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 April 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: 0-27597
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) 946-8300
(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 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 June 12, 2002 there were 90,123,119 shares outstanding of the registrant's
common stock, par value $.01 per share.
NAVISITE, INC.
Form 10-Q for the Quarter ended April 30, 2002
INDEX
Page
Number
------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of April 30, 2002 (unaudited)
and July 31, 2001 ........................................................... 3
Consolidated Statements of Operations for the three and nine months
ended April 30, 2002 and 2001 (unaudited) ................................... 4
Consolidated Statements of Cash Flows for the nine months
ended April 30, 2002 and 2001 (unaudited) ................................... 5
Notes to Interim Consolidated Financial Statements (unaudited) .............. 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations ......................................... 11
Item 3. Quantitative and Qualitative Disclosures About
Market Risk ................................................................. 25
PART II. OTHER INFORMATION
Item 1. Legal Proceedings ................................................... 25
Item 2. Changes in Securities and Use of Proceeds ........................... 25
Item 3. Defaults Upon Senior Securities ..................................... 26
Item 4. Submission of Matters to a Vote of Security Holders ................. 26
Item 5. Other Information ................................................... 26
Item 6. Exhibits and Reports on Form 8-K .................................... 26
SIGNATURE ................................................................... 27
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
NAVISITE, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except par value and share value)
April 30, July 31,
---------------------
2002 2001
---------- ----------
(unaudited)
ASSETS
------
Current assets:
Cash and cash equivalents $ 27,891 $ 22,214
Accounts receivable, less allowance for doubtful accounts
of $2,703 and $6,859 at April 30, 2002 and July 31, 2001,
respectively 5,102 10,933
Due from CMGI and affiliates 3,217 4,362
Assets available for sale 3,531 -
Prepaid expenses and other current assets 2,374 2,184
---------- ----------
Total current assets 42,115 39,693
Property and equipment, net 55,570 63,410
Other assets 3,915 3,718
Restricted cash 3,850 5,051
Goodwill, net of accumulated amortization of $777 and $631
at April 30, 2002 and July 31, 2001, respectively 237 394
---------- ----------
Total assets $ 105,687 $ 112,266
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
----------------------------------------------
Current liabilities:
Capital lease obligations, current portion $ 2,254 $ 42
Due to CMGI 4,993 14,821
Due to Sun Microsystems 937 -
Accounts payable 1,968 10,341
Accrued expenses 15,099 19,299
Deferred revenue 1,697 3,818
Software vendor payable, current portion 237 837
Customer deposits 248 218
---------- ----------
Total current liabilities 27,433 49,376
Software vendor payable, less current portion - 79
Capital lease obligations, less current portion 300 -
Convertible notes payable to CMGI, net of discount of $6,018 and $10,227 3,982 69,773
at April 30, 2002 and July 31, 2001, respectively
Convertible notes payable to Compaq Financial Services,
net of discount of $33,154 21,939 -
---------- ----------
Total liabilities 53,654 119,228
Stockholders' equity (deficit):
Preferred Stock, $.01 par value, 5,000 shares authorized; no
shares issued and outstanding at April 30, 2002 and
July 31, 2001, respectively - -
Common Stock, $.01 par value, 395,000 shares authorized:
90,123 and 61,868 shares issued and outstanding at April
30, 2002 and July 31, 2001, respectively 901 619
Additional paid-in capital 339,940 208,064
Accumulated deficit (288,808) (215,645)
---------- ----------
Total stockholders' equity (deficit) 52,033 (6,962)
---------- ----------
Total liabilities and stockholders' equity (deficit) $ 105,687 $ 112,266
========== ==========
NAVISITE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
(in thousands, except share and per share data)
Three months ended Nine months ended
April 30, April 30,
----------------------- -----------------------
2002 2001 2002 2001
----------- ----------- ----------- -----------
Revenue:
Revenue $ 9,113 $ 17,854 $ 34,343 $ 49,855
Revenue, related parties 5,604 8,850 15,327 30,582
------------ ----------- ----------- -----------
Total revenue 14,717 26,704 49,670 80,437
Cost of revenue 14,150 32,945 55,834 98,772
Equipment impairment and lease restructuring, net (3,985) - 30,600 -
------------ ----------- ----------- -----------
Total cost of revenue 10,165 32,945 86,434 98,772
Gross profit / (deficit) 4,552 (6,241) (36,764) (18,335)
Operating expenses:
Product development 1,003 4,143 4,925 10,836
Selling and marketing 2,731 7,954 7,869 27,246
General and administrative 2,622 8,516 16,543 24,303
Restructuring (2,495) - (2,495) -
------------ ----------- ----------- -----------
Total operating expenses 3,861 20,613 26,842 62,385
------------ ----------- ----------- -----------
Income / (loss) from operations 691 (26,854) (63,606) (80,720)
Other income (expense):
Interest income 389 679 721 2,372
Interest expense (3,763) (2,603) (10,948) (5,305)
Other income (expense), net 639 (6) 670 (126)
------------ ----------- ----------- -----------
Loss before cumulative effect of change
in accounting principle (2,044) (28,784) (73,163) (83,779)
Cumulative effect of change in
accounting principle - - - (4,295)
------------ ----------- ----------- -----------
Net loss $ (2,044) $(28,784) $(73,163) $(88,074)
============ =========== =========== ===========
Basic and diluted net loss per
common share:
Before cumulative effect of change
in accounting principle $ (0.02) $ (0.49) $ (0.93) $ (1.43)
Cumulative effect of change in
accounting principle - - - (0.07)
------------ ----------- ----------- -----------
Basic and diluted net loss per
common share $ (0.02) $ (0.49) $ (0.93) $ (1.50)
============ =========== =========== ===========
Basic and diluted weighted
average number of common
shares outstanding 88,749 58,914 78,652 58,717
============ =========== =========== ===========
NAVISITE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands)
Nine months
ended April 30,
---------------------
2002 2001
--------- ---------
(in thousands)
Cash flows from operating activities:
Net loss $(73,163) $(88,074)
Adjustments to reconcile net loss to net cash
used for operating activities:
Depreciation and amortization 15,999 11,435
Provision for bad debts 3,609 8,127
Amortization of deferred compensation - 1,051
Amortization of beneficial conversion feature to
interest expense 3,389 -
Interest on debt paid in stock 3,118 -
Gain on sale of Streaming Media Division assets (524) -
(Gain)/Loss on disposal of assets (157) 120
Equipment impairment and lease restructuring 30,600 -
Amortization of interest related to stock warrants
issued with the notes to CMGI 1,172 1,614
Cumulative effect of changes in accounting principle - 4,295
Changes in operating assets and liabilities:
Accounts receivable 2,978 (8,180)
Due from CMGI and affiliates 1,145 2,348
Due to CMGI 6,381 7,787
Prepaid expenses and other current assets (189) 455
Other assets (379) -
Accounts payable (8,373) 1,848
Accrued expenses, deferred revenue and other
liabilities (6,784) (10,343)
Customer deposits 30 -
--------- ---------
Net cash used for operating activities (21,148) (67,517)
Cash flows from investing activities:
Purchases of property and equipment (3,639) (24,618)
Proceeds from sale of Streaming Media Division assets 1,600 -
Proceeds from sale of property and equipment 646 13,884
Other assets (237) (586)
Restricted cash 1,201 (4,955)
--------- ---------
Net cash used for investing activities (429) (16,275)
Cash flows from financing activities:
Issuance of convertible notes payable 30,000 80,000
Proceeds from exercise of stock options and
employee stock purchase plan 35 972
Payments of capital lease obligations (1,165) (29,626)
Payments under note payable (937) -
Payments of software vendor obligations (679) (1,446)
--------- ---------
Net cash provided by financing activities 27,254 49,900
--------- ---------
Net increase/(decrease) in cash 5,677 (33,892)
Cash, beginning of period 22,214 77,947
--------- ---------
Cash, end of period $ 27,891 $ 44,055
========= =========
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest $ 2,217 $ 30
========= =========
NAVISITE, INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. Basis of Presentation
The accompanying interim consolidated financial statements have been prepared by
NaviSite, Inc. (NaviSite or the Company) in accordance with accounting
principles generally accepted in the United States of America 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 accounting principles generally accepted in the
United States of America 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 Form 10-K which was filed with the Securities and
Exchange Commission on October 30, 2001.
The information furnished reflects all adjustments, which, in the opinion of
management, are of a normal recurring 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 interim consolidated financial statements in conformity
with accounting principles generally accepted in the United States of America
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. On March 21, 2002, the
Company sold certain of its Streaming Media Division assets. The Company
received proceeds of approximately $1.6 million and recorded a gain on the
transaction in the fiscal year 2002 third quarter of approximately $524,000.
3. Cash and Cash Equivalents
Cash equivalents consist of a money market fund that 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.
