitted to the WorldCom and Digex's boards of directors for
approval, as described in the accompanying consolidated financial statements.
Nonetheless, because of recent events surrounding WorldCom, and the lack of
certainty that WorldCom will be able to continue to fund us, there is
substantial doubt about our ability to continue as a going concern over the next
twelve months, unless the above referenced events stabilize. A substantial doubt
about an entity's ability to continue as a going concern exists when the entity
is unable to continue to meet its obligations as they become due without
substantial disposition of assets outside the ordinary course of business,
restructuring of debt, externally forced revisions of its operations, or similar
actions for a reasonable period of time, not to exceed one year beyond the date
of the financial statements. The accompanying financial statements do not
reflect any adjustments to the carry value of our net assets or the amount and
classification of our liabilities in the event we are not able to continue as a
going concern.
Related Party Transactions
WorldCom is our majority stockholder, primary lender, significant channel
partner, and one of our largest vendors. In particular, under the funding
agreement and subject to the bankruptcy proceedings,
18
WorldCom is obligated to provide funding for the approved Digex business
plan through 2002 only. WorldCom will then have an option to continue funding us
beyond 2002, but may not exercise such option. Through 2002, we anticipate that
our only source to fund our working capital needs and capital expenditure
requirements will be WorldCom.
At June 30, 2002, we served approximately 690 customers, of which
approximately 280 customers are WorldCom channel customers. We also managed
3,827 Windows- and UNIX-based servers in our data centers, which are positioned
on the east and west coasts of the United States, and in Europe and Asia.
Approximately 1,136 of our total managed servers were sold through the WorldCom
sales channel agreement.
Through the sales channel agreement, WorldCom resells our portfolio of
managed hosting products. We also have access to WorldCom's sales force to
enhance our global presence. If we satisfy certain service level and data center
capacity commitments, WorldCom has agreed to purchase up to a total of $500.0
million during the period from 2001 through 2003. WorldCom has agreed to
purchase $50.0 million and $192.0 million of managed hosting services in 2001
and 2002, respectively. WorldCom has agreed to purchase, in 2003, a minimum
amount of managed hosting services equal to the lesser of $260.0 million or an
amount equal to four times the actual services purchased by WorldCom for resale
in the fourth quarter of 2002 ("the Minimum Annual Commitment"). WorldCom agreed
to compensate us, on a quarterly basis, for the full amount of operating losses
before depreciation and amortization incurred in servicing WorldCom customers
under the sales channel agreement, during 2001. However, in 2001 and thereafter,
to the extent that we generate operating income before depreciation and
amortization in servicing WorldCom under the sales channel agreement, we have
agreed to share such operating income with WorldCom. WorldCom's participation in
operating results is recognized as adjustments to revenue recognized under the
sales channel agreement.
Total revenues from WorldCom under the sales channel agreement include (1)
actual managed hosting services purchased for resale by WorldCom and (2) for
each three month period ended December 31 during the term of the sales channel
agreement, the difference, if any, between actual managed hosting services
purchased by WorldCom and WorldCom's Minimum Annual Commitment. These amounts
are further adjusted for compensation due to or due from WorldCom as discussed
above based upon the net results of activity under the agreement.
We recognized revenue from WorldCom of $16.2 million and $27.1 million for
the three and six months ended June 30, 2002, respectively, under the sales
channel agreement. All revenue recognized under the sales channel agreement in
2002 resulted from actual managed hosting services purchased for resale by
WorldCom. We expect to recognize revenue from WorldCom using cash basis
accounting in the foreseeable future, which could have a material impact on
future reported revenue. Deferred revenue will reflect that which has been
billed to WorldCom for those underlying customers but not yet received in cash.
We have reserved all receivables due from WorldCom which were not collected
subsequent to June 30, 2002 as a result of WorldCom's filing for bankruptcy.
Revenues from the sales channel agreement may be adversely affected by
WorldCom's bankruptcy filing.
Through our facilities agreement with WorldCom, we have built managed
hosting facilities in several existing WorldCom data centers in the United
States and around the world. The expense for the data center space and
connections from the space to a WorldCom Internet Protocol network hub amounted
to $1.0 million and $1.6 million for the three and six months ended June 30,
2002, respectively. Expenses were not incurred for these services until the
third quarter of 2001.
Our network agreement with WorldCom provides us with terms to purchase
bandwidth and connectivity from WorldCom in the United States to support our
managed hosting activities. The
19
expense for the dedicated Internet connections and WorldCom network
services amounted to approximately $1.1 million and $1.7 million for the three
and six months ended June 30, 2002, respectively. The expense for the dedicated
Internet connections and WorldCom network services amounted to approximately
$1.4 million and $3.0 million for the three and six months ended June 30, 2001,
respectively. Effective March 2002, WorldCom serves as our primary bandwidth
provider for the U.K. We are currently in search of a secondary provider for the
U.S.
The agreements are subject to termination by either party upon insolvency of
the other. There can be no assurance that changes to the commercial agreements
will not be made, or that WorldCom will be in a position to honor the terms of
the commercial agreements, as WorldCom's bankruptcy filing progresses.
Critical Accounting Policies and Estimates
The following discussion and analysis of financial condition and results of
operations should be read in conjunction with the consolidated financial
statements and related notes herein, which have been prepared in accordance with
accounting principles generally accepted in the United States. The preparation
of these financial statements requires us to make estimates and judgments that
affect the reported amounts of assets, liabilities, revenues and expenses, and
related disclosure of contingent assets and liabilities. We evaluate our
estimates on a continual basis, including those related to revenue recognition,
allowance for doubtful accounts, property and equipment, intangible assets, and
redeemable preferred stock. We base our estimates on historical experience and
on various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from
other sources. Actual results may differ from these estimates under different
assumptions or conditions.
We believe the following critical accounting policies affect our more
significant judgments and estimates used in the preparation of its consolidated
financial statements:
Revenue Recognition. We generate most of our revenues from fixed monthly
fees charged to customers under contracts having terms that typically range from
one to three years. We also charge installation fees for new and existing
customers upgrading service. In accordance with Staff Accounting Bulletin No.
101 ("SAB 101"), we recognize installation revenue and related direct
incremental costs of performing the installation over a period that we estimate
to be the longer of the estimated life of the customer relationship or the
average life of all customer contracts. We continually analyze the average life
of our customer relationships and contracts and have determined that a 24-month
period is a reasonable estimate. Any revisions in the estimated contract period
will be charged to income in the period in which the facts that give rise to the
revision become known.
The difference between the actual amount invoiced to WorldCom through the
sales channel agreement and the minimum annual revenue commitment is recognized
as revenue at the end of the measurement period, net of our share of operating
income before depreciation and amortization in servicing WorldCom. We expect to
recognize revenue from WorldCom using cash basis accounting in the foreseeable
future, which could have a material impact on future reported revenue. Deferred
revenue will reflect that which has been billed to WorldCom for those underlying
customers but not yet received in cash. Amounts due from WorldCom as of June 30,
2002 have been reflected net of a reserve for doubtful accounts.
