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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 quarterly period ended January 31, 2001
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number: 0-27597
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NAVISITE, INC.
(Exact name of registrant as specified in its charter)
Delaware 52-2137343
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation)
400 Minuteman Road
Andover, Massachusetts 01810
(Address of principal executive (Zip Code)
offices)
(978) 682-8300
(Registrant's telephone number, including area code)
----------------
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 than 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 March 13, 2001 there were 58,917,269 shares outstanding of the
Registrant's common stock, par value $.01 per share.
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NAVISITE, INC.
Form 10-Q for the Quarter ended January 31, 2001
INDEX
Page
Number
------
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements (Unaudited)
Consolidated Balance Sheets as of January 31, 2001
and July 31, 2000.................................................. 3
Consolidated Statements of Operations for the three and six
months ended January 31, 2001 and 2000 ............................ 4
Consolidated Statements of Cash Flows for the six months ended
January 31, 2001 and 2000 ......................................... 5
Notes to Interim Consolidated Financial Statements................. 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations................................ 9
Item 3. Quantitative and Qualitative Disclosures About
Market Risk........................................................ 21
PART II. OTHER INFORMATION
Item 1. Legal Proceedings........................................... 22
Item 2. Changes in Securities and Use of Proceeds................... 22
Item 3. Defaults Upon Senior Securities............................. 22
Item 4. Submission of Matters to a Vote of Security Holders......... 23
Item 5. Other Information........................................... 23
Item 6. Exhibits and Reports on Form 8-K............................ 24
SIGNATURE........................................................... 25
EXHIBIT INDEX....................................................... 26
2
FINANCIAL INFORMATION
Item 1. Financial Statements.
NAVISITE, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except par value
January 31, July 31,
2001 2000
---------- --------
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents............................... $ 68,731 $ 77,947
Accounts receivable, less allowance for doubtful
accounts of $4,068 and $1,219 at January 31, 2001 and
July 31, 2000, respectively............................ 16,824 14,025
Due from CMGI and affiliates............................ 5,215 5,985
Prepaid expenses........................................ 5,938 3,201
--------- --------
Total current assets.................................. 96,708 101,158
--------- --------
Property and equipment, net............................. 74,417 70,651
Other assets............................................ 3,630 3,051
Goodwill, net of accumulated amortization of $527 and
$424 at January 31, 2001 and July 31, 2000,
respectively............................................ 498 601
--------- --------
Total assets............................................ $ 175,253 $175,461
========= ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Capital lease obligations, current portion.............. $ 81 $ 5,689
Due to CMGI............................................. 9,047 5,310
Accounts payable........................................ 18,108 13,457
Accrued expenses and deferred revenue................... 21,819 27,776
Software vendor payable, current portion................ 801 767
--------- --------
Total current liabilities............................ 49,856 52,999
--------- --------
Capital lease obligations, less current portion......... - 23,999
Software vendor payable, less current portion........... 545 989
Convertible notes payable to CMGI, net.................. 67,620 -
--------- --------
Total liabilities....................................... 118,021 77,987
--------- --------
Stockholders' equity:
Preferred stock, $.01 par value, 5,000 shares
authorized; No shares issued and
outstanding............................................ - -
Common stock, $.01 par value, 150,000 shares
authorized; 58,777 and 58,364 shares issued and
outstanding at January 31, 2001 and July 31, 2000,
respectively........................................... 588 584
Deferred compensation................................... - (762)
Additional paid-in capital.............................. 204,287 190,301
Accumulated deficit..................................... (147,643) (92,649)
--------- --------
Total stockholders' equity.............................. 57,232 97,474
--------- --------
Total liabilities and stockholders' equity.............. $ 175,253 $175,461
========= ========
See accompanying notes to interim unaudited consolidated financial statements.
3
NAVISITE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
(in thousands, except per share data)
Three months Six months
ended ended
January 31, January 31,
------------------ ----------------
2001 2000 2001 2000
------ ------ ------ ------
Revenue:
Revenue .......................... $ 17,004 $ 3,997 $ 32,002 $ 6,467
Revenue, related parties.......... 10,694 5,173 21,732 8,569
-------- -------- -------- --------
Total revenue.................... 27,698 9,170 53,734 15,036
Cost of revenue................... 33,770 12,322 65,827 21,391
-------- -------- -------- --------
Gross margin...................... (6,072) (3,152) (12,093) (6,355)
-------- -------- -------- --------
Operating expenses:
Selling and marketing............. 11,163 5,264 19,292 9,070
General and administrative........ 9,824 2,663 15,787 5,264
Product development............... 3,797 1,056 6,693 1,947
-------- -------- -------- --------
Total operating expenses......... 24,784 8,983 41,772 16,281
-------- -------- -------- --------
Loss from operations ............. (30,856) (12,135) (53,865) (22,636)
Other income (expense):
Interest income................... 819 756 1,693 839
Interest expense.................. (1,753) (63) (2,702) (196)
Other............................. (120) - (120) -
-------- -------- -------- --------
Net loss ......................... $(31,910 $(11,442) $(54,994) $(21,993)
======== ======== ======== ========
Basic and diluted net loss per
common share...................... $ (.54) $ (.21) $ (.94) $ (.71)
======== ======== ======== ========
Basic and diluted weighted
average number of common
shares outstanding................ 58,707 55,741 58,621 30,891
======== ======== ======== ========
Pro forma basic and diluted
net loss per share................ $ (.44)
========
Pro forma basic and diluted
weighted average number of
shares outstanding................ 50,164
========
See accompanying notes to interim unaudited consolidated financial statements.
4
NAVISITE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands)
Six months
ended January 31,
-----------------
2001 2000
------- -------
Cash flows from operating activities:
Net loss................................................... $(54,994)$ (21,993)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization............................ 7,467 2,814
Amortization of interest related to stock warrants issued
with notes payable to CMGI............................. 538 --
Loss on disposal of assets............................... 120 --
Provision for bad debts.................................. 5,177 283
Amortization of deferred compensation.................... 1,051 --
Changes in operating assets and liabilities:
Accounts receivable..................................... (7,976) (4,230)
Due from CMGI and affiliates............................ 770 (3,064)
Prepaid expenses........................................ (2,737) (403)
Accounts payable........................................ 4,651 3,447
Due to CMGI............................................. 3,737 12,369
Accrued expenses and deferred revenue................... (8,957) 4,304
-------- ---------
Net cash used in operating activities................. (51,153) (6,473)
-------- ---------
Cash flows from investing activities:
Purchases of property and equipment........................ (22,134) (35,453)
Proceeds from sale of property and equipment............... 13,884 -
Other assets............................................... (579) (2,620)
-------- ---------
Net cash used in investing activities................. (8,829) (38,073)
-------- ---------
Cash flows from financing activities:
Proceeds from issuance of common stock, net of issuance
costs..................................................... -- 80,382
Issuance of convertible notes payable to CMGI............. 80,000 -
Repayment of note payable.................................. -- (1,000)
Proceeds from exercise of stock options and ESPP........... 783 14
Payments of capital lease obligations...................... (29,607) (131)
Payments of software vendor obligations.................... (410) (317)
-------- ---------
Net cash provided by financing activities............. 50,766 78,948
-------- ---------
Net (decrease) increase in cash............................. (9,216) 34,402
Cash and cash equivalents, beginning of period.............. 77,947 3,352
-------- ---------
Cash and cash equivalents, end of period.................... $ 68,731 $ 37,754
======== =========
Supplemental disclosure of cash flow information:
Cash paid during the period for interest.................... $ 1,099 $ 211
======== =========
Supplemental Disclosure of Noncash Financing and Investing Activities:
Amount ascribed to the issuance of stock warrants related to
the convertible notes payable to CMGI $ 12,918
Software vendor obligations $ 3,000
See accompanying notes to interim unaudited consolidated financial statements.