During the first quarter of fiscal 2002, the letter of credit related to the
LaJolla, California facility was not renewed and the landlord drew down the
related $555,000 of restricted cash.
During the first quarter of fiscal 2002, non-cash financing activities included
a $35 million obligation to Compaq Financial Services Corporation, a
wholly-owned subsidiary of Compaq Computer Corporation (CFS), incurred for the
purchase of equipment previously held under operating lease agreements with a
fair value, based on a third-party appraisal, of $9.6 million. Since the fair
market value of the equipment purchased was less than the associated obligation,
the Company recorded an impairment charge in the first quarter of fiscal 2002 in
the amount of $25.4 million. See Note 6.
During the second quarter of fiscal year 2002, non-cash financing activities
included the conversion of the $80.0 million face value convertible note payable
to CMGI, Inc. (CMGI), including interest of $1.5 million, and $16.2 million of
amounts due to CMGI into 24,629,900 shares of the Company's common stock. In
addition, 1,003,404 shares of common stock were issued in satisfaction of
accrued interest associated with the $65.1 million notes payable to CMGI and
CFS.
During the third quarter of fiscal 2002, non-cash financing activities included
the issuance of 2,100,444 shares of common stock in satisfaction of accrued
interest associated with the $65.1 million notes payable to CMGI and CFS.
4. Property and Equipment
(unaudited)
April 30, July 31,
------------------------
2002 2001
------------ -----------
(in thousands)
Office furniture and equipment $ 5,657 $ 5,318
Computer equipment 26,198 18,178
Software licenses 16,054 16,657
Leasehold improvements 44,342 45,452
------------ -----------
92,251 85,605
Less: Accumulated depreciation
and amortization (36,681) (22,195)
------------ -----------
$ 55,570 $ 63,410
============ ===========
During the second quarter of fiscal year 2002, the Company performed a physical
inventory of its customer dedicated equipment. As a result of this inventory,
the Company recorded an impairment charge of $1.9 million for obsolete equipment
and for equipment no longer on hand and identified certain excess assets not in
use. The Company approved a plan whereby the excess assets not in use would be
disposed of within twelve months. These assets are classified as assets held for
sale on the Company's balance sheet as of April 30, 2002 and have been valued at
their estimated fair value less costs to sell. The majority of the assets held
for sale were acquired during the first and second quarters of fiscal year 2002
in conjunction with the buyout of equipment previously held under certain
operating leases.
In the second quarter of fiscal year 2002, the Company recorded a $3.2 million
charge representing the future estimated remaining minimum lease payments
related to certain idle equipment held under various operating leases. The
equipment had previously been rented to former customers, and upon the loss of
the customer, the equipment became idle. Based on the Company's forecasts, the
equipment will not be utilized before the related operating leases expire and/or
the equipment becomes obsolete.
In the second quarter of fiscal year 2002, the Company evaluated the current and
forecasted utilization of its purchased software licenses. As a result of this
evaluation, during the second quarter of fiscal year 2002, the Company recorded
a $365,000 impairment for software licenses that would not be utilized before
the licenses expired and/or became obsolete.
In the second quarter of fiscal year 2002, the Company finalized an agreement
with an equipment lessor whereby the Company purchased all equipment previously
held under operating lease for $4.3 million. The fair market value of the
equipment at the time of purchase was $2.3 million. The $2.0 million difference
between the fair market value of the equipment, based on a third-party
appraisal, and the purchase price was previously recorded as an asset impairment
charge for the three-month period ended October 31, 2001.
In the second quarter of fiscal year 2002, the Company purchased certain
equipment with a fair market value of $1.2 million, previously leased by the
Company from two equipment vendors under operating lease agreements, for $2.7
million. As the fair market value of the equipment, based on a third-party
appraisal, was less than the consideration given, the Company recorded an asset
impairment charge for the three-month period ended January 31, 2002 of $408,000.
In the second quarter of fiscal year 2002, the Company modified the payment
amounts and terms of certain operating leases with two equipment vendors such
that the modified leases qualify as capital leases. One of the resulting capital
leases is payable in 24 monthly payments of $38,000, starting in December 2001.
The second capital lease has total payments of $2.6 million, of which $1.0
million was paid in the second quarter of fiscal year 2002 and $1.6 million is
payable in January 2003. The equipment under both capital leases was capitalized
at the fair market value of the equipment at the time of the modification, $1.0
million, which was lower than the present value of the future minimum lease
payments based on the Company's estimated incremental borrowing rate of 12%. As
the fair market value of the equipment, based on a third-party appraisal, was
less than the consideration given, the Company recorded an asset impairment
charge for the three-month period ended January 31, 2002 of $1.3 million.
In the third quarter 2002, the Company modified the payment amounts and terms of
certain operating leases with a lessor such that the
modified leases qualify as capital leases. The resulting capital lease is
payable in 28 monthly payments of $4,700 for the first 4 months and $20,400 for
the remaining 24 months, starting in April 2002. The equipment under this
capital lease was recorded at the estimated fair market value of the equipment
at the time of the modification, $116,000, which was lower than the present
value of the future minimum lease payments based on the Company's estimated
incremental borrowing rate of 12%. As the estimated fair market value of the
equipment was less then the consideration given, the Company has recorded an
asset impairment charge for the three-month period ended April 30, 2002 of
$164,000. In addition to the lease modifications, in March 2002, the Company
returned equipment held under certain operating leases with the same lessor and
incurred and paid a breakage fee of $397,000.
During the third quarter 2002, the Company evaluated the remaining estimated
obligations that were accrued at April 30, 2002 associated with the termination
of equipment operating leases with vendors for both active and idle customer
equipment. As a result of this analysis, the Company reversed approximately $4.8
million of this accrual to reflect positive experience in negotiating
settlements with vendors and other adjustments. This reversal is reflected in
the three and nine month periods ended April 30, 2002 as a benefit of
approximately $835,000 recorded to cost of revenues and a benefit of
approximately $4.0 million recorded to customer equipment and lease
restructuring (a separate component of cost of revenues), consistent with the
classification of the original charges. As a result of the various lease
restructurings and impairments discussed above and in Note 3, the Company has
recorded an equipment impairment and lease restructuring charge, net, of $30.6
million for the nine-month period ended April 30, 2002.
5. Accrued Expenses
(unaudited)
April 30, July 31,
-----------------------------
2002 2001
------------ ----------------
(in thousands)
Accrued payroll, benefits and commissions $ 2,659 $ 2,772
Accrued accounts payable 3,137 3,078
Accrued lease payments 1,812 4,100
Accrued restructuring 310 5,236
Accrued interest 1,600 5
Accrued lease impairment 1,622 1,930
Other 3,959 2,178
------------ ----------------
$15,099 $ 19,299
============ ================
In July 2001, the Company announced a plan, approved by the Board of Directors,
to restructure its operations and consolidate its data centers, which resulted
in a charge of approximately $8.0 million, of which approximately $5.2 million
was accrued for as of July 31, 2001. Of the total restructuring charge,
approximately $1.8 million was related to employee termination benefits. The
Company terminated 126 employees on July 31, 2001.
The restructuring charge also included approximately $6.2 million of costs
related to the closing of the Company's two original data centers. The
components of the facility closing costs included approximately $3.8 million of
estimated lease obligations associated with restoring the facilities to their
original condition, and other contractual obligations to be paid over the term
of the respective agreements through 2002, and approximately $2.4 million of
write-offs of leasehold improvements, which were recorded as of July 31, 2001.
During the third quarter 2002, the Company was able to favorable renegotiate the
facility closing costs. The accrual for estimated restoration costs for the two
original data centers was reduced by an aggregate $1.6 million and the accrual
for bandwidth termination costs was reduced by $803,000. In addition, $63,000 in
severance/employee costs were forfeited by former employees. As a result, the
Company reduced accrued restructuring by approximately $2.5 million.
Details of activity in the restructuring accrual for the nine-month period ended
April 30, 2002 follows:
Balance at Balance at
July 31, 2001 Activity Adjustments April 30, 2002
----------------- --------------- ---------------- ---------------
(in thousands)
Severance/Employee Costs $ 1,408 $(1,253) $ (63) $ 92
Facility Closing Costs 3,828 (1,179) (2,431) 218
---------------- --------------- ---------------- --------------
Total $ 5,236 $(2,432) $(2,494) 310
================ =============== ================ ==============
6. Agreements with CMGI and CFS
In connection with an agreement dated October 29, 2001 among the Company, CMGI
and CFS, the Company purchased certain equipment with a fair market value of
$9.6 million, previously leased by the Company from CFS under operating lease
agreements expiring through 2003, in exchange for a note payable in the face
amount of approximately $35 million. As the fair market value of the equipment,
based on a third-party appraisal, was less than the associated debt obligation,
the Company recorded an asset impairment charge in the first quarter of fiscal
2002 of $25.4 million. The Company recorded the assets purchased and associated
impairment charge effective August 1, 2001 with a corresponding obligation to
CFS. Based on the terms of the $35 million obligation, interest accrues
commencing on November 8, 2001. The Company recognized $1.1 million, $1.0
million, and $1.0 million of interest expense for the first, second and third
quarters of fiscal 2002, respectively.