We also recognize revenues from early termination fees upon collection from
customers not fulfilling the contract terms. This includes certain configuration
changes initiated by the customer or early
20
terminations from the contract terms. These fees are typically comprised of
monthly fees through the remaining term of the contract period and any unpaid
balances.
Allowance for Doubtful Accounts. We regularly assess the credit standing of
our customers and the collectibility of receivables. We cease revenue
recognition when collectibility is not probable. Allowances for doubtful
accounts are maintained for estimated losses resulting from the inability of our
customers to make required payments. If the financial condition of our customers
becomes uncertain or deteriorates, impairing their ability to make payments,
additional allowances may be required. We reserved all receivables due from
WorldCom which were not collected subsequent to June 30, 2002 as a result of
WorldCom's filing for bankruptcy. Ultimately, our judgment regarding the
realizability of WorldCom's receivables will be determined by WorldCom's
bankruptcy proceedings.
Impairment of Long-lived Assets. We review our long-lived assets for
impairment when events or changes in circumstances indicate the carrying value
of such assets may not be recoverable. We also evaluate the useful life of
assets periodically. The review consists of a comparison of the carrying value
of the assets with the assets' 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.
As discussed in Note 3 to the consolidated financial statements, we recognized
an impairment loss of $57.0 million for the quarter ended June 30, 2002 related
primarily to our property and equipment. If actual market conditions are less
favorable than those projected by management, additional asset write-downs may
be required. Management will continue to evaluate overall industry and company
specific circumstances and conditions to determine whether a future analysis of
our long-lived assets is necessary.
Redeemable Preferred Stock We are accreting the preferred stock discount to
the mandatory conversion date in January 2005. To date, management believes that
a redemption event is not probable due to the covenants contained in
Intermedia's indentures, which restrict redemption, and the requirement of legal
availability of funds. These conditions currently prohibit the redemption of the
securities. If these conditions change, our estimate of when the preferred stock
becomes redeemable or will be converted may require an adjustment to the
accretion amount. Management will continue to evaluate the conditions as
necessary.
Refer to "Business - Risk Factors" in our Form 10-K as filed with the SEC
on April 1, 2002 for known trends or uncertainties that are reasonably likely to
affect our financial condition or results of operations.
Refer to Note 1 to the consolidated financial statements for further
discussion of our significant accounting policies.
General
Revenues. Our revenues principally consist of monthly service fees charged
to customers under contracts having terms that typically range from one to three
years. Monthly services fees are recognized in the month the service is
rendered. We also charge installation fees for new and existing customers
upgrading service. Installation revenue and related direct incremental costs of
performing the installation are recognized over the estimated contract period.
We continually analyze the average life of our customer relationships and
contracts and have determined that a 24-month period is a reasonable estimate.
Certain customer payments for managed Web hosting services received in advance
of service delivery are deferred until the service is performed. Additional
services are recognized in the month the services are performed. Revenue earned
from the sale of third party equipment is also included. We also recognize
revenues from early termination fees upon collection from customers not
fulfilling the contract terms. This includes certain configuration changes
initiated by the customer or early terminations from the contract terms. These
fees are typically comprised of monthly fees through the remaining term of the
contract period and any unpaid balances.
21
Costs and Expenses. Costs and expenses include:
o cost of operations;
o cost of services;
o selling, general and administrative expenses;
o provision for doubtful accounts;
o deferred compensation; and
o depreciation and amortization expense.
Cost of operations consist primarily of the costs for our network
connectivity and firewall services. We expect our network connectivity
requirements to grow in conjunction with the growth of our overall business,
including the expansion of our business abroad through our wholly-owned
subsidiaries, and accordingly expect these costs to increase in the future.
Expenses directly attributed to the sale of third party equipment is also
included.
Cost of services consist primarily of facilities administration expenses
including rent, maintenance and utilities to support our data centers and
salaries and related benefits for our technical operations. We expect our cost
of services to increase in dollar amount as our business grows 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, and other miscellaneous expenses. We expect selling, general
and administrative expenses to decrease in dollar amount and as a percentage of
revenue over time due to our planned cost reduction efforts.
Provision for doubtful accounts is maintained to reserve against trade
account receivables that have been estimated to be uncollectible due to the
inability of our customers to make the required payment.
Deferred compensation expense relates to stock options that were granted by
Digex to certain employees at exercise prices below market value. We will
expense deferred compensation as of June 30, 2002 in the third quarter of 2002
as these options will become fully vested on July 1, 2002.
Depreciation and amortization expense consists primarily of depreciation of
our data centers, servers and related equipment and amortization of our
definite-lived intangible assets. We currently expect decreases in depreciation
charges related to our existing tangible assets base due to a write-down of our
long-lived assets to fair market value as a result of SFAS No. 144 in the
future.
22
Results of Operations
The following table presents amounts as reported in our unaudited
consolidated financial statements (in thousands) and certain information derived
from these statements as a percentage of revenue for the three months ended June
30, 2002 and 2001, respectively.
Three months ended
June 30,
----------------------------------------------------
2002 2001
------------------------ -------------------------
Revenue:
Revenue ......................................... $ 32,479 66.7% $ 49,802 92.6%
Revenue from WorldCom ........................... 16,214 33.3 3,989 7.4
----------- ----------- ------------ ----------
Total revenue ...................................... 48,693 100.0 53,791 100.0
Costs and expenses:
Cost of operations .............................. 3,440 7.1 4,375 8.1
Cost of services ................................ 23,008 47.3 26,455 49.2
Selling, general and administrative ............. 20,860 42.8 32,005 59.5
Provision for doubtful accounts ................. 740 1.5 4,601 8.6
Provision for doubtful accounts for WorldCom .... 17,670 36.3 -- --
Deferred compensation ........................... 396 0.8 734 1.4
Impairment loss ................................. 56,990 117.0 -- --
Depreciation and amortization ................... 42,084 86.4 32,401 60.2
----------- ----------- ------------ ----------
Total costs and expenses ........................... 165,188 339.2 100, 571 187.0
----------- ----------- ------------ ----------
Loss from operations ............................... (116,495) (239.2) (46,780) (87.0)
Other income (expense):
Interest expense ............................... (2,143) (4.4) (747) (1.4)
Interest income and other ...................... 135 0.3 204 0.4
----------- ----------- ------------ ----------
Net loss ........................................... $ (118,503) (243.3)% $ (47,323) (88.0)%
=========== =========== ============ ==========
Three months ended June 30, 2002 Compared to Three months ended June 30, 2001
Revenue
Total revenue decreased 9.5% to $48.7 million in the second quarter of 2002
compared to $53.8 million for the same period in 2001. Although our customer
base increased 14.3% to 689 at June 30, 2002 from 603 at June 30, 2001, average
annualized revenue per customer decreased 11.4% to $299,000 from $333,000 for
the same period in 2001. This is primarily due to the loss of a fewer
larger-than-average customers, customers rightsizing their configurations, and
deferred customer ramp up of services due to economic cost pressures. Revenue
recognized through our sales channel agreement with WorldCom has increased as
the customer base under this agreement has grown. We recognized revenue of $16.2
million from WorldCom in the second quarter of 2002 under the sales channel
agreement compared to total revenues of $4.0 million for the same period in
2001. All revenue recognized under the sales channel agreement for the three
months ended June 30, 2002 and 2001 resulted from actual managed hosting
services purchased for resale by WorldCom. Included in our second quarter
revenue is $0.6 million in fees collected in 2002 for early termination,
compared to $0.2 million in fees collected in 2001.