5
NAVISITE, INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
January 31, 2001
1. Basis of Presentation
The accompanying consolidated financial statements have been prepared by
NaviSite, Inc. ("NaviSite" or the "Company") in accordance with generally
accepted accounting principles and pursuant to the rules and regulations of the
Securities and Exchange Commission. Certain information and footnote disclosures
normally included in financial statements prepared in accordance with generally
accepted accounting principles have been condensed or omitted pursuant to such
rules and regulations. It is suggested that the financial statements be read in
conjunction with the audited financial statements and the accompanying notes
included in the Company's Annual Report on Form 10-K for the year ended July 31,
2000, which was filed with the Securities and Exchange Commission on October 30,
2000.
The information furnished reflects all adjustments, which in the opinion of
management, are of a normal reoccurring nature and are considered necessary for
a fair presentation of results for the interim periods. Such adjustments consist
only of normal recurring items. It should also be noted that results for the
interim periods are not necessarily indicative of the results expected for the
full year or any future period.
The preparation of these consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
2. Principles of Consolidation
The accompanying financial statements include the accounts of the Company and
its wholly owned subsidiary, ClickHear, Inc. ("ClickHear"), after elimination of
all significant intercompany balances and transactions.
3. Cash and Cash Equivalents
Cash equivalents consist of a money market fund, which invests in high
quality short-term debt obligations, including commercial paper, asset-backed
commercial paper, corporate bonds, U.S. government agency obligations, taxable
municipal securities and repurchase agreements.
On February 3, 2001, the Company renewed two letters of credit related to
certain of our leased facilities. Under the terms of the letters of credit, the
Company was required to maintain a restricted cash balance of approximately $5.0
million. This restricted balance was not required at January 31, 2001.
4. Property and Equipment
January 31, July 31,
2001 2000
---------- -----------
(In thousands)
Office furniture and
equipment...................... $ 5,682 $ 4,335
Computer equipment............... 18,100 21,558
Software licenses................ 19,805 11,941
Leasehold improvements........... 33,016 42,101
Leasehold improvements in
progress....................... 13,580 --
---------- -----------
90,183 79,935
Less: Accumulated
depreciation and
amortization................... (15,766) (9,284)
---------- -----------
$ 74,417 $ 70,651
========== ===========
6
5. Net Loss Per Common Share
Basic loss per share is computed using the weighted average number of common
shares outstanding during the period. Diluted loss per share is computed using
the weighted average number of common and dilutive common equivalent shares
outstanding during the period, using either the "as-if-converted" method for
convertible preferred stock and convertible notes payable due to CMGI or the
treasury stock method for options, unless such amounts are anti-dilutive.
For the six and three months ended January 31, 2001, and three month period
ended January 31, 2000, net loss per basic and diluted share is based on
weighted average common shares and excludes any common stock equivalents, as
they would be anti-dilutive due to the reported loss. For the six months ended
January 31, 2000, a pro forma basic and diluted loss per share calculation,
assuming the conversion of all amounts due to CMGI and all outstanding shares of
preferred stock into common stock using the "as-if-converted" method from the
later of the date of issuance or beginning of the period, is presented. All
amounts due to CMGI were converted to preferred stock, and all outstanding
preferred stock was converted into 43,244,630 shares of common stock in
connection with the closing of the Company's initial public offering. The
following table provides a reconciliation of the denominators used in
calculating the pro forma basic and diluted loss per share for the six months
ended January 31, 2000:
Numerator:
Net loss............................................... $ (21,993)
==========
Denominator:
Basic weighted average number of common shares
outstanding............................................ 30,891
Assumed conversion of amounts due to CMGI and
preferred stock........................................ 19,273
----------
Weighted average number of pro forma basic and diluted
shares outstanding..................................... $ 50,164
==========
Pro forma basic and diluted net loss per share........... $ (.44)
==========
6. Leases
In June 2000, the Company sold certain equipment and leasehold improvements
in its two new data centers in a sale-leaseback transaction to a bank for
approximately $30.0 million. The Company entered into a capital lease, (the
"Capital Lease"), upon the leaseback of those assets. In January 2001, the
Company paid-off the Capital Lease obligation for approximately $27.0 million.
During the second quarter of fiscal year 2001, the Company sold certain
equipment in sale-leaseback transactions for a total of approximately $13.9
million. Simultaneously with the sales, the Company entered into operating
leases for the equipment. The leases are payable in monthly installments of
principal and interest totaling approximately $607,000 through December 31,
2002.
7
7. Convertible Notes
On December 12, 2000, the Company entered into a Note and Warrant Purchase
Agreement (the "Agreement") with CMGI, Inc. The Agreement provides for the sale
of a subordinated, unsecured, convertible note in the principal amount of
$50,000,000 (the "Initial Note") and a subordinated, unsecured, convertible note
in the principal amount of $30,000,000 (the "Second Note") (collectively the
"Notes"). The Notes are convertible at CMGI's option, and by NaviSite under
defined circumstances, into NaviSite common stock at a conversion price of
$5.535 per share. In connection with the Agreement, the Company granted to CMGI,
effective December 15, 2000, two warrants to purchase 2,601,525 shares of
NaviSite common stock for an aggregate amount of 5,203,050 shares of Navisite
common stock. The exercise price for these warrants is $5.77 and $6.92 per
share. These warrants are exercisable upon issuance and expire on December 15,
2005. The Company ascribed a fair value, using the Black-Scholes model, to the
warrants of approximately $12.9 million and is amortizing this value over the
life of the Notes as an additional component of interest expense.
During the quarter ended January 31, 2001, the Company received gross
proceeds of $80.0 million from the issuance of these Notes. The annual interest
rate of these Notes is 7.5% payable quarterly in, at the Company's discretion,
either cash or the Company's common stock. The principal amount of these Notes
are due in full by December 12, 2003. See Note 6.
8. Stockholders' Equity
During the six months ended January 31, 2001 the Company granted options to
purchase 3,757,660 shares of the Company's common stock at exercise prices
ranging from $2.0938 to $49.8125 per share. During the six months ended
January 31, 2001, 312,468 options were exercised at prices ranging from $.01 to
$7.00 per share.
9. New Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 133, Accounting for Derivative
Instruments and Hedging Activities ("SFAS 133"). SFAS 133 was amended by SFAS
138 in June 2000. SFAS 133 and 138 will require that Company record all
derivatives on the balance sheet at fair value. The Company adopted these
statements on August 1, 2000. Since the Company does not have any derivative
financial instruments and does not engage in hedging activities, the adoption of
SFAS 133 and SFAS 138 had no impact on the consolidate financial statements.
In December 1999, the Securities and Exchange Commission (SEC) released Staff
Accounting Bulletin (SAB) No. 101, Revenue Recognition in Financial Statements,
as amended by SAB No. 101A and SAB 101B, which expresses the views of the SEC
staff in applying generally accepted accounting principles to certain revenue
recognition issues. SAB 101 is effective to be adopted by the Company in its
fourth quarter of fiscal 2001. Although we do not expect the adoption of SAB
101 to have a material effect on our consolidated financial position or results
of operations, the SEC recently released implementation guidance and we are in
the process of analyzing the effect.
8
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
This Quarterly Report on Form 10-Q contains forward-looking statements within
the meaning of Section 21E of the Securities Exchange Act of 1934, as amended,
that involve risks and uncertainties. All statements other than statements of
historical information provided herein are forward-looking statements and may
contain information about financial results, economic conditions, trends and
known uncertainties. Our actual results could differ materially from those
discussed in the forward-looking statements as a result of a number of factors,
which include those discussed in this section and elsewhere in this report and
the risks discussed in our other filings with the Securities and Exchange
Commission. Readers are cautioned not to place undue reliance on these forward-
looking statements, which reflect management's analysis, judgment, belief or
expectation only as of the date hereof. We undertake no obligation to publicly
reissue these forward-looking statements to reflect events or circumstances that
arise after the date hereof.