On November 8, 2001, in connection with the October 29, 2001 agreement, the
Company received $20 million and $10 million in cash from CFS and CMGI,
respectively, in exchange for six-year convertible notes payable in the face
amounts of $20 million and $10 million to CFS and CMGI, respectively, making the
total notes payable issued by the Company to CFS and CMGI approximately $55
million and $10 million, respectively. The notes require payment of interest
only, at 12% per annum, for the first three years from the date of issuance and
then repayment of principal and interest, on a straight-line basis, over the
next three years until maturity on the sixth anniversary of the date of
issuance. At the Company's option, the Company may make interest payments (i)
100% in shares of the Company's common stock, in the case of amounts owed to
CMGI, through December 2007 and (ii) approximately 16.67% in shares of the
Company's common stock, in the case of amounts owed to CFS, through December
2003. The convertible notes payable are secured by substantially all of the
assets of the Company and cannot be prepaid.
The principal balances of these notes may be converted into the Company's common
stock at the option of the holders at any time prior to or at maturity at a
conversion rate of $0.26 per share. The conversion rate of $0.26 results in
beneficial conversion rights for both CMGI and CFS. The intrinsic value of the
beneficial conversion rights amounted to $6.5 million and $36.0 million for CMGI
and CFS, respectively. The value of the beneficial conversion rights are being
amortized into interest expense over the life of the convertible notes payable.
CMGI also converted its $80 million in aggregate principal outstanding under its
existing notes payable as an additional component of interest expense, plus the
accrued interest thereon, into approximately 14.7 million shares of the
Company's common stock. CMGI also converted approximately $16.2 million in other
amounts due by the Company to CMGI into approximately 9.9 million shares of the
Company's common stock.
Holders of the convertible notes payable are entitled to both demand and
piggyback registration rights, and CFS is entitled to anti-dilution protection
under certain circumstances. The agreement with CFS and CMGI also contains
certain restrictive covenants, including but not limited to limitations on the
issuance of additional debt, the sale of equity securities to affiliates and
certain acquisitions and dispositions of assets.
In the third quarter of fiscal year 2002, the Company issued 2,100,444 shares of
common stock in satisfaction of accrued interest associated with the $65.1
million notes payable to CMGI and CFS.
7. Revenue Recognition
Effective August 1, 2000, the Company adopted SEC Staff Accounting Bulletin No.
101 - Revenue Recognition in Financial Statements (SAB 101). Under SAB 101,
installation fees are recognized over the life of the related customer contract.
Prior to fiscal year 2001, the Company recognized installation fees at the time
that the installation occurred. The cumulative effect of the change in
accounting for installation services on all prior periods resulted in a $4.3
million increase in net loss for the quarter ended October 31, 2000 and is
reflected as a cumulative effect of change in accounting principle. For the
three and nine-month periods ended April 30, 2001, revenue has been increased by
$541,000 and $540,000, respectively, than was previously recognized in the
fourth quarter of 2001 in connection with the implementation of SAB 101.
On March 7, 2002, the Company signed an agreement (the "Engage Agreement") with
Engage, Inc. ("Engage"), a related party, whereby Engage's contract with the
Company was terminated. Pursuant to the Engage Agreement, the Company received
cash
payments of $1.2 million in March 2002 and $1.2 million in April 2002 and will
receive a cash payment of $1.2 million in July 2002, for a total of $3.6
million. For the three and nine-month periods ended April 30, 2002, Engage,
exclusive of the contract termination revenue, represented 0% and 3%,
respectively, of the Company's total revenue. As a result of the Engage
Agreement, the Company recognized $2.3 million of non-recurring revenue in the
third quarter of fiscal year 2002.
8. Legal Matters
On or about June 13, 2001, Stuart Werman and Lynn McFarlane filed a lawsuit
against the Company, BancBoston Robertson Stephens, Inc., an underwriter of the
Company's initial public offering in October 1999, Joel B. Rosen, the Company's
then Chief Executive Officer, and Kenneth W. Hale, the Company's then Chief
Financial Officer. The suit was filed in the United States District Court for
the Southern District of New York. The suit generally alleges that the
defendants violated federal securities laws by not disclosing certain actions
allegedly taken by Robertson Stephens in connection with the Company's initial
public offering. The suit alleges specifically that Robertson Stephens, in
exchange for the allocation to its customers of shares of the Company's common
stock sold in the Company's initial public offering, solicited and received from
its customers undisclosed commissions on transactions in other securities and
required its customers to purchase additional shares of the Company's common
stock in the aftermarket at pre-determined prices. The suit seeks unspecified
monetary damages and certification of a plaintiff class consisting of all
persons who acquired shares of the Company's common stock between October 22,
1999 and December 6, 2000.
On or about June 21, 2001, David Federico filed in the United States District
Court for the Southern District of New York a lawsuit against the Company, Mr.
Rosen, Mr. Hale, FleetBoston Robertson Stephens, Inc. and other underwriter
defendants including J.P. Morgan Chase, First Albany Companies, Inc., Bank of
America Securities, LLC, Bear Stearns & Co., Inc., B.T. Alex.Brown, Inc., Chase
Securities, Inc., CIBC World Markets, Credit Suisse First Boston Corp., Dain
Rauscher, Inc., Deutsche Bank Securities, Inc., The Goldman Sachs Group, Inc.,
J.P. Morgan & Co., J.P. Morgan Securities, Lehman Brothers, Inc., Merrill Lynch,
Pierce, Fenner & Smith, Inc., Morgan Stanley Dean Witter & Co., Robert Fleming,
Inc. and Salomon Smith Barney, Inc. The suit generally alleges that the
defendants violated the anti-trust laws and the federal securities laws by
conspiring and agreeing to raise and increase the compensation received by the
underwriter defendants by requiring those who received allocation of initial
public offering stock to agree to purchase shares of manipulated securities in
the after-market of the initial public offering at escalating price levels
designed to inflate the price of the manipulated stock, thus artificially
creating an appearance of demand and high prices for that stock, and initial
public offering stock in general, leading to further stock offerings. The suit
also alleges that the defendants arranged for the underwriter defendants to
receive undisclosed and excessive brokerage commissions and that, as a
consequence, the underwriter defendants successfully increased investor interest
in the manipulated initial public offering securities and increased the
underwriter defendants' individual and collective underwritings, compensation
and revenues. The suit further alleges that the defendants violated the federal
securities laws by issuing and selling securities pursuant to the initial public
offering without disclosing to investors that the underwriter defendants in the
offering, including the lead underwriters, had solicited and received excessive
and undisclosed commissions from certain investors. The suit seeks unspecified
monetary damages and certification of a plaintiff class consisting of all
persons who acquired shares of the Company's common stock between October 22,
1999 and June 12, 2001.
The Company believes that the allegations are without merit, and it intends to
vigorously defend against the plantiffs' claims. As the litigation is in an
initial stage, the Company is not able to predict the possible outcome of the
suits and their ultimate effect, if any, on its financial condition.
On June 7, 2002, the Company received a letter from the Vice President and
General Counsel of Level 3 Communications, LLC (Level 3) alleging that the
Company improperly rejected and later cancelled co-location space ordered by the
Company pursuant to the General Terms and Conditions for Delivery of Service
Agreement, dated as of June 29, 2000, between the Company and Level 3. Level 3
has demanded payment of certain fees relating to the co-location space,
including interest on previously invoiced amounts. The Company believes that the
allegations are without merit, and it intends to vigorously dispute Level 3's
claims. Because this dispute is in an early stage, the Company is not able to
predict the possible outcome of the dispute with Level 3 or its ultimate effect,
if any, on its financial condition.
The Company is also subject to other legal proceedings and claims which arise in
the ordinary course of its business. In the opinion of management, the amount of
ultimate liability with respect to these actions will not materially affect the
consolidated financial position or results from operations of the Company.
9. Net Loss Per Common Share
Basic earnings (loss) per share is computed using the weighted average number of
common shares outstanding during the period. Diluted earnings (loss) per share
is computed using the weighted average number of common and dilutive common
equivalent shares outstanding during the period using the as-if-converted method
for convertible notes payable or the treasury stock method for options, unless
such amounts are anti-dilutive.
For the three and nine-month periods ended April 30, 2002 and 2001, 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 three and nine-month periods ended April 30, 2002, 277,239 and
894,076, respectively, of dilutive shares related to employee stock options and
250 million shares issuable related to convertible debt were excluded as they
had an anti-dilutive effect due to the net loss.