23
Cost of Operations
Cost of operations decreased 21.4% to $3.4 million in the second quarter of
2002 compared to $4.4 million for the same period in 2001. The decrease was
primarily due to improved network and facility costs. As a percentage of
revenue, cost of operations decreased to 7.1% in the second quarter of 2002
compared to 8.1% for the same period in 2001 as a result of improved network
utilization.
Cost of Services
Cost of services decreased 13.0% to $23.0 million in the second quarter of
2002 compared to $26.5 million for the same period in 2001. The decrease was
primarily related to a reduction in outside consultants' fees and accrued
payroll-related costs associated with a reduced workforce compared to 2001. As a
percentage of revenue, total cost of services decreased to 47.3% in the second
quarter of 2002 compared to 49.2% for the same period in 2001.
Selling, General and Administrative
Selling, general and administrative expenses decreased 34.8% to $20.9
million in the second quarter of 2002 compared to $32.0 million for the same
period in 2001. The decrease was primarily attributable to a large decrease in
marketing and advertising expenses. Marketing and advertising expenses for the
second quarter were approximately $0.5 million in 2002 compared with $7.0
million in 2001. Additional factors contributing to the decline in selling,
general and administrative expense include a reduction in travel costs
associated with the regional deployment of the sales force, telephone-related
costs, outside consultants' fees, utilities as a result of the consolidation of
several office space leases, and less property taxes as a result of a
revaluation of fiscal year 2002 property value assessments, partly offset by
increased costs associated with the 24-month amortization of potential retention
bonus amounts and rent for office space. As a percentage of revenue, total
selling, general and administrative expenses decreased to 42.8% in the second
quarter of 2002 compared to 59.5% in the same period in 2001, primarily due to
our planned reductions in certain selling, general and administrative costs in
2002.
Provision for Doubtful Accounts
Provision for doubtful accounts, other than doubtful accounts for WorldCom,
decreased 83.9% to $0.7 million in the second quarter of 2002 compared to $4.6
million for the same period in 2001 as many of our customers, particularly
Internet-based businesses, ceased operations or reduced or eliminated our Web
hosting services during 2001.
Provision for Doubtful Accounts for WorldCom
Provision for doubtful accounts for WorldCom was established in the second
quarter of 2002 due to recent events surrounding WorldCom's planned restatement
of its financial results and subsequent bankruptcy filing. We expect to
recognize revenue from WorldCom using cash basis accounting in the foreseeable
future, which could have a material impact on future reported revenue.
24
Deferred Compensation
Deferred compensation expense decreased 46.0% to $0.4 million in the second
quarter of 2002 compared to $0.7 million for the same period in 2001. The
decrease was due to forfeitures in stock options held by executive officers and
key employees terminated since June 30, 2001. Approximately $1.2 million of
unearned compensation was forfeited since June 30, 2001. There have been no
options granted since January 31, 2001. In accordance with the Digex Long-Term
Incentive Plan, all stock options granted to participants who were employed by
Digex as of July 1, 2001, the consummation date of the Intermedia - WorldCom
Merger, will become fully vested on July 1, 2002 through a provision for
accelerated vesting upon a change of control of Digex. Deferred compensation of
$2.6 million as of June 30, 2002 for options granted at exercise prices less
than fair market value will be expensed in the third quarter of 2002.
Impairment Loss
Impairment loss related to our long-lived assets of $57.0 million, of which
$55.4 million relates to property and equipment and $1.6 million relates to
identifiable intangible assets, was recognized in the second quarter of 2002 as
a result of the events surrounding WorldCom as described in "Management's
Discussion and Analysis -- Overview." Under SFAS No. 144, we review our
long-lived assets for impairment when events or changes in circumstances
indicate that carrying value of such assets may not be recoverable. We have
adjusted our long-lived assets down to fair value as determined by an
independent appraisal.
Depreciation and Amortization
Depreciation and amortization expenses increased 29.9% to $42.1 million in
the second quarter of 2002 compared to $32.4 million for the same period in
2001. The increase was principally due to the additional servers and other
facilities and equipment placed in service during and subsequent to fiscal year
2001. We entered into $10.7 million of capital leases for equipment subsequent
to June 30, 2001, which have also contributed to the increase in expense. We
have electronics, computer hardware, and computer software with useful lives
ranging from three to five years.
Interest Expense
Interest expense increased 186.9% to $2.1 million in the second quarter of
2002 compared to $0.7 million for the same period in 2001. The increase resulted
primarily from the increase of approximately $11.9 million of equipment acquired
under capital leases and from the issuance of $106.2 million of notes payable to
Intermedia since June 30, 2001.
Interest Income and Other
Interest income and other decreased 33.8% to $0.1 million in the second
quarter of 2002 compared to $0.2 million for same period in 2001. The decrease
resulted principally from declining cash balances and falling interest rates
during the period.
EBITDA Before Certain Charges
EBITDA before certain charges, as defined below, increased 24.8% to $(17.0)
million in the second quarter of 2002 compared to $(13.6) million for the same
period in 2001. The change is primarily attributable to a provision for doubtful
accounts for WorldCom of $17.7 million as a result of its reorganization filing,
offset by planned reductions in operating costs in 2002.
25
EBITDA before certain charges consists of earnings (loss) before interest
expense, interest income and other, merger-related expenses, foreign exchange
gains (losses), income tax benefit, deferred compensation, impairment loss, and
depreciation and amortization. EBITDA before certain charges does not represent
funds available for management's discretionary use and is not intended to
represent cash flow from operations. EBITDA before certain charges should also
not be construed as a substitute for operating income or a better measure of
liquidity than cash flow from operating activities, which are determined in
accordance with generally accepted accounting principles. This caption excludes
components that are significant in understanding and assessing our results of
operations and cash flows. In addition, EBITDA before certain charges is not a
term defined by generally accepted accounting principles and as a result our
measure of EBITDA before certain charges might not be comparable to similarly
titled measures used by other companies. However, we believe that EBITDA before
certain charges is relevant and useful information which is often reported and
widely used by analysts, investors and other interested parties in the Web and
application hosting industry. Accordingly, we are disclosing this information to
permit a more comprehensive analysis of our operating performance, as an
additional meaningful measure of performance and liquidity, and to provide
additional information with respect to our ability to meet future debt service,
capital expenditure and working capital requirements. See the consolidated
financial statements and notes thereto contained elsewhere in this report for
more detailed information.
The following table presents amounts as reported in our unaudited
consolidated financial statements (in thousands) and certain information derived
from these statements as a percentage of revenue for the six months ended June
30, 2002 and 2001, respectively.