Overview
We provide enhanced, integrated hosting and management services for business
Web sites and Internet applications. We also provide application rentals to
customers and developers and supply related consulting services. Our Internet
application service offerings allow businesses to outsource the deployment,
configuration, hosting, management and support of their Web sites and Internet
applications in a cost-effective and rapid manner. Our focus on enhanced
management services, beyond basic co-location services, allows us to meet the
expanding needs of businesses as their Web sites and Internet applications
become more complex. The cost for our services varies from customer to customer
based on the number of hosted or managed servers and the nature and level of
services provided.
We intend to expand domestically and internationally. During fiscal year
2000, we opened two new data center facilities, one at Zanker Road, San Jose,
California and one at 400 Minuteman Road, Andover, Massachusetts. In addition to
our new domestic data centers, during fiscal year 2000, we entered into an
agreement with Level 3 Communications, Inc. to provide domestic data center
space, as needed.
As of January 31, 2000, our corporate headquarters were located at 400
Minuteman Road, Andover, Massachusetts. Before this date, our corporate
headquarters were shared with CMGI and several other CMGI affiliates. CMGI
allocated rent, facility maintenance and service costs among these affiliates
based upon headcount within each affiliate and within each department of each
affiliate. Other services provided by CMGI to us included support for enterprise
services, human resources and benefits and Internet marketing and business
development. Management believes that costs approximate the fair value of the
services received. Actual expenses could have varied had we been operating on a
stand-alone basis. Costs are allocated to us on the basis of the fair market
value for the facilities used and the services provided.
We derive our revenue from a variety of services, including: Web site and
Internet application hosting, which includes access to our state-of-the-art data
centers, bandwidth and basic back-up, storage and monitoring services; enhanced
server management, which includes custom reporting, hardware options, load
balancing, system security, advanced back-up options, and the services of our
business solution managers; specialized application management, which includes
management of e-commerce and other sophisticated applications support services,
including ad-serving, streaming, databases and transaction processing services;
and application rentals and related consulting and other professional services.
Revenue also includes income from the rental of equipment to customers and one-
time installation fees. Revenue is recognized in the period in which the
services are performed and installation fees are recognized in the period of
installation. Our contracts generally are a one to three year commitment.
Our revenue from sales to related parties principally consists of sales of
services to CMGI and other customers that are CMGI affiliates. In general, in
pricing the services provided to CMGI and its affiliates, we have: negotiated
the services and levels of service to be provided; calculated the price of the
services at those service levels based on our then-current, standard prices;
and, in exchange for customer referrals provided to us by CMGI, discounted these
prices by 10%.
9
THREE-MONTH PERIOD ENDED JANUARY 31, 2001 COMPARED TO THE THREE-MONTH PERIOD
ENDED JANUARY 31, 2000
Revenue
Total revenue increased 202% to approximately $27.7 million for the three-
month period ended January 31, 2001, from approximately $9.2 million for the
same period in 2000. The increase in revenue is due primarily to an increase of
approximately $19.8 million of revenue related to the number of new unaffiliated
customers and additional business with both existing unaffiliated customers, and
affiliated customers of CMGI and termination fees offset by a reduction of
approximately $1.3 million of revenue related to lost customers. Revenue from
unaffiliated customers increased to approximately $17.0 million or 61% of total
revenue for the three-month period ended January 31, 2001, from approximately
$4.0 million or 44% of total revenue for the same period in 2000. The number of
unaffiliated customers increased 108% to 357 at January 31, 2001 from 172 as of
January 31, 2000. We will continue to focus our efforts to expand our revenues
with new unaffiliated customers over the near term. However, there can be no
assurance that we will be successful.
Cost of Revenue
Cost of revenue principally includes labor and headcount expenses, equipment
and maintenance costs, bandwidth and connectivity charges and depreciation and
lease expense from our data centers. Cost of revenue increased 174% to
approximately $33.8 million for the three-month period ended January 31, 2001,
from approximately $12.3 million for the same period in 2000. As a percentage of
revenue, cost of revenue decreased to 122% for the three-month period ended
January 31, 2001, from 134% for the same period in 2000. The dollar-value
increase in the three-month period ended January 31, 2001 as compared to the
same period in 2000 is due primarily to the costs associated with the increased
investment in our existing data centers and an increase in labor expense.
Management anticipates that our cost of revenue as an absolute dollar value will
increase going forward. However, as a percentage of revenue, this percentage
should continue to decrease beginning in our fiscal fourth quarter of 2001 as we
continue to focus on our efforts to improve operational efficiencies and
economies of scale and expand our revenue base. However, there can be no
assurances that we will be successful.
Gross Margin
The gross margin improved to approximately a negative (22%) of total revenue
for the three-month period ended January 31, 2001, from approximately a negative
(34%) of total revenue for the same period in 2000. The improvement in the gross
margin for the three-months ended January 31, 2001, as compared to the same
period in 2000 is a direct result of scaling the fixed infrastructure and labor
costs across a larger customer base. Our business model requires that we make
"up-front" fixed investments in both equipment and personnel. These costs are
leveraged across our data centers We anticipate that our gross margins should
continue to improve beginning in our fiscal fourth quarter of 2001, based on
current estimates and expectations, as our occupancy rate increases and we
achieve higher operational efficiencies and economies of scale.
Operating Expenses
Selling and Marketing. Selling and marketing expenses primarily include
salaries and commissions and expenses for marketing programs, including
advertising, events, sponsorships, direct marketing, product literature and
agency fees. Selling and marketing expenses increased 112% to approximately
$11.2 million for the three-month period ended January 31, 2001, from
approximately $5.3 million for the same period in 2000. On a percentage of
revenue basis, selling and marketing expenses decreased to 40% of total revenue
for the three-months ended January 31, 2001 from 57% of total revenue for the
same period in 2000. The increase in absolute dollars is due primarily to the
continued development of our sales and marketing capability, in the form of
increased headcount and marketing programs, and the increase of commission
expense resulting from increased revenue levels. The reduction of sales and
marketing expense as a percentage of revenue is a result of the scaling of the
sales and marketing infrastructure over a larger customer base with low
incremental customer costs. We anticipate that our selling and marketing
expenses in the aggregate dollar amount will increase slightly. However, we also
expect that this amount will decrease as a percentage of revenue as we expand
our revenue base.
10
General and Administrative. General and administrative expenses primarily
include the costs of financial, leasing, human resources, information
technology, business development, administrative personnel, professional
services and corporate overhead and bad debt expense. General and administrative
expenses increased 269% to approximately $9.8 million for the three-month period
ended January 31, 2001, from approximately $2.7 million for the same period in
2000. On a percentage of revenue basis, general and administrative expenses
increased to 35% of total revenue for the three-months ended January 31, 2001
from 29% of total revenue for the same period in 2000. The increase in absolute
dollars is due to an increase in the provision for doubtful accounts of $3.8
million and the costs of $3.8 million results from the hiring and increased
infrastructure costs related to additional administrative and finance personnel
to support our growing operations and offset by a reduction of $0.5 million in
Y2K related expense.
Our increased bad debt expense is related to the continuing evaluation of our
customer base and the deterioration of the "Dot Com" market segment. Excluding
this increase in our provision bad debt expense, the general and administrative
expense for the three-month period ended January 31, 2001 would have decreased
as a percentage of revenue, as compared to the same three-month period in 2000.
We believe that our general and administrative costs will decrease as a
percentage of revenue as we continue to expand our customer base.
Product Development. Product development expenses consist mainly of salaries
and related costs. Product development expenses increased 260% to approximately
$3.8 million for the three-month period ended January 31, 2001, from
approximately $1.1 million for the same period in 2000. This increase is due
primarily to the costs associated with an increase in product development
personnel as of January 31, 2001 to 59, from 26 employees for the same period in
2000 and the use of consultants. This growth in product development personnel
reflects our increased service offerings and emphasis on application services.
We anticipate that our product development cost will remain constant as an
aggregate dollar amount as we continue to invest to expand our product offering
and service. However, we expect that this amount will decrease as a percentage
of revenue beginning in our fiscal fourth quarter of 2001 as we expand our
revenue base.