10. New Accounting Pronouncements
In June 2001, the FASB issued Statement of Financial Accounting Standards (SFAS)
No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible
Assets. SFAS No. 141 will apply to all business combinations that the Company
enters into after June 30, 2001 and eliminates the pooling-of-interest method
of accounting. SFAS No. 142 is effective for fiscal years beginning after
December 15, 2001. Under SFAS Nos. 141 and 142, goodwill and intangible assets
deemed to have indefinite lives will no longer be amortized but will be subject
to annual impairment tests in accordance with the Statements. Other intangible
assets will continue to be amortized over their useful lives.
The Company is required to adopt these Statements for accounting for goodwill
and other intangible assets beginning the first quarter of fiscal year 2003.
Unamortized goodwill at April 30, 2002 amounts to $237,000. The Company intends
to continue to perform an impairment analysis of the remaining goodwill through
the end of fiscal year 2002. Upon adoption on August 1, 2002, the Company will
perform the required impairment test of goodwill and does not expect the
implementation of these standards to have a material impact on its financial
condition or results of operations.
SFAS No. 143, Accounting For Asset Retirement Obligations, issued in August
2001, addresses financial accounting and reporting for obligations associated
with the retirement of tangible long-lived assets and for the associated
retirement costs. SFAS No. 143, which applies to all entities that have a legal
obligation associated with the retirement of a tangible long-lived asset, is
effective for fiscal years beginning after June 15, 2002. The Company does not
expect the implementation of SFAS No. 143 to have a material impact on its
financial condition or results of operations.
SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets,
issued in October 2001, addresses financial accounting and reporting for the
impairment or disposal of long-lived assets. SFAS No. 144, which applies to all
entities, is effective for fiscal years beginning after December 15, 2001. The
Company does not expect the implementation of SFAS No. 144 to have a material
impact on its financial condition or results of operations.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
This 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 outsourced Web hosting and managed application services for companies
conducting business on the Internet, including enterprises and other businesses
deploying Internet applications. Our goal is to help customers focus on their
core competencies by outsourcing the management and hosting of their Web
operations and applications, allowing customers to fundamentally improve the
efficiency of their Web operations. We also provide related professional and
consulting services. 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. We believe that
we are the leader of "Always On Managed Hosting" and that there are a relatively
small number of companies that combine a highly scalable and developed
infrastructure with experience, intellectual property, skill sets, processes and
procedures for delivering managed hosting services. We define "Always On Managed
Hosting" as a combination of high availability infrastructure, high performance
monitoring systems and proactive problem resolution management processes
designed to recognize patterns and identify and address potentially crippling
problems before they are able to cause downtime in customers' Web operations.
The cost for our services varies from customer to customer based on the number
of managed servers and the nature, extent and level of services provided.
We were incorporated in Delaware in December 1998 and are a 76.73% owned
subsidiary of CMGI. In July 1998, our predecessor, NaviSite Internet Services
Corporation, acquired Servercast Communications, L.L.C., a Delaware limited
liability company and developer and integrator of Internet applications, for
$1.0 million in notes, plus $25,000 of bridge notes receivable and $20,000 in
acquisition costs. We acquired Servercast principally for its expertise in
application management, online advertising, e-commerce, content management and
streaming media. In February 2000, we acquired ClickHear Inc., a streaming media
management and development company, for consideration valued at approximately
$4.7 million, including approximately $50,000 of direct costs of the
acquisition. We made the decision last fall to sell NaviSite's streaming media
business. The streaming business was cash flow negative, faces a difficult
competitive market, and was non-core to our overall strategy. On March 21, 2002,
we sold certain of our Streaming Media Division assets to SMC Corporation and
now provide streaming service offerings only through third parties. We received
proceeds of approximately $1.6 million in cash. We recorded a gain on the
transaction in the fiscal year 2002 third quarter of approximately $524,000. As
part of the sale of our Streaming Media Division assets, we are subleasing part
of our La Jolla facility to SMC Corporation for the next two years for an
aggregate amount of approximately $700,000.
Since January 31, 2000, our corporate headquarters has been 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. 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. Through July 31, 2001, we operated two data
centers in California and two data centers in Andover, Massachusetts. On July
31, 2001, we announced the closure of our two original data centers, one in
Andover, Massachusetts and one in Scotts Valley, California.
We derive our revenue primarily from managed hosting services, but within that
framework, from a variety of services, including: Web site and Internet
application hosting, which includes access to our state-of-the-art data centers,
a range of bandwidth services, Content Distribution Network services, advance
back-up options, managed storage and monitoring services; enhanced server
management, which includes custom reporting, hardware options, network and
application load balancing, system security, and the services of our technical
account managers; specialized application management, which includes management
of e-commerce and other sophisticated applications support services, including
scalability testing, databases and transaction processing services. We also
derive revenue from related consulting and other professional services. Revenue
also includes income from the rental of equipment to customers, termination fees
and one-time installation fees. Revenue is recognized in the period in which the
services are performed. Installation fees are recognized ratably over the period
of the customer contract. Previous to fiscal year 2001, installation revenue was
recognized at the time installation services were provided. Our customer
contracts generally are a one to two year commitment.
We have incurred significant net losses and negative cash flows from operations
since our inception and, as of April 30, 2002, had an accumulated deficit of
approximately $288.8 million. These losses have been funded primarily by CMGI
through the issuance of common stock, preferred stock and convertible debt and
by our initial public offering and related exercise of the underwriters'
over-allotment option in October 1999 and November 1999, respectively, as well
as by the sale-leaseback of certain assets and through the issuance of
convertible debt to Compaq Financial Services Corporation, a wholly owned
subsidiary of Compaq Computer Corporation (CFS). Since the beginning of fiscal
year 2002 we have implemented labor efficiencies, restructured our major
operating leases and obligations and eliminated excess capacity in order to
accelerate our path to profitability. Although we expect that we will continue
to incur operating losses and negative cashflows from operations for at least
the remainder of this fiscal year, we have systematically reduced our run-rate
cash expenses and have lowered our revenue requirement for EBITDA break-even.
Recent Developments
We are currently evaluating our business model whereby we would provide
integrated managed hosting services in data centers owned by third parties in
addition to our own data centers. We believe that this approach could augment
our existing management expertise, software and operating processes with
third-party infrastructure and geographic reach. As a result of the evaluation,
we may restructure our business, which could result in, among other things: a
change in our asset lives, impairment charges and decreased capital
requirements. The evaluation is still in the preliminary stages, and the outcome
is uncertain at this point in time. We expect to complete this evaluation in our
next fiscal year.
During the second quarter of fiscal year 2002, we made the decision to
discontinue our practice, on a prospective basis, of obtaining equipment under
lease arrangements and subsequently renting the equipment to our customers. The
decision was made for two reasons. First, many of our enterprise customers can
acquire hardware equipment with a lower cost of capital. Second, it eliminates
additional credit and financial risk associated with an early customer contract
termination. This decision will reduce revenue potential from future customers
and impact overall revenues as existing equipment leases terminate and are not
renewed. We will continue to service our customers' equipment needs as the
single point of procurement and management.
On May 10, 2002, we applied to transfer voluntarily from the Nasdaq National
Market to the Nasdaq SmallCap Market. On June 4, 2002, Nasdaq approved our
transfer application, and our common stock was transferred to the Nasdaq
SmallCap Market at the opening of business on June 10, 2002.
Revenue
Total revenue was approximately $14.7 million for the three-month period ended
April 30, 2002, a decrease of 44.9% from approximately $26.7 million for the
same period in 2001. The decrease is due primarily to a decrease in revenue from
unaffiliated customers of approximately $8.7 million, or 48.9%, combined with a
decrease of approximately $3.2 million, or 36.7%, of revenue from CMGI and CMGI
affiliates. Included in the revenue from CMGI and CMGI affiliates is $2.3
million of non-recurring contract termination fees with Engage, a related party.
Excluding the Engage contract termination fees, revenue from CMGI and CMGI
affiliates for the three-month period ended April 30, 2002 decreased $5.5
million as compared to the same period in 2001. Revenue
from unaffiliated customers represented 61.9% of total revenue for the
three-month period ended April 30, 2002, a decrease from approximately 66.9% of
total revenue for the same period in 2001. Excluding the Engage contract
termination fees, unaffiliated customers increased to 73.4% of total revenue for
the three-month period ended April 30, 2002. The number of unaffiliated
customers decreased 51% to 160 at April 30, 2002 from 327 as of April 30, 2001.
During the three-month period ended April 30, 2002, we lost 22 customers, which
generated approximately $2.8 million of revenue for that period, inclusive of
contract termination fees. The number of CMGI and CMGI affiliated customers
decreased 67% to 7 at April 30, 2002 from 21 as of April 30, 2001.