Six months ended
June 30,
--------------------------------------------------------
2002 2001
---------------------------- --------------------------
Revenue:
Revenue ......................................... $ 73,347 73.0% $ 101,739 95.2%
Revenue from WorldCom ........................... 27,103 27.0 5,104 4.8
----------- --------- ----------- --------
Total revenue ...................................... 100,450 100.0 106,843 100.0
Costs and expenses:
Cost of operations .............................. 7,728 7.7 9,531 8.9
Cost of services ................................ 48,078 47.9 51,000 47.7
Selling, general and administrative ............. 48,871 48.7 66,287 62.1
Provision for doubtful accounts ................. 2,005 2.0 7,499 7.0
Provision for doubtful accounts for WorldCom .... 18,578 18.5 -- --
Deferred compensation ........................... 993 0.9 1,806 1.7
Impairment loss ................................. 56,990 56.6 -- --
Depreciation and amortization ................... 82,307 81.9 61,890 57.9
----------- --------- ----------- --------
Total costs and expenses ........................... 265,550 264.4 198,013 185.3
----------- --------- ----------- --------
Loss from operations ............................... (165,100) (164.4) (91,170) (85.3)
Other income (expense):
Interest expense ............................... (4,135) (4.1) (1,445) (1.4)
Interest income and other ...................... 296 0.3 1,073 1.0
----------- --------- ----------- --------
Net loss ........................................... $(168,939) (168.2)% $ (91,542) (85.7)%
=========== ========= =========== ========
26
Six months ended June 30, 2002 Compared to Six months ended June 30, 2001
Revenue
Total revenue decreased 6.0% to $100.5 million for the six months ended June
30, 2002 compared to $106.8 million for the same period in 2001. Although our
customer base increased 14.0% to 689 at June 30, 2002 from 603 at June 30, 2001,
average annualized revenue per customer decreased 11.4% to $299,000 from
$333,000 for the same period in 2001. This is primarily due to the loss of a
fewer larger-than-average customers, customers rightsizing their configurations,
and deferred customer ramp up of services due to economic cost pressures.
Revenue recognized through our sales channel agreement with WorldCom has
increased as the customer base under this agreement has grown. We recognized
revenue of $27.1 million from WorldCom in the first half of 2002 under the sales
channel agreement compared to total revenues of $5.1 million for the same period
in 2001. All revenue recognized under the sales channel agreement for the six
months ended June 30, 2002 and 2001 resulted from actual managed hosting
services purchased for resale by WorldCom. Included in our revenue is $3.5
million in fees collected in 2002 for early termination and one-time sale of
third party equipment, compared to $0.2 million in early termination fees
collected in 2001.
Cost of Operations
Cost of operations decreased 18.9% to $7.7 million for the six months ended
June 30, 2002 compared to $9.5 million for the same period in 2001. The decrease
was primarily due to improved network and facility costs. As a percentage of
revenue, cost of operations decreased to 7.7% for the six months ended June 30,
2002 compared to 8.9% for the same period in 2001 as a result of improved
network utilization.
Cost of Services
Cost of services decreased 5.7% to $48.1 million for the six months ended
June 30, 2002 compared to $51.0 million for the same period in 2001. The
decrease was primarily related to a reduction in outside consultants' fees and
accrued payroll-related costs associated with a smaller workforce compared to
2001, partly offset by an increased level of operations, costs associated with
the 24-month amortization of potential retention bonus amounts, and accruals for
changes in employee benefits. As a percentage of revenue, total cost of services
increased to 47.9% for the six months ended June 30, 2002 compared to 47.7% for
the same period in 2001.
Selling, General and Administrative
Selling, general and administrative expenses decreased 26.3% to $48.9
million for the six months ended June 30, 2002 compared to $66.3 million for the
same period in 2001. The decrease was primarily attributable to a large decrease
in marketing and advertising expenses. Marketing and advertising expenses in the
first six months were approximately $3.2 million in 2002 compared with $13.2
million in 2001. Additional factors contributing to the decline in selling,
general and administrative expense include a reduction in travel costs
associated with the regional deployment of the sales force, telephone-related
costs, outside consultants' fees, utilities as a result of the consolidation of
several office space leases, and less property taxes as a result of a
revaluation of fiscal year 2002 property value assessments, partly offset by
increased costs associated with the 24-month amortization of potential retention
bonus amounts,
27
accruals for changes in employee benefits, and rent for office space. As a
percentage of revenue, total selling, general and administrative expenses
decreased to 48.7% for the six months ended June 30, 2002 compared to 62.1% in
the same period in 2001, primarily due to our planned reductions in certain
selling, general and administrative costs in 2002.
Provision for Doubtful Accounts
Provision for doubtful accounts, other than doubtful accounts for WorldCom,
decreased 73.3% to $2.0 million for the six months ended June 30, 2002 compared
to $7.5 million for the same period in 2001 as many of our customers,
particularly Internet-based businesses, ceased operations or reduced or
eliminated our Web hosting services during 2001.
Provision for Doubtful Accounts for WorldCom
Provision for doubtful accounts for WorldCom was established in the second
quarter of 2002 due to recent events surrounding WorldCom's planned restatement
of its financial results and subsequent bankruptcy filing. We expect to
recognize revenue from WorldCom using cash basis accounting in the foreseeable
future, which could have a material impact on future reported revenue.
Deferred Compensation
Deferred compensation expense decreased 45.0% to $1.0 million for the six
months ended June 30, 2002 compared to $1.8 million for the same period in 2001.
The decrease was due to forfeitures in stock options held by executive officers
and key employees terminated since June 30, 2001. Approximately $1.2 million of
unearned compensation was forfeited since June 30, 2001. There have been no
options granted since January 31, 2001. In accordance with the Digex Long-Term
Incentive Plan, all stock options granted to participants who were employed by
Digex as of July 1, 2001, the consummation date of the Intermedia - WorldCom
Merger, will be fully vested on July 1, 2002 through a provision for accelerated
vesting upon a change of control of Digex. Deferred compensation of $2.6 million
as of June 30, 2002 for options granted at exercise prices less than fair market
value will be expensed in the third quarter of 2002.
Impairment Loss
Impairment loss related to our long-lived assets of $57.0 million, of which
$55.4 million relates to property and equipment and $1.6 million relates to
identifiable intangible assets, was recognized in the second quarter of 2002 as
a result of the events surrounding WorldCom as described in "Management's
Discussion and Analysis -- Overview." Under SFAS No. 144, we review our
long-lived assets for impairment when events or changes in circumstances
indicate that carrying value of such assets may not be recoverable. We have
adjusted our long-lived assets down to fair value as determined by an
independent appraisal.
Depreciation and Amortization
Depreciation and amortization expenses increased 33.0% to $82.3 million for
the six months ended June 30, 2002 compared to $61.9 million for the same period
in 2001. The increase was principally due to additional servers and other
facilities and equipment placed in service during and subsequent to fiscal year
2001. We entered into $10.7 million of capital leases for equipment subsequent
to June 30, 2001, which have also contributed to the increase in expense. We
have electronics, computer hardware, and computer software with useful lives
ranging from three to five years.