Interest Income
Interest income increased to approximately $819,000 for three-month period
ended January 31, 2001, from approximately $756,000 for the same period in 2000.
The increase is due primarily to the funds available for investment resulting
from our various fiscal year 2001 financing activities, primarily from the sale
of common stock, issuance of convertible notes and sale-leaseback transactions.
We anticipate that this amount will remain constant through the quarter ended
April 30, 2001 and thereafter decrease as our cash investments decrease in order
to fund operations.
Interest Expense
Interest expense increased to approximately $1.8 million for the three-month
period ended January 31, 2001, from approximately $63,000 from the same period
in 2000. This increase is due primarily to interest incurred on capital lease
obligations, convertible notes payable to CMGI and the related amortization of
warrants as a component of interest expense. We anticipate that interest
expense will increase in the future due to our $80 million convertible notes
payable to CMGI being outstanding for the entire period.
SIX-MONTH PERIOD ENDED JANUARY 31, 2001 COMPARED TO THE SIX-MONTH PERIOD ENDED
JANUARY 31, 2000
Revenue
Total revenue increased 257% to approximately $53.7 million for the six-month
period ended January 31, 2001, from approximately $15.0 million for the same
period in 2000. The increase in revenue is due to an increase of approximately
$40.6 million revenue related to the number of new unaffiliated customers and
additional business with both existing unaffiliated customers and affiliated
customers of CMGI and termination fees offset by a reduction of approximately
$1.9 million revenue related to lost customers. The related party revenue
increased 154% while the unaffiliated revenue increased 395% over the same six-
month period ended January 31, 2000. We will continue to focus our efforts to
expand our business revenue with new unaffiliated customers over the near term.
11
Cost of Revenue
Cost of revenue principally includes labor and headcount expenses, additional
equipment, maintenance and facilities costs, increased bandwidth,
connectivity charges and depreciation and lease expense from our lost customers.
Cost of revenue increased 208% to approximately $65.8 million for the six-month
period ended January 31, 2000, from approximately $21.4 million for the same
period in 2000. As a percentage of revenue, cost of revenue decreased to 123%
for the six-month period ended January 31, 2001, from 142% for the same period
in 2000. The dollar-value increase for the six months ended January 31, 2001 is
due primarily to the costs associated with increased investment in our existing
and our new data centers in San Jose, California and Andover, Massachusetts and
an increase in our labor expense. Management anticipates that our cost of
revenue in absolute dollar value will increase going forward. However, as a
percentage of revenue, this percentage should continue to decrease beginning in
our fiscal fourth quarter of 2001 as we continue to focus on our efforts to
improve our operational efficiencies and economies of scale and expand our
revenue base. However, there can be no assurances that we will be successful.
Gross Margin
The gross margin improved to approximately a negative (23%) of total revenue
for the six-month period ended January 31, 2001, from approximately a negative
(42%) of total revenue for the same period in 2000. The improvement in the gross
margin for the six-months ended January 31, 2001, as compared to the same period
in 2000 is a direct result of scaling the fixed infrastructure and labor costs
across a larger customer base. Our business model requires that we makes "up-
front" fixed investments in both equipment and personnel. We anticipate that our
gross margins should continue to improve beginning in our fiscal fourth quarter
of 2001, based on current estimates and expectations, as our occupancy rate
increases and we achieve higher operational efficiencies and economies of scale.
Operating Expenses
Selling and Marketing. Selling and marketing expenses primarily include
salaries and commissions and expenses for marketing programs, including
advertising, events, sponsorships, direct marketing, product literature and
agency fees. Selling and marketing expenses increased 113% to approximately
$19.3 million for the six-month period ended January 31, 2001, from
approximately $9.1 million for the same period in 2000. The increase in absolute
dollars is due primarily to the continued development of our sales and marketing
capability, in the form of increased headcount and marketing programs, and the
increase of commission expense resulting from increased revenue levels. The
reduction of sales and marketing expense as a percentage of revenue is a result
of the scaling of the sales and marketing infrastructure over a larger customer
base with low incremental customer costs. We believe that our selling and
marketing expenses in the aggregate amount will increase slightly. However,
this amount will decrease as a percentage of revenue as we expand our revenue
base.
General and Administrative. General and administrative expenses primarily
include the costs of financial, leasing, human resource, information technology,
business development and administrative personnel, professional services, and
corporate overhead and bad debt expense. General and administration expenses
increased 200% to approximately $15.8 million for the six-month period ended
January 31, 2001, from approximately $5.3 million for the same period 2000. The
increase in absolute dollars is due to an increase in the provision for doubtful
accounts of $4.8 million and the cost of $7.0 million resulting from the hiring
and increased infrastructure cost related to additional administrative and
finance personnel to support our growing operations and, offset by a reduction
of $1.3 million in Y2K related expenses.
Our increased bad debt expense is related to the continuing evaluation of our
customer base and the deterioration of the "Dot Com" market segment. Excluding
this increase in our bad debt provision, the general and administrative expense
for the six-month period ended January 31, 2001 would have decreased as a
percentage of revenue, as compared to the same three-month period in 2000. We
believe that our general and administrative costs will decrease as a percentage
of revenue as we continue to expand our revenue base.
Product Development. Product development expenses consist primarily of
salaries and related costs. Product development expenses increased 244% to
approximately $6.7 million for the six-month period ended January 31, 2001, from
approximately $1.9 million for the same period in 2000. This increase is due
primarily to the costs
12
associated with an increase in product development personnel as of January 31,
2001 to 59, from 26 employees at January 31, 2000. This growth in product
development personnel reflects our increased service offerings and emphasis on
application services. We anticipate that our product development cost will
remain constant as an aggregate dollar amount as we continue to invest to expand
our product offering and service. However, this amount will decrease as a
percentage of revenue beginning in our fiscal fourth quarter of 2001 as we
expand our revenue.
Interest Income
The increase is due primarily to the funds available for investment resulting
from our various fiscal year 2001 financing activities, primarily from the sale
of common stock, issuance of convertible notes due to CMGI and sale-leaseback
transaction. We anticipate that our average cash and cash equivalent balances
will remain constant through the quarter ended April 30, 2001 and thereafter
decrease as our cash investments decrease in order to fund future operations.
Interest Expense
Interest expense increased to approximately $2.7 million for the six-month
period ended January 31, 2001, from approximately $196,000 from the same period
in 2000. This increase is due primarily to interest incurred on capital lease
obligations, convertible notes due to CMGI and the related amortization of
warrants as a component of interest expense. We anticipate that interest expense
will increase in the future due to the Company's outstanding $80 million
convertible notes payable to CMGI.
Liquidity and Capital Resources
Since our inception, our operations have been funded primarily by CMGI
through the issuance of common stock, preferred stock and convertible debt,
preferred stock to strategic investors, and our initial public offering and
related underwriters' over-allotment in November 1999.
Net cash used for operating activities for the six-month period ended January
31, 2001 amounted to $51.1 million, resulting primarily from net operating
losses, increases in accounts receivable and prepaid expenses, and decreases in
accrued expenses and deferred revenue, which are partially offset by an increase
in accounts payable and non-cash depreciation and amortization charges and
increase an amounts due to CMGI. The available for collection days sales
outstanding is approximately 47 for both the January 31, 2001 and 2000 periods.
Available for collection days sales outstanding represents the weighted average
number of days sales are outstanding based on the date that services rendered
during the period are billed. We increased our provision for doubtful accounts
to $4.0 million that resulted in an additional bad debt expense of $5.2 million
for the six months ended January 31, 2001.