Total revenue was approximately $49.7 million for the nine-month period ended
April 30, 2002, a decrease of 38.2% from approximately $80.4 million for the
same period in 2001. The decrease is due to a decrease in revenue from
unaffiliated customers of approximately $15.5 million, or 31.1%, combined with a
decrease of approximately $15.2 million, or 49.9% of revenue from CMGI and CMGI
affiliates. Net of the Engage contract termination fees, revenue from CMGI and
CMGI affiliates for the nine-month period ended April 30, 2002 decreased $17.5
million as compared to the same period in 2001. Revenue from unaffiliated
customers represented 69.1% of total revenue for the nine-month period ended
April 30, 2002, from approximately 62% of total revenue for the same period in
2001. Excluding the Engage contract termination fees, unaffiliated customers
represented 72.5% of total revenue for the nine-month period ended April 30,
2002. During the nine-month period ended April 30, 2002, we lost 143 customers,
which generated approximately $11.3 million of revenue for that period,
inclusive of contract termination fees.
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%. In the three and nine-month periods ended April 30, 2002, we sold
services to CMGI and CMGI affiliates totaling approximately $5.6 million, or
38.1% of revenue and $15.3 million, or 30.9% of revenue, respectively. Net of
the Engage contract termination fees, CMGI and CMGI affiliates represented $3.3
or 26.6% of revenue and 13.0 million, or 27.5% of revenue for the three and
nine-month periods ended April 30, 2002, respectively. Three of our related
customers accounted for approximately 16%, 11% and 6% of revenue for the
three-months ended April 30, 2002 and approximately 10%, 8%, and 5% for the same
period in 2001.
During the three and nine-month periods ended April 30, 2002, we recognized $2.4
million and $2.6 million, respectively, in revenue related to contract
terminations with customers, which compares with approximately $0 and $596,000
for the same three and nine-month periods in 2001. Revenue from contract
terminations is non-recurring in nature.
As we manage out non-productive customers, we continue to focus our sales and
marketing efforts on generating revenues from new un-affiliated enterprise
customers.
While we will continue to service our customers' equipment needs as the single
point of procurement and management, in the third quarter of fiscal year 2002,
we discontinued our practice of renting equipment on behalf of customers. While
this practice is expected to reduce the revenue potential from new customers and
new revenue potential from our current customer base, it is expected to reduce
financial and credit risk and improve overall margins. Revenue from equipment
rental accounted for approximately 17% and 22% of our revenue for the three and
nine-month periods ended April 30, 2002 as compared to 25% the same periods in
2001.
Cost of Revenue
Cost of revenue consists primarily of salaries and benefits for operations
personnel, bandwidth fees and related Internet connectivity charges, equipment
costs and related depreciation and costs to run our two data centers, such as
rent and utilities. In the fiscal year 2001 fourth quarter, a restructuring plan
was approved and the costs to shut down our two original data centers were
accrued as part of the restructuring costs. As a result of the restructuring
plan, the financial periods before August 2001 have the costs of the two
original data centers included and the financial periods subsequent to July 2002
do not. Our fiscal year 2001 fourth quarter restructuring plan combined with our
continuing efforts to improve operating efficiencies has resulted in
significantly lower cost of revenue levels for the three and nine-month periods
ended April 30, 2002 as compared to the same periods in 2001.
Cost of revenue decreased 69.1% to approximately $10.2 million for the
three-month period ended April 30, 2002, from approximately $32.9 million for
the same period in 2001. Included in the cost of revenue for the three-month
period ended April 30, 2002 are reversals of lease accruals of approximately
$4.8 million. During the third quarter 2002, we evaluated the remaining
estimated obligations that were accrued at April 30, 2002 associated with the
termination of equipment operating leases with vendors for both active and idle
customer equipment. As a result of this analysis, we reversed $4.8 million of
this accrual to reflect positive experience in negotiating settlements with
vendors and other adjustments. This reversal is reflected in the three and nine
month periods ended April 30, 2002 as a benefit of approximately $835,000
recorded to cost of revenues and a benefit of approximately $4.0 million
recorded to customer equipment and lease restructuring (a separate component of
cost of revenues), consistent with the classification of the original charges.
Excluding the $4.8 million lease accrual adjustment, cost of revenue for the
three-month period ended April 30, 2002 would have been approximately $15.0
million, a decrease of approximately $18.0 million or 54.5% as compared to the
same period in 2001. The $18.0 million dollar value decrease resulted from a
$10.6 million reduction in equipment lease and related costs; a $3.6 million
reduction in labor costs due to headcount reductions to 166 from 287 for the
same period in 2001; a $1.9 million reduction in facility related costs; and a
$1.8 million reduction in bandwidth and bandwidth related
costs. Excluding the Engage contract termination fee discussed above from
revenues and the $4.8 million from cost of revenues, cost of revenues for the
three-month period ended April 30, 2002 as a percentage of revenue decreased to
approximately 121% of revenue from approximately 123% for the same period in
2001. The reduction in cost of revenues as a percentage of revenue for the
three-months ended April 30, 2002 as compared to the same period in 2001
resulted primarily from a reduction in equipment lease and related costs to
28.1% of revenue from 52.7% offset by an increase in depreciation to 22% of
revenue from 9%. This resulted primarily from the buyout of equipment previously
held under operating leases during fiscal 2002. The equipment was recorded at
fair market value and amortized over the estimated remaining useful lives of
approximately 2 years.
Cost of revenue decreased 12.5% to approximately $86.4 million for the
nine-month period ended April 30, 2002, from approximately $98.8 million for the
same period in 2001. Included in the cost of revenue for the nine-month period
ended April 30, 2002 is a net charge of $30.6 million related to customer
equipment impairment charges, which represents the excess amounts paid to
purchase customer equipment previously held under operating leases over the
estimated fair value of the equipment, and permanently idled customer equipment
held under operating leases. Excluding this $30.6 million charge, cost of
revenue for the nine-month period ended April 30, 2002 would have been
approximately $55.8 million, a decrease of approximately $42.9 million or 43.5%
as compared to the same period in 2001. The $42.9 million dollar value decrease
in cost of revenue for the nine-month period ended April 30, 2002 as compared to
the same period in 2001 resulted from a $20.2 million reduction in equipment
lease and related costs; a $15.3 million reduction in labor costs due to
headcount reductions to 166 from 287 for the same period in 2001; a $2.1 million
reduction in facility related costs; and a $4.6 million reduction in bandwidth
and bandwidth related costs. Excluding the Engage contract termination fee
discussed above from revenues and the $30.6 million charge from cost of
revenues, cost of revenues for the nine-month period ended April 30, 2002 as a
percentage of revenue decreased to approximately 118% of revenue from
approximately 123% for the same period in 2001. The reduction in cost of
revenues as a percentage of revenue for the nine-months ended April 30, 2002 as
compared to the same period in 2001 resulted primarily from a reduction in
equipment lease and related costs to 36% of revenue from 46%, a decrease in
labor to 29% of revenue from 36% offset by an increase in depreciation to 18% of
revenue from 9%. This resulted primarily from the buyout of equipment previously
held under operating leases during fiscal 2002. The equipment was recorded at
fair market value and amortized over the estimated remaining useful lives of
approximately 2 years.
During the fiscal year 2002 third quarter, we reorganized our cost of revenue
personnel and consolidated end-to-end service responsibility into an integrated
Service Delivery organization. As a result, implementation of various
technologies including network storage, back-up, and security for both our
internal network and solutions we offer our customers are now performed by the
Service Delivery organization.
As our business grows, we would expect the dollar value of these expenses to
increase, but decline on a percentage of revenue basis. We also expect to
achieve economies of scale as a result of spreading increased volume over our
fixed assets, increasing productivity and using new technological tools. For
fiscal year 2002, we anticipate that the cost of revenue, excluding impairment
and lease restructuring charges, will decrease in absolute dollars from fiscal
2001 levels. The anticipated decrease is a result of our fiscal 2001
restructuring efforts which are expected to result in labor efficiencies with
corresponding decreased labor costs and reduced equipment and infrastructure
expenses going forward.
Due to changes in the industry environment and our recent operating results,
consistent with our accounting policy, we are in the process of performing an
analysis to determine if our long-lived assets are impaired. Our long-lived
assets consist of property and equipment totaling approximately $56 million at
April 30, 2002, primarily comprised of leasehold improvements related to our
data centers, computer equipment, and software licenses. We will complete this
analysis by the end of our fiscal year 2002.
Gross Profit /(Deficit)
The gross profit was approximately 31% for the three-month period ended April
30, 2002, an improvement from an approximate gross deficit of 23% for the same
period in 2001. Excluding the $4.8 million reversal of estimated lease payment
accruals from cost of revenues and the $2.3 million of nonrecurring Engage
contract termination revenue recorded during the third quarter of 2002, the
gross deficit for the three-month period ended April 30, 2002 would have
improved to approximately 21% from 23% in the same period of 2001. The gross
deficit was approximately 74% of total revenue for the nine-month period ended
April 30, 2002, up from approximately 23% of total revenue for the same period
in 2001. Excluding the $30.6 million charge for asset impairments from cost of
revenue and the $2.3 million nonrecurring Engage contract termination revenue,
the gross deficit for the nine-month period ended April 30, 2002 would have
improved to 18% from 23% in the same period of 2001.