28
Interest Expense
Interest expense increased 186.2% to $4.1 million for the six months ended
June 30, 2002 compared to $1.4 million for the same period in 2001. The increase
resulted primarily from the increase of approximately $11.9 million of equipment
acquired under capital leases and from the issuance of $106.2 million of notes
payable to Intermedia since June 30, 2001.
Interest Income and Other
Interest income and other decreased 72.4% to $0.3 million for the six months
ended June 30, 2002 compared to $1.1 million for same period in 2001. The
decrease resulted principally from declining cash balances and falling interest
rates during the period.
EBITDA Before Certain Charges
EBITDA before certain charges, as defined below, decreased 9.7% to $(24.8)
million for the six months ended June 30, 2002 compared to $(27.5) million for
the same period in 2001. The change is primarily attributable to a provision for
doubtful accounts for WorldCom of $17.7 million as a result of its
reorganization filing, offset by planned reductions in operating costs in 2002.
EBITDA before certain charges consists of earnings (loss) before interest
expense, interest income and other, merger-related expenses, foreign exchange
gains (losses), income tax benefit, deferred compensation, impairment loss, and
depreciation and amortization. EBITDA before certain charges does not represent
funds available for management's discretionary use and is not intended to
represent cash flow from operations. EBITDA before certain charges should also
not be construed as a substitute for operating income or a better measure of
liquidity than cash flow from operating activities, which are determined in
accordance with generally accepted accounting principles. This caption excludes
components that are significant in understanding and assessing our results of
operations and cash flows. In addition, EBITDA before certain charges is not a
term defined by generally accepted accounting principles and as a result our
measure of EBITDA before certain charges might not be comparable to similarly
titled measures used by other companies. However, we believe that EBITDA before
certain charges is relevant and useful information which is often reported and
widely used by analysts, investors and other interested parties in the Web and
application hosting industry. Accordingly, we are disclosing this information to
permit a more comprehensive analysis of our operating performance, as an
additional meaningful measure of performance and liquidity, and to provide
additional information with respect to our ability to meet future debt service,
capital expenditure and working capital requirements. See the consolidated
financial statements and notes thereto contained elsewhere in this report for
more detailed information.
Liquidity and Capital Resources
Cash Flows
WorldCom is our majority stockholder, primary lender, significant channel
partner, and one of our largest vendors. In particular, under the funding
agreement and subject to the bankruptcy proceedings, WorldCom is obligated to
provide funding for the approved Digex business plan through 2002 only.
29
WorldCom will then have an option to continue funding us beyond 2002, but may
not exercise such option. Through 2002, we anticipate that our only source to
fund our working capital needs and capital expenditure requirements will be
WorldCom. There can be no assurance that WorldCom will provide us with any
additional funding. We believe that funding from any source other than WorldCom
on appropriate or commercially acceptable terms is currently unavailable.
Net cash used in operating activities was $3.5 million and $21.7 million
during the six months ended June 30, 2002 and 2001, 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 in 2002 has
decreased largely due to changes in accounts receivable, prepaid expenses,
accounts payable and accrued expenses, and amounts due to/from WorldCom compared
to the same period in 2001.
Net cash used for investing activities was $22.8 million and $63.3 million
during the six months ended June 30, 2002 and 2001, respectively. Net cash used
for investing activities in each of these periods was primarily the result of
capital expenditures for data center infrastructure, which includes servers
purchased for customer use, as well as leasehold improvements, furniture and
fixtures, and computers and other equipment. We have reduced our capital
expenditures in 2002 in accordance with our business needs and as a result of
the economic downturn. Although we have plans to invest in property and
equipment, we have no material commitments for such items at this time.
Net cash provided by financing activities was $18.8 million and $16.5
million during the six months ended June 30, 2002 and 2001, respectively. Net
cash provided by financing activities resulted principally from proceeds from
our notes payable issued to Intermedia offset by payments on a long-term note
payable to Prince George's County Economic Development Corporation and on our
increased capital lease obligations in 2002.
Stock Offerings
On January 12, 2000, we sold 100,000 shares of our non-voting, redeemable
preferred stock, designated as Series A convertible preferred stock, with
detachable warrants to purchase 1,065,000 shares of our Class A common stock, to
Microsoft Corporation and CPQ Holdings, Inc., a subsidiary of Compaq Computer
Corporation, for an aggregate of $100.0 million, of which $85.0 million was in
cash, and $15.0 million was in the form of equipment purchase credits. Of the
$15.0 million of equipment purchase credits, approximately $5.5 million and $3.1
million was used for equipment purchases in the first half of 2002 and 2001,
respectively. On April 1, 2002, Microsoft converted its 50,000 shares of Series
A convertible preferred stock into 730,995 shares of Digex Class A common stock.
Subsequent to the conversion, Microsoft has given some indication that it may
seek to rescind the conversion. We believe that the conversion was proper in all
respects.
Funding from Affiliates
On July 31, 2001, we entered into a note purchase agreement with WorldCom
whereby WorldCom agreed to provide funding for the Digex business plans for
2001 and 2002 as approved by the Digex and WorldCom boards of directors. The
Digex and WorldCom boards of directors have approved the Digex business plan for
2002. The preparation of the Digex business plan for 2003 is currently underway
and is expected to be submitted to the WorldCom and Digex's boards of directors
for approval no later than December 1, 2002. Subject to the terms and conditions
of the agreement, we will issue and WorldCom will purchase (or cause an
affiliate to purchase) a series of senior notes up to an aggregate
30
principal amount sufficient to satisfy our net cash requirements under the
approved business plan. Given WorldCom's bankruptcy filing, there can be no
assurance that WorldCom will honor its contractual commitments to Digex. See
Note 2 "Recent Events related to WorldCom and Digex" to the accompanying
unaudited consolidated financial statements. Interest on the unpaid principal
balance is payable monthly at a rate equal to LIBOR plus 300 basis points.
Repayment of principal is due on December 31, 2002 and may be extended to
December 31, 2006 upon our election by written notice. We expect to make this
election by December 2002, at which time amounts then outstanding will be repaid
in equal monthly straight-line amortization payments of principal through
December 31, 2006. As a result, any amounts due after June 30, 2003 have been
classified as long-term. Approximately $10.9 million of our total notes payable
to Intermedia has been classified as current as of June 30, 2002. Any changes to
our business plan that require increased funding would require the WorldCom
board of directors' approval before WorldCom would be obligated to fund any such
increase.
In 2002, Digex issued and WorldCom caused Intermedia to purchase a series
of senior notes totaling $22.2 million to satisfy our net cash requirements
under our approved 2002 business plan. Total principal outstanding under the
note purchase agreement with WorldCom was $87.2 million at June 30, 2002.
Through June 30, 2002, variable interest on the unpaid principal balance was
paid monthly at an interest rate of 300 basis points over LIBOR rate (weighted
average interest rate of 5.05%).