Net cash used for investing activities for the six-month period ended January
31, 2001 amounted to $8.8 million. The net cash used in investing activities is
the result of sale proceeds from the sale leaseback of $13.9 million less $22.1
million utilized to acquire property and equipment required to support the
growth of the business and to expand data center infrastructure and $0.6 million
used for the acquisition of other assets. We also acquired a software license
for $3.0 million that we are required to pay for over eleven monthly
installments beginning February 2001. We also purchased approximately $1.0
million of equipment during the quarter ended January 31, 2001 that we intend to
sell under a sale-leaseback transaction during the quarter ended April 30, 2001.
Net cash provided by financing activities for the six-month period ended
January 31, 2001 amounted to $50.8 million, consisting primarily of $80.0
million in proceeds from the sale of convertible notes to CMGI offset by the
scheduled pay-off and other payments of the capital lease for approximately
$30.0 million.
13
In June 2000, we sold certain of our equipment and leasehold improvements in
our two new data centers in a sale-leaseback transaction ("the capital lease")
to a bank for approximately $30.0 million. As discussed above, we repaid the
remaining balance of the capital lease obligation totaling approximately $27.0
million. The pay-off of this capital lease will result in a net reduction in
cash outflows for principal and interest payment of approximately $2.0 million
per fiscal quarter, starting in the third quarter of fiscal year 2001.
On December 12, 2000, we entered into a Note and Warrant Purchase Agreement
("the Agreement"), with CMGI. The Agreement provided for the sale of a
subordinated, unsecured, convertible note in the principal amount of $50
million, ("the Initial Note"), and a subordinated, unsecured, convertible note
in the principal amount of $30 million, (the "Second Note"). The Initial Note
and the Second Note are collectively referred to as the Notes. The Notes are
convertible at CMGI's option, and by NaviSite under defined circumstances, into
NaviSite common stock at a conversion price equal to 5.535, (the "Closing
Price"). In connection with the Agreement, we granted CMGI, effective December
15, 2000, a warrant to purchase 2,601,626 shares of NaviSite common stock at
$5.77 per share, and a warrant to purchase 2,601,626 shares of NaviSite common
stock at $6.92 per share. The warrants are exercisable upon issuance and expire
on December 15, 2005. We ascribed a fair value of $12.9 million to the warrants
using the Black-Scholes model and are amortizing this fair value over the life
of the Notes as an additional component of interest expense.
During the quarter ended January 31, 2001 we received gross proceeds of
$80 million from the issuance of the Notes. The annual interest rate on the
notes is 7.5% payable quarterly in, at our discretion, either cash or Navisite
common stock. The principal amount is due in full by December 12, 2003.
On December 12, 2000, we sold certain equipment in a sale-leaseback
transaction to an equipment vendor for approximately $13.9 million. We
simultaneously entered into an operating lease of the equipment with the vendor.
The lease is payable in monthly installments through December 2002.
On February 3, 2001 we renewed a letter of credit for the lease on our
facility at 400 Minuteman Road, Andover, Massachusetts. The terms of the letter
of credit required a restricted cash balance in the amount of approximately 4.4
million. The restricted balance was not required at January 31, 2001.
On February 3, 2001 we entered into a letter of credit for the lease on our
San Diego, California location. The terms of the letter of credit require a
restricted cash balance of approximately $555,000. The restricted cash balance
was not required at January 31, 2001.
We have experienced a substantial increase in our expenditures since
inception consistent with our growth in operations and staffing. We anticipate
that expenditures will continue to increase as we grow our business.
Additionally, we will continue to evaluate investment opportunities in
businesses that management believes will complement our technologies and market
strategies.
We currently anticipate that our available cash resources at January 31,
2001, combined with our ability to obtain additional lease financing credit
lines, will be sufficient to meet our anticipated needs for working capital and
capital expenditures over the next twelve months based on current estimates and
expectations. However, we may need to raise additional funds in order to fund
more rapid expansion, to fund our domestic and international expansion, to
develop new, or enhance existing, services or products, to respond to
competitive pressures or to acquire complementary businesses, products or
technologies. In addition, on a long-term basis, we may require additional
external financing for working capital and capital expenditures through credit
facilities, sales of additional equity or other financing vehicles. If
additional funds are raised through the issuance of equity or convertible debt
securities, the percentage ownership of our stockholders will be reduced and our
stockholders may experience additional dilution. We cannot assure you that
additional financing will be available on terms favorable to us, if at all. If
adequate funds are not available or are not available on acceptable terms, our
ability to fund our expansion, take advantage of unanticipated opportunities,
develop or enhance services or products or otherwise respond to competitive
pressures would be significantly limited.
14
INFLATION
We believe that our revenue and results from operations have not been
significantly impacted by inflation.
Additional Risk Factors That May Affect Future Results:
The risks and uncertainties described below are not the only risks we face.
Additional risks and uncertainties not presently known to us or that are
currently deemed immaterial may also impair our business operations. If any of
the following risks actually occur, our financial condition and operating
results could be materially adversely affected.
We have a history of operating losses and expect future losses. There can be
no assurance that we will ever achieve profitability on a quarterly or annual
basis or, if we achieve profitability, that it will be sustainable. We were
organized in 1996 by CMGI to support the networks and host the Web sites of CMGI
and a number of CMGI affiliates. It was not until the fall of 1997 that we began
providing Web site hosting and Internet application management services to
companies unaffiliated with CMGI. Since our inception in 1996, we have
experienced operating losses and negative cash flows for each quarterly and
annual period. As of January 31, 2001, we had an accumulated deficit of $147.6
million. We anticipate increased expenses as we continue to expand and improve
our infrastructure, introduce new services, enhance our application management
expertise, expand our sales and marketing efforts, expand internationally and
pursue additional industry relationships. As a result, we expect to incur
operating losses for at least the next five fiscal quarters.
Fluctuations in our quarterly operating results may negatively impact our
stock price. Our quarterly operating results may fluctuate significantly in the
future as a result of a variety of factors, many of which are outside our
control. These factors include: continued market demand and acceptance for our
Web site and Internet application hosting and management services; our ability
to develop, market and introduce new services on a timely basis; downward price
adjustments by our competitors; changes in the mix of services provided by our
competitors; technical difficulties or system downtime affecting the Internet
generally or our hosting operations specifically; our ability to meet any
increased technological demands of our customers; the amount and timing of costs
related to our marketing efforts and service introductions; and economic
conditions specific to the Internet application service provider industry. Our
operating results for any particular quarter may fall short of our expectations
or those of investors or securities analysts. In this event, the market price of
our common stock would be likely to fall.
CMGI is a majority stockholder, and CMGI may have interests that conflict
with the interests of our other stockholders. As of January 31, 2001, CMGI
beneficially owned approximately 76.21% of our outstanding common stock.
Accordingly, CMGI has the power, acting alone, to elect a majority of our board
of directors and has the ability to determine the outcome of any corporate
actions requiring stockholder approval, regardless of how our other stockholders
may vote. Under Delaware law, CMGI may exercise its voting power by written
consent, without convening a meeting of the stockholders, meaning that CMGI
could affect a sale or merger of our company without prior notice to, or the
consent of, our other stockholders. CMGI's interests could conflict with the
interests of our other stockholders. The possible need of CMGI to maintain
control of us in order to avoid becoming a registered investment company could
influence future decisions by CMGI as to the disposition of any or all of its
ownership position in our company. CMGI would be subject to numerous regulatory
requirements with which it would have difficulty complying if it were required
to register as an investment company. As a result, CMGI may be motivated to
maintain at least a majority ownership position in us, even if our other
stockholders might consider a sale of control of our company to be in their best
interests. As long as it is a majority stockholder, CMGI has contractual rights
to purchase shares in any of our future financing sufficient to maintain its
majority ownership position. CMGI's ownership may have the effect of delaying,
deferring or preventing a change in control of our company or discouraging a
potential acquirer from attempting to obtain control of us, which in turn could
adversely affect the market price of our common stock.