This improvement in the gross deficit, excluding the impact of the $30.6 million
customer equipment impairment charge and lease
restructuring from cost of revenues and the nonrecurring Engage settlement from
revenue, for the three and nine-month period ended April 30, 2002, as compared
to the same periods in 2001, is the result of our restructuring efforts. These
efforts have resulted in lower labor costs through increased efficiencies and
headcount reductions and reduced equipment expenses resulting from the buyout of
certain operating leases. We typically make up-front fixed investments in both
equipment and personnel and the costs are leveraged across our data centers. We
anticipate that our gross margins will improve, based on current estimates and
expectations and barring unforeseen circumstances, as we achieve higher
operational efficiencies, implement further cost reduction initiatives and
increase revenues.
Operating Expenses
Product Development. Product development expenses consist mainly of salaries and
related costs. Our product development staff focuses on Internet applications,
solutions and network architecture. This group identifies new Internet
application software, equipment and network infrastructure and develops and
incorporates these new capabilities into our suite of service offerings.
Product development expenses decreased 75.8% to approximately $1.0 million for
the three-month period ended April 30, 2002, from approximately $4.1 million for
the same period in 2001. As a percentage of revenue, product development
expenses decreased to 6.8% in the three-month period ended April 30, 2002, from
15.5% for the same period in 2001. The dollar value decrease in product
development expenses is primarily related to reduced headcount costs resulting
from the decrease in product development personnel as of April 30, 2002 to 12
from 73 employees for the same period in 2001 combined with a reduction in the
usage of outside consultants.
Product development expenses decreased 54.5% to approximately $4.9 million for
the nine-month period ended April 30, 2002, from approximately $10.8 million for
the same period in 2001. As a percentage of revenue, product development
expenses decreased to 9.9% in the nine-month period ended April 30, 2002, from
13.5% for the same period in 2001. The dollar value decrease in product
development expenses is primarily related to reduced headcount costs resulting
from the decrease in product development personnel combined with a reduction in
the usage of outside consultants at a rate faster than the decline in revenue
between the two periods.
In the fourth quarter of fiscal 2002, we expect our product development expenses
to decrease slightly from the fiscal 2002 third quarter levels as we narrow the
focus of our investments in mobile infrastructure and web services technologies.
Additionally, we continue to augment our own product development capabilities by
working with and leveraging key technology and go-to-market partners.
Selling and Marketing. Selling and marketing expenses consist primarily of
salaries and related benefits, commissions and marketing expenses such as
channel programs, advertising, product literature, trade shows, marketing and
direct mail programs. Selling and marketing expenses decreased 65.7% to
approximately $2.7 million for the three-month period ended April 30, 2002, from
approximately $8.0 million for the same period in 2001. As a percentage of
revenue, selling and marketing expenses decreased to 18.6% of total revenue for
the three-month period ended April 30, 2002 from 29.8% of total revenue for the
same period in 2001. The dollar value decrease is due primarily to reduced
headcount, related salaries and commissions, and decreased expenses for
marketing programs, advertising and product literature at a rate faster than the
decline in revenue between the two periods.
Selling and marketing expenses decreased 71.1% to approximately $7.9 million for
the nine-month period ended April 30, 2002, from approximately $27.2 million for
the same period in 2001. As a percentage of revenue, selling and marketing
expenses decreased to 15.8% of total revenue for the nine-month period ended
April 30, 2002 from 33.9% of total revenue for the same period in 2001. The
dollar value decrease is due primarily to reduced headcount, related salaries
and commissions, and decreased expenses for marketing programs, advertising and
product literature at a rate faster than the decline in revenue between the two
periods.
For fiscal 2002, we expect selling and marketing expenses to decline in dollar
terms as compared to fiscal 2001. We continue to make targeted investments in
areas that promote brand recognition and increase new customer acquisitions. We
intend to accomplish this by adding capabilities in our direct sales and
marketing organizations, building leveraged distribution channels with selected
technology and system integration partners and increasing spending in targeted
public relations and marketing programs. In the third quarter fiscal 2002,
NaviSite launched a indirect channel program and a suite of channel ready
solutions. We expect these efforts to improve overall the sales productivity and
lower the cost of customer acquisition.
General and Administrative. General and administrative expenses include the
costs of financial, leasing, human resources, IT and administrative personnel,
professional services, bad debt, and corporate overhead. Also included are
intercompany charges from CMGI for human resource support and business
development. As our business grows, we expect the dollar value of these expenses
to increase, but decline on a percentage of revenue basis, as we hire additional
personnel and incur additional costs related to the growth of our business,
however, if this growth does not materialize, we would expect the dollar value
of these expenses to remain constant or decline and to remain constant or
increase on a percentage of revenue basis as we manage our costs to expected
revenue levels.
General and administrative expenses decreased 69.2% to approximately $2.6
million for the three-month period ended April 30, 2002, from approximately $8.5
million for the same period in 2001. As a percentage of revenue, general and
administrative expenses
decreased to 17.8% of total revenue for the three-month period ended April 30,
2002 from 31.9% of total revenue for the same period in 2001. The dollar value
decrease in general and administrative expenses is primarily due to reduced bad
debt expense and reduced headcount levels and headcount expenses.
General and administrative expenses decreased 31.9% to approximately $16.5
million for the three-month period ended April 30, 2002, from approximately
$24.3 million for the same period in 2001. As a percentage of revenue, general
and administrative expenses increased slightly to 33.3% of total revenue for the
three-month period ended April 30, 2002 from 30.2% of total revenue for the same
period in 2001. The dollar value decrease in general and administrative expenses
is primarily due to reduced bad debt expense and reduced headcount levels and
headcount expenses. Revenue declined at a rate faster than the decline in
general and administrative costs for the nine month period ended April 30, 2002
compared to the same period in 2001.
For fiscal year 2002, we are anticipating a decrease in general and
administrative expense resulting from the fiscal year 2001 restructuring, lower
labor levels and decreased bad debt expense.
Restructuring
In July 2001, we announced a plan, approved by our Board of Directors, to
restructure our operations and consolidate our data centers, which resulted in a
charge of approximately $8.0 million, of which approximately $5.2 million was
accrued for as of July 31, 2001. Of the total restructuring charge,
approximately $1.8 million was related to employee termination benefits. We
terminated 126 employees on July 31, 2001.
The restructuring charge also included approximately $6.2 million of costs
related to the closing of our two original data centers. The components of the
facility closing costs included approximately $3.8 million of estimated lease
obligations associated with restoring the facilities to their original
condition, and other contractual obligations, to be paid over the term of the
respective agreements through 2002, and approximately $2.4 million of write-offs
of leasehold improvements, which were recorded as of July 31, 2001.
During the third quarter 2002, we were able to favorably renegotiate the
facility closing costs. The accrual for estimated restoration costs for the two
original data centers was reduced by an aggregate $1.6 million and the accrual
for bandwidth termination costs was reduced by approximately $803,000. In
addition, $63,000 in severance/employee costs were forfeited by former
employees. As a result, we reduced accrued restructuring by approximately $2.5
million during the third quarter.
Interest Income
Interest income decreased to approximately $389,000 and $721,000 for the three
and nine-month periods ended April 30, 2002, from approximately $679,000 and
$2.4 million for the same periods in 2001. The decrease is due primarily to the
lower average cash on hand during 2002 due to operating requirements during the
fiscal year offset by interest income from customer equipment rentals under
direct financing leases.
Interest Expense
Interest expense increased to approximately $3.8 and $10.9 million for the three
and nine month period ended April 30, 2002, from approximately $2.6 and $5.3
million for the same periods in 2001. This increase was primarily due to
interest on the $80 million face value note payable to CMGI in the amount of
$2.7 million, including the amortization of the related warrants; interest on
the $65.1 million face value notes payable due to CMGI and CFS, in the amount of
$4.8 million, and the amortization of the beneficial conversion feature of the
notes payable to CMGI and CFS in the amount of $3.4 million.
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, the issuance
of preferred stock and convertible debt to strategic investors, our initial
public offering and related exercise of the underwriters' over-allotment option
in October 1999 and November 1999, respectively.
Our cash and cash equivalents increased to $27.9 million at April 30, 2002 from
$22.2 million at July 31, 2001, and we had working capital of $14.7 million at
April 30, 2002. Net cash used by operating activities for the nine-month period
ended April 30, 2002 amounted to $21.1 million, resulting primarily from the net
loss, increases in amount due from CMGI and affiliates and other assets,
and a decrease in accounts payable, partially offset by a decrease in accounts
receivable, decreases in accrued expenses and deferred revenue, amounts due to
CMGI, bad debt expense, and depreciation and amortization and asset impairment
charges.