On January 14, 2002, we entered into a note purchase agreement, dated July
31, 2001, with Intermedia to refinance the $13.0 million intercompany loan and
$12.0 million promissory note to Intermedia under a series of senior notes
totaling $25.0 million. The terms of the agreement are substantially the same as
the original note purchase agreement, dated July 31, 2001 between Digex and
WorldCom, with the repayment of principal due on December 31, 2003. There is no
option to extend the maturity date of the notes. Interest is payable monthly at
an interest rate of 300 basis points over LIBOR.
Management intends to seek to renegotiate the maturity dates of the note
purchase agreements with WorldCom and Intermedia as a result of WorldCom's
filing for reorganization. There can be no assurance that management will be
able to do so.
Other Indebtedness
In the first and second quarters of 2001, we entered into master lease and
financing agreements with two vendors for lines of credit to facilitate the
leasing of computer hardware and software. The terms of the associated schedules
range from 12 months for financing a maintenance contract to 36 months for
leasing computer equipment. We will have an option to purchase the equipment at
the end of the initial lease term. Interest and principal are payable monthly
with interest rates ranging from 7.2% to 12.3% per annum. As of June 30, 2002,
we acquired $11.9 million of computer equipment and maintenance services under
these leasing and financing arrangements.
31
Contractual Obligations and Contingent Commitments
Our contractual obligations and contingent commitments as of June 30, 2002
are aggregated below (in thousands):
Amounts due by period
-----------------------------------------------------
Less than
Total 1 year 1 - 3 years 4 - 5 years Thereafter
------------ ---------- ------------ ------------ ------------
Contractual obligations:
Notes payable to Intermedia ........... $ 112,200 $ 10,900 $ 68,600 $ 32,700 $ --
Notes payable to third parties ........ 3,386 57 3,274 55 --
Capital lease obligations ............. 43,694 8,411 12,961 9,817 12,505
Operating leases ...................... 19,740 3,913 7,161 5,007 3,659
Contingent Commitments:
Redeemable preferred stock ............ 50,000 -- 50,000 -- --
Employee retention bonuses ............ 12,318 -- 12,318 -- --
--------- --------- ---------- --------- ----------
Total .................................... $ 241,338 $ 23,281 $ 154,314 $ 47,579 $ 16,164
========= ========= ========== ========= ==========
We lease certain property and equipment under various operating and capital
lease arrangements that expire over the next 11 years. Refer also to the notes
to our consolidated financial statements in our Form 10-K for the year ended
December 31, 2001, as filed with the SEC on April 1, 2002, for discussion of our
capital and operating leases.
We entered into retention bonus agreements with certain of our executive
officers and key employees. Under the agreements, each such officer or employee
(or his or her estate) is entitled to receive the amounts (1) if he or she is
actively employed with us through and including November 1, 2003 or (2) if prior
to that time we terminate his or her employment without cause or his or her
employment is terminated as a result of death or permanent disability. No
officer or employee is entitled to the retention bonus under this agreement, or
any pro rata portion thereof, if his or her employment terminates prior to
November 1, 2003 by reason of termination for cause, resignation for any reason
or termination resulting from constructive discharge by us. As of June 30, 2002,
the potential retention bonus pool payable in 2003 under these agreements
totaled $12.3 million.
Increases in interest rates on variable rate debt would have an adverse
effect upon our reported net loss and cash flow. We believe that we will have
adequate cash flow to service our debt and capital requirements in 2002 under
our funding agreement with WorldCom. However, economic downturns, increased
interest rates and other adverse developments, including factors beyond our
control, could impair our ability to service our indebtedness. In addition, the
cash flow required to service our debt may reduce our ability to fund internal
growth, additional acquisitions and capital improvements.
We currently project continued significant losses and operating cash flow
deficits. We anticipate that we will have significant cash requirements for
several years as we repay principal and interest associated with our notes
payable, fill our existing data center capacity, and increase servers under
management. If necessary, we intend to pursue additional equipment lease
financing from our vendors or third parties to facilitate the acquisition of
computer hardware and related software in the future. At the same time, we are
taking steps to minimize the amount of capital required to deliver customer
solutions by implementing customer furnished equipment offerings along with
third party leasing options. We remain dependent on WorldCom to fund our
operating cash flow deficits and capital expenditures. Actual funding through
June 30, 2002 was $22.2 million, substantially less than forecasted under the
Digex original 2002 business plan. The ultimate amount of borrowings can be
affected by WorldCom's bankruptcy, changes
32
in the economy, and our ability to execute our business plan, among other
factors. Further, as of June 30, 2002, approximately $52.8 million in notes
payable and capital lease obligations come due in 2003. We currently believe
that some or all of these obligations will need to be restructured. There can be
no assurance that these obligations will be restructured or that WorldCom will
provide us with any additional funding. We believe that funding from any source
other than WorldCom on appropriate or commercially acceptable terms is currently
unavailable.
The impact of the above events on Digex remains unclear. We cannot predict
what will happen at WorldCom, nor can we predict the impact of events at
WorldCom on Digex. Further, we cannot predict how our customers, vendors,
employees and strategic partners, will react to the unfolding events. If any of
those entities react negatively to the events or perceptions generated from
those events, whether accurate or not, then we may be significantly and
negatively impacted, and our ability to execute on our plans may be
substantially impaired.
Although no assurances can be given, management believes that we have the
ability to continue as a going concern unless WorldCom's bankruptcy filing
impacts any necessary future borrowings to fund our business operations. The
preparation of the Digex business plan for 2003 is currently underway and is
expected to be submitted to the WorldCom and Digex's boards of directors for
approval, as described in the accompanying consolidated financial statements.
Nonetheless, because of recent events surrounding WorldCom, and the lack of
certainty that WorldCom will be able to continue to fund us, there is
substantial doubt about our ability to continue as a going concern over the next
twelve months, unless the above referenced events stabilize. A substantial doubt
about an entity's ability to continue as a going concern exists when the entity
is unable to continue to meet its obligations as they become due without
substantial disposition of assets outside the ordinary course of business,
restructuring of debt, externally forced revisions of its operations, or similar
actions for a reasonable period of time, not to exceed one year beyond the date
of the financial statements. The accompanying financial statements do not
reflect any adjustments to the carry value of our net assets or the amount and
classification of our liabilities in the event we are not able to continue as a
going concern.
WorldCom has expressed its intention to fund our operations and cash flow
requirements through March 31, 2003. We are seeking reaffirmation from WorldCom
regarding this funding. There can be no assurance that WorldCom will provide
such funding to us.
We encourage you to read "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Liquidity and Capital Resources" in
WorldCom's Form 10-K for the year ended December 31, 2001, as well as its
subsequent periodic filings with the SEC, since our ability to succeed is
dependent on WorldCom.
Recent Accounting Pronouncements
Goodwill and Other Intangible Assets
In June 2001, the FASB issued SFAS No. 142, Goodwill and Other Intangible
Assets. Under the new rules, goodwill and intangible assets deemed to have
indefinite lives are no longer amortized but are subject to annual impairment
tests based upon estimated fair value. We adopted the provisions of SFAS No.