15
A significant portion of our revenue currently is generated by services
provided to CMGI and companies affiliated with CMGI, and the loss of this
revenue would substantially impair the growth of our business. We anticipate
that we will continue to receive a significant portion of our revenue in the
future from CMGI and CMGI affiliates. CMGI and CMGI affiliates accounted for
approximately 38.6% of our revenue in the quarter ended January 31, 2001 and
approximately 50% of our revenue for the fiscal year ended July 31, 2000. We
cannot assure you that revenues generated by CMGI and CMGI affiliates will
continue or that we will be able to secure business from unaffiliated customers
to replace this revenue in the future. The loss of revenue from CMGI and CMGI
affiliates, or our inability to replace this operating revenue, would
substantially impair the growth of our business.
Our ability to grow our business would be substantially impaired if we were
unable to obtain, on commercially reasonable terms, certain equipment that is
currently provided under leases executed or guaranteed by CMGI. Certain of the
equipment that we use or provide to our customers for their use in connection
with our services is provided under leases executed or guaranteed by CMGI prior
to our October 1999 initial public offering. CMGI has not continued this
practice, and accordingly, we or our customers will have to obtain this
equipment for new leases and renewal of existing leases directly, on a stand
alone basis. Our ability to grow our business would be substantially impaired if
we were unable to obtain, on commercially reasonable terms, leases for this
equipment. We cannot assure you that it or its customers can do so on similar
financial terms.
If the growth of the market for Internet commerce and communication does not
continue, or it decreases, there may be insufficient demand for our services,
and as a result, our business strategy may not be successful. The increased use
of the Internet for retrieving, sharing and transferring information among
businesses and consumers has developed only recently, and the market for the
purchase of products and services over the Internet is new and emerging. If
acceptance and growth of the Internet as a medium for commerce and communication
does not continue, our business strategy may not be successful because there may
not be a continuing market demand for our Web site and Internet application
hosting and management services. Our growth could be substantially limited if
the market for Internet application services fails to continue to develop or if
we cannot continue to achieve broad market acceptance.
Our ability to successfully market our services could be substantially
impaired if we are unable to deploy new Internet applications or if new Internet
applications deployed by us prove to be unreliable, defective or incompatible.
We cannot assure you that we will not experience difficulties that could delay
or prevent the successful development, introduction or marketing of Internet
application services in the future. If any newly introduced Internet
applications suffer from reliability, quality or compatibility problems, market
acceptance of our services could be greatly hindered and our ability to attract
new customers could be adversely affected. We cannot assure you that new
applications deployed by us will be free from any reliability, quality or
compatibility problems. If we incur increased costs or are unable, for technical
or other reasons, to host and manage new Internet applications or enhancements
of existing applications, our ability to successfully market our services could
be substantially impaired.
The market we serve is highly competitive, and as a rapidly growing company,
we may lack the financial and other resources, expertise or capability needed to
capture increased market share. We compete in the Internet application service
market. This market is rapidly evolving, highly competitive and likely to be
characterized by an increasing number of market entrants and by industry
consolidation. We believe that participants in this market must grow rapidly and
achieve a significant presence to compete effectively. As a rapidly growing
company, our business is not as developed as that of many of our competitors.
For example, we estimate that the growth capacity of our facilities may be
sufficient only for the next two fiscal years. Insufficient growth capacity in
our facilities or the lack of availability of non-owned facilities could impair
our ability to achieve rapid growth through an increase in our customer base.
Moreover, many of our competitors have substantially greater financial,
technical and marketing resources, greater name recognition and more established
relationships in the industry than we have. We may lack the financial and other
resources, expertise or capability needed to capture increased market share in
this environment in the future.
16
Any interruptions in, or degradation of, private transit Internet connections
could result in the loss of customers or hinder our ability to attract new
customers. Our customers rely on our ability to move their digital content as
efficiently as possible to the people accessing their Web sites and Internet
applications. We utilize our direct private transit Internet connections to
major backbone providers as a means of avoiding congestion and resulting
performance degradation at public Internet exchange points. We rely on these
telecommunications network suppliers to maintain the operational integrity of
their backbones so that our private transit Internet connections operate
effectively.
Increased costs associated with our private transit Internet connections
could result in the loss of customers or significant increases in operating
costs. Our private transit Internet connections are already more costly than
alternative arrangements commonly utilized to move Internet traffic. If
providers increase the pricing associated with utilizing their bandwidth, we may
be required to identify alternative methods to distribute our customers' digital
content. We cannot assure you that our customers will continue to be willing to
pay the higher costs associated with direct private transit or that we could
effectively move to another network approach. If we are unable to access
alternative networks to distribute our customers' digital content on a cost-
effective basis or to pass any additional costs on to our customers, our
operating costs would increase significantly.
If we are unable to maintain existing and develop additional relationships
with Internet application software vendors, the sale, marketing and provision of
our Internet application services may be unsuccessful. We believe that to
penetrate the market for Web site and Internet application hosting and
management services we must maintain existing and develop additional
relationships with industry-leading Internet application software vendors and
other third parties. We license or rent select software applications from
Internet application software vendors. The loss of our ability to continually
obtain any of these applications could materially impair our ability to provide
services to our customers or require us to obtain substitute software
applications of lower quality or performance standards or at greater cost. In
addition, because we generally license applications on a non-exclusive basis,
our competitors may license and utilize the same software applications. In fact,
many of the companies with which we have strategic relationships currently have,
or could enter into, similar license agreements with our competitors or
prospective competitors. We cannot assure you that software applications will
continue to be available to us from Internet application software vendors on
commercially reasonable terms. If we are unable to identify and license software
applications which meet our targeted criteria for new application introductions,
we may have to discontinue or delay introduction of services relating to these
applications.
We purchase from a limited number of suppliers key components of our
infrastructure, including networking equipment, that are available only from
limited sources in the quantities and with the quality that we demand. For
example, we purchase most of the routers and switches used in our infrastructure
from Cisco Systems Inc. We cannot assure you that we will have the necessary
hardware or parts on hand or that our suppliers will be able to provide them in
a timely manner in the event of equipment failure. Our inability or failure to
obtain the necessary hardware or parts on a timely basis could result in
sustained equipment failure and a loss of revenue due to customer loss or claims
for service credits under our service level guarantees.
Our inability to scale our infrastructure or otherwise manage our anticipated
growth and the related expansion of our operations could result in decreased
revenue and continued negative margins and operating losses. We have experienced
rapid growth in our service offerings and our customer base. We were a Web site
hosting provider with approximately 76 customers as of January 31, 2000. As of
January 31, 2001, we are currently providing Web site and Internet application
hosting and management services to 379 customers. In order to service our
growing customer base, we will need to continue to improve and expand our
network infrastructure. Our ability to continue to meet the needs of a
substantial and growing number of customers while maintaining superior
performance is largely unproven. If our network infrastructure is not scalable,
we may not be able to provide our services to additional customers, which would
result in decreased revenue.
In addition, between January 31, 2000 and January 31, 2001, we increased the
number of our employees from 297 to 604. This growth has placed, and likely will
continue to place, a significant strain on our financial, management,
operational and other resources. To effectively manage our anticipated growth,
we will be required to continue to enhance our operating and financial
procedures and controls, to upgrade or replace our operational, financial and
management information systems and to attract, train, motivate, manage and
retain key employees. If we are unable
17
to effectively manage our rapid growth, we could experience continued negative
margins and operating losses.
Our customer base includes a significant number of businesses that face
increased risk of loss of funding depending upon the availability of private
and/or public funding. Many of our customers are small start-up Internet based
businesses that have traditionally been initially funded by venture capital
firms and then through public securities offerings. If the market for technology
and Internet based businesses is not supported by the private investors who have
funded these customers, we face the risk that these customers may cease, curtail
or limit Web site operations hosted by us. If this occurs, we could experience a
loss of revenue associated with these customers and will then have to increase
sales to other businesses using the Internet in order to preserve and grow our
revenue.