Net cash used by investing activities was approximately $429,000 for the
nine-month period ended April 30, 2002, which was primarily associated proceeds
from the sale of equipment and the sale of our Streaming Media Division assets
and reduction of restricted cash, offset by expenditures for the acquisition of
property and equipment. Net cash provided by financing activities was
approximately $27.3 million for the nine-month period ended April 30, 2002,
which was primarily associated with the proceeds of the $30.0 million
convertible notes payable from CFS and CMGI, respectively, offset by repayment
of capital lease and financed software obligations.
In connection with an agreement dated October 29, 2001 among NaviSite, CMGI and
CFS, we purchased certain equipment with a fair market value of $9.6 million,
previously leased by us from CFS under operating lease agreements expiring
through 2003, in exchange for a note payable in the face amount of approximately
$35 million. As the fair market value of the equipment, based on a third-party
appraisal, was less than the associated debt obligation, we have recorded an
asset impairment charge in the first quarter of fiscal 2002 of $25.4 million. We
recorded the assets purchased and associated impairment charge effective August
1, 2001 with a corresponding obligation to CFS. Based on the terms of the $35
million obligation, interest accrues commencing on November 8, 2001. We recorded
$1.1 million, $1.0 million and $1.0 million of interest expense for the first,
second and third quarters of fiscal year 2002, respectively.
On November 8, 2001, in connection with the October 29, 2001 agreement, we
received $20 million and $10 million in cash from CFS and CMGI, respectively, in
exchange for six-year convertible notes payable in the face amounts of $20
million and $10 million to CFS and CMGI, respectively, making the total notes
payable issued by us to CFS and CMGI approximately $55 million and $10 million,
respectively. The notes require payment of interest only, at 12% per annum, for
the first three years from the date of issuance and then repayment of principal
and interest, on a straight-line basis, over the next three years until maturity
on the sixth anniversary of the date of issuance. At our option, we may make
interest payments (i) 100% in shares of NaviSite common stock, in the case of
amounts owed to CMGI, through December 2007 and (ii) approximately 16.67% in
shares of NaviSite common stock, in the case of amounts owed to CFS, through
December 2003. The convertible notes payable are secured by substantially all of
the assets of NaviSite and cannot be prepaid.
In the second and third quarters of fiscal year 2002, we issued 1,003,404 shares
and 2,100,444 shares of common stock in satisfaction of accrued interest
associated with the $65.1 million face value notes payable to CMGI and CFS.
The principal balances of the notes may be converted into NaviSite common stock
at the option of the holders at any time prior to or at maturity at a conversion
rate of $0.26 per share. The conversion rate of $0.26 results in beneficial
conversion rights for both CMGI and CFS. The intrinsic value of the beneficial
conversion rights amounted to $6.5 million and $36.0 million for CMGI and CFS,
respectively. The intrinsic value of the beneficial conversions rights are being
amortized into interest expense over the life of the convertible notes payable
as an additional component of interest expense. CMGI also converted its $80
million in aggregate principal outstanding under its existing notes payable,
plus the accrued interest thereon, into approximately 14.7 million shares of
NaviSite common stock. CMGI also converted approximately $16.2 million in other
amounts due by NaviSite to CMGI into approximately 9.9 million shares of
NaviSite common stock.
Holders of the convertible notes payable are entitled to both demand and
piggyback registration rights, and CFS is entitled to anti-dilution protection
under certain circumstances. The agreement with CFS also contains certain
restrictive covenants, including but not limited to limitations on the issuance
of additional debt, the sale of equity securities to affiliates and certain
acquisitions and dispositions of assets.
On March 7, 2002, we signed an agreement with Engage, Inc., a related party,
whereby Engage's contract with us was terminated. Pursuant to our agreement with
Engage, we received cash payments of $1.2 million in March 2002, $1.2 million in
April 2002, and will receive $1.2 million in July 2002, for a total of $3.6
million related to amounts previously due for services rendered and amounts
payable for early termination of the contracts and deinstallation of equipment.
For the three and nine-month periods ended April 30, 2002, Engage represented 0%
and 3%, respectively, of our total revenue. As a result of our agreement with
Engage, we recognized approximately $2.3 million of non-recurring deinstallation
and contract termination revenue in the third quarter of fiscal year 2002.
In the third quarter 2002, we modified the payment amounts and terms of certain
operating leases with a lessor such that the modified leases qualify as capital
leases. The resulting capital lease is payable in 28 monthly payments of $4,700
for the first 4 months and $20,400 for the remaining 24 months, starting in
April 2002. Total payments, including principle and interest, aggregate $508,400
under this arrangement. In addition to the lease modifications, in March 2002,
we returned equipment held under certain operating leases with the same lessor
and incurred a breakage fee of $397,000.
We currently anticipate that our available cash resources at April 30, 2002 will
be sufficient to meet our anticipated needs, barring
unforeseen circumstances and subject to the impact of the factors noted below,
for working capital and capital expenditures over the next twelve months. Our
projected cash usage could be significantly impacted by: (1) our ability to
maintain our current revenue levels through retaining existing customer accounts
and acquiring revenue growth at levels greater than customer revenue churn; (2)
our ability to achieve our projected operating results; (3) our ability to
collect accounts receivables in a timely manner; (4) our ability to collect
amounts due from Engage related to the termination of our contract with them;
(5) our ability to achieve expected cash expense reductions; and (6) our ability
to sell our assets which are held for sale at their fair-market value. However,
we may need to raise additional funds in order to develop new, or enhance
existing, services or products, to respond to competitive pressures, to acquire
complementary businesses, products or technologies or to continue as a going
concern. 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. Under our
arrangement with CFS, we must obtain their consent in order to issue debt
securities or sell shares of our common stock to affiliates. We may not receive
their consent. 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.
Contractual Obligations and Commercial Commitments
In the normal course of our business, we enter into contracts related to the
leasing of facilities and equipment and the purchase of minimum amounts of
bandwidth. In addition, we have $65.1 million face value of long-term debt
outstanding at April 30, 2002. Future payments required under these long-term
obligations are as follows:
Payment Due by Period
(in thousands)
Less than After
Contractual Obligations Total 1 year 1 - 3 years 4 - 5 years 5 years
--------- ---------- ------------- ------------- ---------
Short-term debt $ 237 $ 237 $ -- $ -- $ --
Long-term debt 65,093 -- -- -- 65,093
Interest on debt 25,893 5,509 11,294 8,264 826
Capital leases 3,765 3,192 573 -- --
Operating leases 1,451 968 483 -- --
Bandwidth commitments 3,425 1,898 1,478 49 --
Level 3 agreement 1,560 1,560 -- -- --
Maintenance for hardware and software 1,980 1,080 900 -- --
Property leases 27,945 4,701 10,191 6,891 6,162
--------- ---------- ------------- ------------- ---------
Total $131,349 $ 19,145 $ 24,919 $ 15,204 $ 72,081
========= ========== ============= ============= =========
Critical Accounting Policies
We prepare our consolidated financial statements in accordance with accounting
principles generally accepted in the United States of America. As such,
management is required to make certain estimates, judgments and assumptions that
they believe are reasonable based on the information available. These estimates
and assumptions affect the reported amounts of assets and liabilities at the
date of the financial statements and the reported amounts of revenues and
expenses for the periods presented. The significant accounting policies which
management believes are the most critical to aid in fully understanding and
evaluating our reported financial results include revenue recognition, allowance
for doubtful accounts and impairment of long-lived assets.
Revenue Recognition. We provide outsourced web hosting and managed application
services and related professional and consulting services. Revenue consists of
monthly fees for web site and internet application management, application
rentals, and hosting. Revenues related to monthly fees for web site and internet
application management, application rentals and hosting are recognized over the
term of the customer contract based on actual usage and services. Fees charged
for the installation of customer equipment are generally received in advance and
are deferred and recognized as revenue over the life of the related customer
contract, typically 12 to 24 months. In the event a customer terminates their
agreement prior to its stated maturity, all deferred revenue related to
installation services is automatically recognized upon the effective date of the
termination, and we generally charge cancellation fees that are also recognized
upon the effective date of the termination. Cancellation fees are calculated as
the customer's remaining base monthly fees obligation times the number of months
remaining in the contract term.
Existing customers are subject to ongoing credit evaluations based on payment
history and other factors. If it is determined subsequent to our initial
evaluation and at any time during the arrangement that collectability is not
reasonably assured, revenue is recognized as cash is received. Due to the nature
of our service arrangements, we provide written notice of termination of
services, typically 90 days in advance of disconnecting a customer. Revenue for
services rendered during this notification period is recognized on a cash basis
as
collectability is not considered probable at the time the services are provided.