142, effective January 1, 2002, and ceased amortization of amounts assigned to
goodwill and acquired workforce. Depreciation and amortization expense excluding
the amortization of goodwill and acquired workforce in the second quarter of
2001 was $31.9 million. The net book value of goodwill and acquired workforce at
June 30, 2002 was approximately $11.9 million.
33
We completed our fair value assessment of goodwill as of January 1, 2002
and determined that goodwill was not impaired. However, given the decrease in
our market capitalization since January 1, 2002 and the uncertainty created by
WorldCom's recent announcements of its intention to restate its financial
statements, as described above, we reassessed the recoverability of our
goodwill as of June 30, 2002 pursuant to SFAS No. 142. Pursuant to an
independent appraisal, we determined that goodwill was not impaired as of
June 30, 2002. We have elected to assess impairment of goodwill annually as of
July 1st, unless events or changes in circumstances indicate a more frequent
review is necessary. Any impairment then identified would be recorded in
operations in the period in which the impairment is identified.
Impairment of Long-Lived Assets
In August 2001, the FASB issued SFAS No. 144, Impairment or Disposal of
Long-Lived Assets, which supercedes both No. 121, Impairment of Long-Lived
Assets for Long-Lived Assets to be Disposed Of, and the accounting and reporting
provisions for the disposal of a segment of a business contained in APB Opinion
No. 30, Reporting the Results of Operations - Reporting the Effects of Disposal
of a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions. We have adopted the provisions of SFAS No.
144 as of January 1, 2002.
Under SFAS No. 144, we review our long-lived assets for impairment when
events or changes in circumstances indicate the carrying value of such assets
may not be recoverable. The review consists of a comparison of the carrying
value of the assets with the assets' 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 undiscounted cash flow exceeds the carrying
value of the asset, no impairment indicator is considered present. If the
carrying value exceeds the future undiscounted cash flow, an impairment
indicator is considered present. The amount of impairment may be measured using
discounted cash flows or other means of determining fair value.
The events surrounding WorldCom, as described above, resulted in management
revising our estimates of future financial projections. We have also performed
an undiscounted cash flow analysis related to our long-lived assets. The result
of that analysis indicates that an impairment to the carrying value of our fixed
assets and other intangible assets may exist as of June 30, 2002. Based upon an
independent appraisal, we have adjusted our long-lived assets down to fair
value. An impairment loss related to our property and equipment of $55.4 million
and identifiable intangible assets of $1.6 million has been included in the
results of operations for the three months and six months ended June 30, 2002.
Should we fail to meet our operating budget during the balance of 2002,
management's estimates of future cash flows may be further adjusted downward.
Such downward adjustments could trigger a further impairment of our long-lived
assets.
34
Accounting for Costs Associated with Exit or Disposal Activities
In July 2002, the FASB has issued SFAS No. 146, Accounting for Costs
Associated with Exit or Disposal Activities, which supercedes EITF Issue No.
94-3, Liability Recognition for Certain Employee Termination Benefits and Other
Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring),
to be applied prospectively to exit or disposal activities initiated after
December 31, 2002.
SFAS No. 146 requires companies to recognize costs associated with exit or
disposal activities when they are incurred rather than at the date of a
commitment to an exit or disposal plan. Costs covered by the standard include
lease termination costs and certain employee severance costs that are associated
with a restructuring, discontinued operation, plant closing, or other exit or
disposal activity. We do not expect the adoption of SFAS No. 146 to have a
material impact on our consolidated results of operations or financial position.
Information Regarding Forward-Looking Statements
The information set forth above in "Management's Discussion and Analysis of
Financial Conditions and Results of Operations" includes forward-looking
statements that involve numerous risks and uncertainties. Forward-looking
statements can be identified by the use of forward-looking terminology such as
"estimates," "projects," "anticipates," "expects," "intends," "believes," or the
negative thereof or other variations thereon or comparable terminology or by
discussions of strategy that involve risks and uncertainties. This report
includes forward-looking statements, which could differ from actual results. See
"Risk Factors" in our Form 10-K for the year ended December 31, 2001 as filed
with the SEC on April 1, 2002.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
No changes.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
On August 1, 2002, the law firm of Richards Layton & Finger ("Richards
Layton") requested that the Delaware Chancery Court enter judgment against Digex
for payment of success bonuses of $500,000 apiece to Richards Layton and a
second law firm, Cahill Gordon & Reindel ("Cahill Gordon"), in connection with
their representation of the Special Committee of the Digex board of directors in
In re Digex, Inc. Shareholders Litigation, Consolidated Civil Action No. 18336
(Del. Ch.) (the "Shareholder Action"). The requested order would modify the
court's order of July 29, 2002 (the "Order"), which requires WorldCom to pay
approximately $1.9 million to reimburse certain expenses approved by the Special
Committee pursuant to the settlement of the Shareholder Action, including the
success bonuses for Richards Layton and Cahill Gordon. Insofar as the bankruptcy
of WorldCom prevents immediate enforcement of the Order against WorldCom,
Richards Layton has sought the requested modification to obtain payment directly
from Digex. Digex opposes Richards Layton's request on the grounds that (i) the
court has not conclusively decided whether Digex is independently liable for the
fees approved by the Special Committee in the absence of reimbursement by
WorldCom and (ii) the proceedings relating to enforcement of WorldCom's
settlement obligations do not present the appropriate context or forum to
resolve that issue. Counsel for the plaintiffs in the Shareholder Action also
opposes the request. The court currently has the matter under advisement.
It cannot be determined at this time when the court will rule on Richards
Layton's request or what its ruling will be. Because the pendency of the
WorldCom bankruptcy makes it unlikely that WorldCom will be able to honor its
obligation to pay the $1.0 million in fees, an order that requires Digex to pay
that $1.0 million directly would impose a significant additional cash burden on
Digex. In order to meet that burden, Digex would be required to seek additional
borrowings from WorldCom under its debtor-in-possession financing of Digex.
There is no assurance that debtor-in-possession financing will continue to be
available from WorldCom to fund any payments that Digex might be ordered to make
to the law firms.
Item 2. Changes in Securities and Use of Proceeds
Recent Sales of Unregistered Securities
None.
35
Use of Proceeds from a Sale of Registered Securities
None.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
Matters submitted to a vote at the Annual Meeting of Stockholders held on
June 13, 2002 and the results of such meeting are as follows:
Votes Votes Votes Votes
For Against Withheld Abstained
----- --------- -------- ---------
1. Election of directors to serve until the
2003 Annual Meeting of Stockholders.
Ronald R. Beaumont ........................... 413,988,038 ---- 1,716,415 ----
Gregory J. Clark ............................. 415,324,112 ---- 380,341 ----
K. William Grothe, Jr. ....................... 414,323,826 ---- 1,380,627 ----
Edith E. Holiday ............................. 415,324,912 ---- 379,541 ----
Bert C. Roberts, Jr. ......................... 415,320,062 ---- 384,391 ----
Mark K. Shull ................................ 414,956,184 ---- 748,269 ----
Scott D. Sullivan ............................ 414,321,376 ---- 1,383,077 ----
Lawrence C. Tucker ........................... 415,269,812 ---- 434,641 ----
A majority of the votes present, in person or by proxy, and entitled to
vote at the meeting, were cast in favor of the proposal.