You may experience dilution because our historical source of funding is
expected to change, and other funding may not be available to us on favorable
terms, if at all. Until the completion of our initial public offering, CMGI
funded our operations as needed, increasing our obligations to CMGI and allowing
us to maintain a zero-balance cash account. Upon completion of our initial
public offering, our net obligations to CMGI, together with all convertible
preferred stock held by CMGI, were converted into common stock. We may need to
raise additional funds from time to time. In December 2000, we entered into an
agreement to sell CMGI convertible notes with warrants for total proceeds of
$80.0 million and completed a $13.9 million sale-leaseback transaction with an
equipment vendor, and in June 2000 we completed a $30 million sale-leaseback
transaction with a bank and a $50 million private placement sale of common stock
to CMGI. There is no assurance that we will be able to obtain additional
financing on terms favorable to us, if at all. If adequate funds were not
available or were not available on acceptable terms, our ability to respond to
competitive pressures would be significantly limited. Moreover, if additional
funds are raised through the issuance of equity or convertible debt securities,
your percentage ownership in us will be reduced, and you may experience
additional dilution.
Our network infrastructure could fail, which would impair our ability to
provide guaranteed levels of service and could result in significant operating
losses. To provide our customers with guaranteed levels of service, we must
operate our network infrastructure 24 hours a day, seven days a week without
interruption. In order to operate in this manner, we must protect our network
infrastructure, equipment and customer files against damage from human error,
natural disasters, unexpected equipment failure, power loss or
telecommunications failures, sabotage or other intentional acts of vandalism.
Even if we take precautions, the occurrence of a natural disaster, equipment
failure or other unanticipated problem at one or more of our data centers could
result in interruptions in the services we provide to our customers. We cannot
assure you that our disaster recovery plan will address all, or even most, of
the problems we may encounter in the event of such a disaster.
We have experienced service interruptions in the past, and any future service
interruptions could: require us to spend substantial amounts of money to replace
equipment or facilities; entitle customers to claim service credits under our
service level guarantees; cause customers to seek damages for losses incurred;
or make it more difficult for us to attract new customers or enter into
additional strategic relationships. Any of these occurrences could result in
significant operating losses.
The misappropriation of our proprietary rights could result in the loss of
our competitive advantage in the market. We rely on a combination of trademark,
service mark, copyright and trade secret laws and contractual restrictions to
establish and protect our proprietary rights. We do not own any patents that
would prevent or inhibit competitors from using our technology or entering our
market. We cannot assure you that the contractual arrangements or other steps
taken by us to protect our proprietary rights will prove sufficient to prevent
misappropriation of our proprietary rights or to deter independent, third-party
development of similar proprietary assets. In addition, we provide our services
in other countries where the laws may not afford adequate protection for our
proprietary rights.
18
Third-party infringement claims against our technology suppliers, customers
or us could result in disruptions in service, the loss of customers or costly
and time consuming litigation. We license or lease most technologies used in the
Internet application services that we offer. Our technology suppliers may become
subject to third-party infringement claims, which could result in their
inability or unwillingness to continue to license their technology to us. We
expect that we and our customers increasingly will be subject to third-party
infringement claims as the number of Web sites and third-party service providers
for Web-based businesses grows. In addition, we have received notices alleging
that our service marks infringe the trademark rights of third parties. We cannot
assure you that third parties will not assert claims against us in the future or
that these claims will not be successful. Any infringement claim as to our
technologies or services, regardless of its merit, could result in delays in
service, installation or upgrades, the loss of customers or costly and time-
consuming litigation, or require us to enter into royalty or licensing
agreements.
The loss of key officers and personnel could impair our ability to
successfully execute our business strategy, because we substantially rely on
their experience and management skills, or could jeopardize our ability to
continue to provide service to our customers. We believe that the continued
service of key personnel, including Joel B. Rosen, our Chief Executive Officer,
is a key component of the future success of our business. None of our key
officers or personnel is currently a party to an employment agreement with us.
This means that any officer or employee can terminate his or her relationship
with us at any time. In addition, we do not carry life insurance for any of our
key personnel to insure our business in the event of their death. In addition,
the loss of key members of our sales and marketing teams or key technical
service personnel could jeopardize our positive relations with our customers.
Any loss of key technical personnel would jeopardize the stability of our
infrastructure and our ability to provide the guaranteed service levels our
customers expect.
If we fail to attract and retain additional skilled personnel, our ability to
provide Web site and Internet application management and technical support may
be limited, and as a result, we may be unable to attract customers and our
business. Our business requires individuals with significant levels of Internet
application expertise, in particular to win consumer confidence in outsourcing
the hosting and management of mission-critical applications. Competition for
such personnel is intense, and qualified technical personnel are likely to
remain a limited resource for the foreseeable future. Locating candidates with
the appropriate qualifications, particularly in the desired geographic location,
can be costly and difficult. We may not be able to hire the necessary personnel
to implement our business strategy, or may need to provide higher compensation
to such personnel than we currently anticipate.
Any future acquisitions we make of companies or technologies may result in
disruptions to our business or distractions of our management due to
difficulties in assimilating acquired personnel and operations. Our business
strategy contemplates future acquisitions of complementary businesses or
technologies. If we do pursue additional acquisitions, our risks may increase
because our ongoing business may be disrupted and management's attention and
resources may be diverted from other business concerns. In addition, through
acquisitions, we may enter into markets or market segments in which we have
limited prior experience.
Once we complete an acquisition, we will face additional risks. These risks
include: difficulty assimilating acquired operations, technologies and
personnel; inability to retain management and other key personnel of the
acquired business; and changes in management or other key personnel that may
harm relationships with the acquired business's customers and employees. We
cannot assure you that any acquisitions will be successfully identified and
completed or that, if one or more acquisitions are completed, the acquired
business, assets or technologies will generate sufficient revenue to offset the
associated costs or other adverse effects.
19
The market for our services in international territories is unproven, and as
a result, the revenue generated by any future international operations may not
be adequate to offset the expense of establishing and maintaining those
operations. One component of our strategy is to expand into international
markets. We cannot assure you that we will be able to market, sell and provide
our services successfully outside the United States. We could suffer significant
operating losses if the revenue generated by any current or future international
data center or other operations adequate to offset the expense of establishing
and maintaining those international operations. Our present international
strategy is based upon the creation of alliances with foreign telecommunications
companies that own or operate data centers into which we intend to place our
infrastructure and to service our current customers as well as the customers of
those telecommunications companies desiring our services. In the event that we
are unable to negotiate favorable agreements with or successfully market our
services together with such telecommunications companies, our international
strategy will be significantly impaired, curtailed or eliminated.
We face risks inherent in doing business in international markets that could
adversely affect the success of our international operations. There are risks
inherent in doing business in international markets, including different
regulatory requirements, trade barriers, challenges in staffing and managing
foreign operations, currency risk, different technology standards, different tax
structures which may adversely impact earnings, different privacy, censorship
and service provider liability standards and regulations and foreign political
and economic instability, any of which could adversely affect the success of our
international operations.
The emergence and growth of a market for our Internet application services
will be impaired if third parties do not continue to develop and improve the
Internet infrastructure. The recent growth in the use of the Internet has caused
frequent periods of performance degradation, requiring the upgrade of routers
and switches, telecommunications links and other components forming the
infrastructure of the Internet, by Internet service providers and other
organizations with links to the Internet. Any perceived degradation in the
performance of the Internet as a means to transact business and communicate
could undermine the benefits and market acceptance of our Web site and Internet
application hosting and management services. Our services are ultimately limited
by, and dependent upon, the speed and reliability of hardware, communications
services and networks operated by third parties. Consequently, the emergence and
growth of the market for our Internet application services will be impaired if
improvements are not made to the entire Internet infrastructure to alleviate
overloading and congestion.
We could be subject to increased operating costs, as well as claims,
litigation or other potential liability, in connection with risks associated
with Internet security and the security of our systems. A significant barrier to
the growth of e-commerce and communications over the Internet has been the need
for secure transmission of confidential information. Several of our Internet
application services utilize encryption and authentication technology licensed
from third parties to provide the protections necessary to ensure secure
transmission of confidential information. We also rely on security systems
designed by third parties and the personnel in our network operations centers to
secure those data centers. Any unauthorized access, computer viruses, accidental
or intentional actions and other disruptions could result in increased operating
costs. For example, we may incur significant costs to protect against these
interruptions and the threat of security breaches or to alleviate problems
caused by such interruptions or breaches, and we expect to expend significant
financial resources in the future to equip our new and existing data centers
with state-of-the-art security measures. If a third party were able to
misappropriate a consumer's personal or proprietary information, including
credit card information, during the use of an application solution provided by
us, we could be subject to claims, litigation or other potential liability.
We may become subject to burdensome government regulation and legal
uncertainties that could substantially impair the growth of our business or
expose us to unanticipated liabilities. It is likely that laws and regulations
directly applicable to the Internet or to Internet application service providers
may be adopted. These laws may cover a variety of issues, including
user privacy and the pricing, characteristics and quality of products and
services. The adoption or modification of laws or regulations relating to
commerce over the Internet could substantially impair the growth of our business
or expose us to unanticipated liabilities. Moreover, the applicability of
existing laws to the Internet and Internet application service providers is
uncertain. These existing laws could expose us to substantial liability if they
are found to be applicable to
20
our business. For example, we provide services over the Internet in many states
in the United States and in the United Kingdom and facilitate the activities of
our customers in these jurisdictions. As a result, we may be required to qualify
to do business, be subject to taxation or be subject to other laws and
regulations in these jurisdictions, even if we do not have a physical presence,
employees or property there.
We may be subject to legal claims in connection with the information
disseminated through our network, which could have the effect of diverting
management's attention and require us to expend significant financial resources.
We may face potential direct and indirect liability for claims of defamation,
negligence, copyright, patent or trademark infringement, violation of securities
laws and other claims based on the nature and content of the materials
disseminated through our network. For example, lawsuits may be brought against
us claiming that content distributed by some of our current or future customers
may be regulated or banned. In these and other instances, we may be required to
engage in protracted and expensive litigation which could have the effect of
diverting management's attention and require us to expend significant financial
resources. Our general liability insurance may not necessarily cover any of
these claims or may not be adequate to protect us against all liability that may
be imposed.
In addition, on a limited number of occasions in the past, businesses,
organizations and individuals have sent unsolicited commercial e-mails from
servers hosted at our facilities to massive numbers of people, typically to
advertise products or services. This practice, known as "spamming," can lead to
complaints against service providers that enable such activities, particularly
where recipients view the materials received as offensive. We have in the past
received, and may in the future receive, letters from recipients of information
transmitted by our customers objecting to such transmission. Although we
prohibit our customers by contract from spamming, we cannot assure you that our
customers will not engage in this practice, which could subject us to claims for
damages.
The market price of our common stock may experience extreme price and volume
fluctuations. The market price of our common stock may fluctuate substantially
due to a variety of factors, including: any actual or anticipated fluctuations
in our financial condition and operating results; public announcements
concerning us or our competitors, or the Internet industry; the introduction or
market acceptance of new service offerings by us or our competitors; changes in
industry research analysts' earnings estimates; changes in accounting
principles; sales of our common stock by existing stockholders; and the loss of
any of our key personnel.
In addition, the stock market has experienced extreme price and volume
fluctuations. The market prices of the securities of technology and Internet-
related companies have been especially volatile. This volatility often has been
unrelated to the operating performance of particular companies. In the past,
securities class action litigation often has been brought against companies that
experience volatility in the market price of their securities. Whether or not
meritorious, litigation brought against us could result in substantial costs and
a diversion of management's attention and resources.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Our exposure to market rate risk for changes in interest rates relates
primarily to our cash equivalents. We invest our cash primarily in money market
funds. An increase or decrease in interest rates would not significantly
increase or decrease interest expense on capital lease obligations and our
outstanding debt due to CMGI due to the fixed nature of such obligations. We do
not currently have any significant foreign operations and thus are not exposed
to foreign currency fluctuations.
21
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
None.
Item 2. Changes in Securities and Use of Proceeds.
None.
Item 3. Defaults Upon Senior Securities.
None.
22
Item 4. Submission of Matters to a Vote of Security Holders.
At the Company's Annual Meeting of Stockholders held on December 20,
2000, the Company's stockholders approved the following:
Total Vote For Each Total Vote Withheld
Director From Each Director
(1) To elect six members of the Board
of Directors of NaviSite to
serve for one-year terms.
Nominees:
Craig D. Goldman....................... 51,921,960 145,171
Andrew J. Hajducky, III................ 50,981,802 1,085,329
James F. Moore, Ph.D................... 51,924,894 142,237
Stephen D.R. Moore..................... 51,924,494 142,637
Joel B. Rosen.......................... 51,919,494 147,637
David S. Wetherell..................... 50,953,299 1,113,832
BROKER
FOR AGAINST ABSTAIN NON-VOTE
(2) To approve an amendment
increasing the maximum number of
shares of common stock, par value
$.01 per share, of NaviSite,
subject to awards made under
NaviSite's Amended and Restated
1998 Equity Incentive
Plan............................... 45,553,496 1,334,236 29,053 5,150,346
(3) To approve an amendment to
allow for the monthly vesting of
options granted under NaviSite's
Amended and Restated 1998 Director
Stock Option
Plan............................... 51,772,963 264,458 29,710 0
(4) To approve the amendment and
restatement of NaviSite's 1999
Stock Option Plan for Non-Employee
Directors to (i) permit the grant
of annual options to all
non-employee directors, and (ii)
to provide for the monthly vesting
of such annual options............. 51,669,712 365,237 32,182 0
(5) To approve an amendment
increasing the number of shares of
NaviSite's common stock reserved
for issuance under NaviSite's 1999
Employee Stock Purchase
Plan............................... 46,803,054 89,941 23,790 5,150,346
(6) To ratify the appointment by
the Board of Directors of KPMG LLP
as the independent auditors of
NaviSite for the fiscal year ended
July 31, 2001...................... 52,018,472 29,881 18,778 0
Item 5. Other Information.
None.
23
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
Exhibit
Number Exhibit
10.1 Common Stock Warrant No. 1, dated as of December 15, 2000, issued
by the Registrant to CMGI, Inc.
10.2 Common Stock Warrant No. 2, dated as of December 15, 2000, issued
by the Registrant to CMGI, Inc.
10.3 7.5% Convertible Subordinated Note due December 12, 2003, dated
as of January 24, 2001, issued by the Registrant to CMGI, Inc.
10.4 Non-Competition Agreement, dated as of January 18, 2001, by and
between the Registrant and John B. Muleta
10.5 Security Agreement and Assignment of Account, dated as of January
30, 2001, between the Registrant and Fleet National Bank.
10.6 Security Agreement and Assignment of Account, dated as of
February 7, 2001, between the Registrant and Fleet National Bank.
(b) Reports on Form 8-K
None.
24
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, the Registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.
NAVISITE, INC.
Date: March 16, 2001
By /s/ Kenneth W. Hale
-----------------------------------
Kenneth W. Hale
Chief Financial Officer (Principal
Financial and Accounting
Officer)
25
EXHIBIT INDEX
Exhibit
Number Exhibit
10.1 Common Stock Warrant No. 1, dated as of December 15, 2000, issued
by the Registrant to CMGI, Inc.
10.2 Common Stock Warrant No. 2, dated as of December 15, 2000, issued
by the Registrant to CMGI, Inc.
10.3 7.5% Convertible Subordinated Note due December 12, 2003, dated
as of January 24, 2001, issued by the Registrant to CMGI, Inc.
10.4 Non-Competition Agreement, dated as of January 18, 2001, by and
between the Registrant and John B. Muleta.
10.5 Security Agreement and Assignment of Account, dated as of January
30, 2001, between the Registrant and Fleet National Bank.
10.6 Security Agreement and Assignment of Account, dated as of
February 7, 2001, between the Registrant and Fleet National Bank.