On July 15, 2002, Digex received resignation letters from the following
members of the Digex Board and Audit Committee: Lawrence C. Tucker, Gregory J.
Clark, and Edith E. Holiday. Digex's majority stockholder removed Scott Sullivan
from the Digex Board in early July 2002. It also removed Mark Shull from the
Digex Board in June 2002. Digex has commenced a search to fill the open seats.
Item 5. Other Information
On July 17, 2002, we announced that we received correspondence from The
Nasdaq Stock Market, Inc. indicating that the price of our common stock has
closed below the minimum USD$1.00 per share requirement for continued inclusion
under Nasdaq Marketplace Rule 4450(a)(5), and therefore in accordance with
Marketplace Rule 4450(e)(2), we will have until September 5, 2002 to regain
compliance.
According to the Nasdaq rule, compliance will entail the bid price of our
common stock to close at USD$1.00 per share or more for a minimum of ten
consecutive trading days before September 5, 2002. Under certain circumstances,
to ensure that we can sustain long-term compliance, Nasdaq may require that the
closing bid price equals USD$1.00 per share or more for more than ten
consecutive trading days before determining that we comply.
36
We currently expect to apply for transfer to The Nasdaq SmallCap Market. To
transfer, we must satisfy the continued inclusion requirements for the
SmallCap Market, which makes available an extended grace period for the minimum
USD$1.00 bid price requirement. If the transfer application is approved, we will
be afforded the 180-calendar day SmallCap Market grace period, or until December
4, 2002, to demonstrate compliance. We may also be eligible for an additional
180 calendar day grace period provided that we meet the initial listing criteria
for the SmallCap Market under Marketplace Rule 4310(c)(2)(A). If Nasdaq
determines that we do not qualify for an extension under Marketplace Rule
4310(c)(2)(A), we will be provided with written notification that our securities
will be delisted. At that time, we may appeal the Staff Determination to delist
our securities to a Nasdaq Listing Qualification Panel.
On or about July 18, 2002, we received notification from the Nasdaq
indicating that we no longer complied with Nasdaq's independent director and
audit committee requirements under Nasdaq Marketplace Rule 4350(c) and
4350(d)(2). Based on a further review and materials submitted on July 31, 2002,
the Nasdaq has determined to grant us an extension to regain compliance with the
rules. We expect to submit to the Nasdaq documentation, including biographies of
any proposed directors, evidencing compliance with the rules on or before
September 12, 2002. In the event we do not satisfy the terms, the Nasdaq Staff
will provide us with written notice that our common stock will be delisted. At
that time, we may appeal the Staff Determination to delist our securities to a
Nasdaq Listing Qualification Panel.
On August 9, 2002, we received notification from the Nasdaq indicating that
our common stock has not maintained a minimum market value of publicly held
shares of $5,000,000 for the last 30 consecutive trading days as required for
continued inclusion by Marketplace Rule 4450(a)(2), and therefore in accordance
with Marketplace Rule 4450(e)(1), we will have until November 7, 2002 to regain
compliance. If, at anytime before November 7, 2002, the market value of our
publicly held shares is $5,000,000 or greater for a minimum of ten consecutive
trading days, the Nasdaq Staff will provide written notification that we comply
with the rule. In the event we do not satisfy the terms, the Nasdaq Staff will
provide us with written notice that our common stock will be delisted. At that
time, we may appeal the Staff Determination to delist our securities to a Nasdaq
Listing Qualification Panel.
Alternatively, we may apply to transfer our common stock to The Nasdaq
SmallCap Market. To transfer, we must satisfy the continued inclusion
requirements for the SmallCap Market and submit the transfer application and
applicable listing fees by November 7, 2002. At this time, the initiation of the
delisting proceedings will be stayed pending the Nasdaq Staff's review of the
application. If the Nasdaq Staff does not approve our transfer application, we
will be provided with written notification that our securities will be delisted.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Number Exhibit
------ -------
3.1 -- Certificate of Incorporation of Digex and amendments
thereto, including the Certificate of Designation for
the Series A Preferred Stock. Incorporated herein by
reference from Digex's Form 10-K (File No. 000-26873)
filed with the SEC on April 1, 2002.
3.2 -- Bylaws of Digex, as amended. Incorporated herein by
reference to Digex's Form 10-Q (File No. 000-26873)
filed with the SEC on May 12, 2000.
(b) Reports on Form 8-K
The following reports on Form 8-K of Digex were filed during the second
quarter of 2002:
Digex filed a Current Report on Form 8-K, dated April 24, 2002, reporting
under Item 5 the issuance of a press release discussing Digex's first quarter
2002 results. Digex also reported under Item 7 the filing of the press release
as an exhibit to the Form 8-K.
Digex filed a Current Report on Form 8-K, dated May 15, 2002, reporting
under Item 4 regarding a change in certifying accountant. Digex also reported
under Item 7 the filing of a letter addressed to the SEC stating whether Arthur
Andersen LLP agrees with certain statements made in the Form 8-K as an exhibit.
37
Digex filed a Current Report on Form 8-K, dated June 10, 2002, reporting
under Item 4 regarding the appointment of its certifying accountant to Ernst &
Young LLP.
Digex filed a Current Report on Form 8-K, dated June 21, 2002, reporting
under Item 5 regarding changes in senior management. Digex also reported under
Item 7 the filing of the press releases as exhibits to the Form 8-K.
38
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
DIGEX, INCORPORATED
(Registrant)
/s/ T. SCOTT ZIMMERMAN
--------------------------
T. Scott Zimmerman
Chief Financial Officer
Dated: August 14, 2002
39
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
PURSUANT TO 18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO SECTION 906
OF THE SARBANES-OXLEY ACT OF 2002
In connection with the accompanying Quarterly Report of Digex, Incorporated
(the "Company") on Form 10-Q for the quarter ended June 30, 2002 (the "Report"),
I, George Kerns, President and Chief Executive Officer of the Company, certify,
pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the
Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of section 13(a) of the
Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material
respects, the financial condition and result of operations of the Company.
/s/ GEORGE L. KERNS
---------------------
Name: George Kerns
Date: August 14, 2002
40
CERTIFICATION OF CHIEF FINANCIAL OFFICER
PURSUANT TO 18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO SECTION 906
OF THE SARBANES-OXLEY ACT OF 2002
In connection with the accompanying Quarterly Report of Digex, Incorporated
(the "Company") on Form 10-Q for the quarter ended June 30, 2002 (the "Report"),
I, T. Scott Zimmerman, Chief Financial Officer of the Company, certify, pursuant
to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act
of 2002, that:
(1) The Report fully complies with the requirements of section 13(a) of the
Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material
respects, the financial condition and result of operations of the Company.
/s/ T. SCOTT ZIMMERMAN
--------------------------
Name: T. Scott Zimmerman
Date: August 14, 2002
41