Allowance for Doubtful Accounts. We perform periodic credit evaluations of our
customers' financial condition and generally do not require collateral or other
security against trade receivables. Our customer base includes a significant
number of dot.com businesses that face increased risk of loss of funding
depending on the availability of private and or public funding. We make
estimates of the uncollectability of our accounts receivables and maintain an
allowance for doubtful accounts for potential credit losses. We specifically
analyze accounts receivable and consider historical bad debts, customer and
industry concentrations, customer credit-worthiness, current economic trends and
changes in our customer payment patterns when evaluating the adequacy of the
allowance for doubtful accounts. We specifically reserve for 100% of the balance
of customer accounts deemed uncollectible. For all other customer accounts, we
reserve for 50% of the balance over 120 days old and 3% of all other customer
balances. This method historically approximated actual write off experience.
Changes in economic conditions or the financial viability of our customers may
result in additional provisions for doubtful accounts in excess of our current
estimate.
Impairment of Long-lived Assets. We review our long-lived assets, primarily
property and equipment, for impairment whenever events or changes in
circumstances indicate that the carrying amount of these assets may not be
recoverable. Recoverability is measured by a comparison of the carrying amount
of an asset to future undiscounted cash flows expected to be generated by the
asset. If such assets were considered to be impaired, the impairment to be
recognized would be measured by the amount by which the carrying value of the
assets exceed their fair value. Fair value is determined based on discounted
cash flows or appraised values, depending on the nature of the asset. Assets to
be disposed of are valued at the lower of the carrying amount or their fair
value less disposal costs. Property and equipment is primarily comprised of
leasehold improvements, computer and office equipment, and software licenses.
During the fourth quarter of fiscal 2001, due to significant industry and
economic trends affecting both our current and future operations as well as a
significant decline in our stock price, we completed an impairment review of our
property and equipment. This review included a comparison of the carrying amount
of such assets to the estimated future undiscounted net cash flows expected to
be generated by those assets at an enterprise level. As a result of this review,
we determined that there was no impairment in the property and equipment. The
preparation of future cash flows requires significant judgments and estimates
with respect to future revenues related to the respective asset and the future
cash outlays related to those revenues. Actual revenues and related cash flows
or changes in anticipated revenues and related cash flows could result in a
change in this assessment and result in an impairment charge. In addition, we
are currently evaluating our business model and the manner in which we provide
services. As of result of this evaluation, we may decide to restructure how we
deliver our services which could result in, but not be limited to, an impairment
of our data center assets and/or a change in the estimated useful life of
certain assets. The preparation of discounted cash flows also requires the
selection of an appropriate discount rate. The use of different assumptions
would increase or decrease estimated discounted cash flows and could increase or
decrease the related impairment charge.
Included in the cost of revenue for the nine-month period ended April 30, 2002
is a net charge of $30.6 million related to customer equipment impairment
charges, which represents the excess amounts paid to purchase customer equipment
previously held under operating leases over the estimated fair value of the
equipment, and permanently idled customer equipment held under operating leases.
During the third quarter of fiscal year 2002 we evaluated the remaining
estimated obligations that were accrued at April 20, 2002 associated with the
termination of equipment operating leases with vendors for both active and idle
customer equipment. As a result of this analysis, we reversed approximately $4.8
million of this accrual to reflect positive experience in negotiating
settlements with vendors and other adjustments. This reversal is reflected in
the three and nine month periods ended April 30, 2002 as a benefit of
approximately $835,000 recorded to cost of revenues and a benefit of
approximately $4.0 million recorded to customer equipment and lease
restructuring (a separate component of cost of revenues), consistent with the
classification of the original charges.
We performed an evaluation of our customer dedicated equipment inventory during
the second quarter of fiscal 2002 and identified $3.4 million of excess and idle
equipment which is held for sale. The carrying value of this equipment
approximated its fair value less costs to sell as most of the equipment was
included in the lease restructuring agreements and were recorded at their fair
value based on appraisal. Our plan is to sell this excess equipment at its fair
value. Should we not realize the fair value of the equipment upon sale or not be
able to sell the equipment, we may incur additional impairment charges. We also
recorded an impairment charge of $1.9 million for obsolete equipment and
equipment no longer on hand.
Related Party Transactions
We are currently a 76.73% owned subsidiary of CMGI. CMGI has provided us with
funding since our inception through the issuance of common stock, preferred
stock and convertible debt.
We sell our products and services to companies in which CMGI has an investment
interest or a significant ownership interest. Total revenue realized from
services to related parties was $5.6 million and $15.3 million for the three and
nine-month periods ended April 30, 2002 compared to $8.9 million and $30.6
million for the three and nine-month periods ended April 30, 2001. These related
parties typically receive a 10% discount for services provided by us. The
related cost of revenue is consistent with the costs incurred on similar
transactions with unrelated parties. On March 7, 2002, we signed a settlement
agreement with Engage, Inc., a related party, whereby Engage's service contract
with us was terminated. Pursuant to our agreement with Engage, we received cash
payments of $1.2 million in March 2002, $1.2 million in April 2002, and will
receive $1.2 million in July 2002, for a total of $3.6 million, related to
amounts previously due for services rendered and amounts payable for early
termination of the contracts and
deinstallation of equipment. For the three and nine-month periods ended April
30, 2002, Engage represented 0% and 3%, respectively, of our total revenue. As a
result of our agreement with Engage, we recognized approximately $2.3 million of
non-recurring deinstallation and contract termination revenue in the third
quarter of fiscal year 2002. CMGI has provided us with accounting, systems and
related services at amounts that approximated the fair value of services
received in each of the periods presented in these financial statements. We also
purchase certain employee benefits (including 401(k) plan participation by our
employees) and insurance (including property and casualty insurance) through
CMGI. CMGI also has provided us with Internet marketing and business development
services. Amounts due to CMGI related to these services as of April 30, 2002
totaled approximately $5.0 million.
We provide administrative services to CMGI and related entities as they relate
to lease schedules for equipment ordered by NaviSite prior to October 22, 1999.
These lease schedules include equipment leased for both NaviSite and CMGI,
however, the majority of the equipment was used by NaviSite. Secondarily, as
part of this understanding, CMGI provides administrative services for leases
that include equipment for both NaviSite and CMGI under which CMGI or a related
entity is the primary equipment user. The administrative services include the
payment of the lessor's monthly lease charges. In both cases, the entity
providing the administrative services charges the other for the actual lease
fees, however in all of these cases, CMGI bears all liability for the payment
and we are not financially obligated under the leases. While we have no
financial obligation going forward, there is a disputed past due amount for
which we have and will continue to accrue fees until a settlement is reached.
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. We cannot assure
you 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 April 30, 2002, we had an accumulated deficit of $288.8 million. We
anticipate increased expenses as we continue to improve our infrastructure,
introduce new services, enhance our application management expertise, expand our
sales and marketing efforts, and pursue additional industry relationships. As a
result, we expect to incur operating losses for at least the next fiscal year.
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: reduction of market demand and or acceptance for our Web
site and Internet application hosting and management services; oversupply of
data center space in the industry; 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 CURRENTLY A MAJORITY STOCKHOLDER, AND CFS IS A POTENTIAL MAJORITY
STOCKHOLDER, AND BOTH MAY HAVE INTERESTS THAT CONFLICT WITH THE INTERESTS OF OUR
OTHER STOCKHOLDERS. As of April 30, 2002, CMGI beneficially owned approximately
83.69% 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.
On November 8, 2001, in conjunction with the restructuring of certain of our
lease obligations, we issued convertible notes which, upon conversion, would
give CFS a controlling interest in NaviSite. Should CFS elect to convert its
$55 million in convertible notes into our common stock and CMGI elect not to
convert, CFS would own approximately 211,897,436 shares of our common stock,
which, based on our capitalization as of November 8, 2001, would be
approximately 71% of our then outstanding shares of common stock. In the event
both CFS and CMGI elect to convert their notes into our common stock, CFS would
own approximately 63% of our common stock and CMGI would own approximately 28%
of our common stock. Accordingly, if CFS converts these notes to shares of our
common stock, CFS would have the power, acting alone, to elect a majority of our
board of directors and would have the ability to determine the outcome of any
corporate actions requiring stockholder approval regardless of how our other
stockholders may vote. If CFS becomes a majority stockholder, it may have
interests that conflict with the interests of our other stockholders, as
described above for CMGI.
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 30.9%
of our revenue in the nine months ended April 30, 2002 and approximately 35.4%
of our revenue for the fiscal year ended July 31, 2001. 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. The number of CMGI and CMGI affiliated customers
decreased 66.6% to 7 at April 30, 2002 from 21 as of April 30, 2001.
WE MAY NEED TO RAISE ADDITIONAL FUNDS, AND SUCH FUNDING MAY NOT BE AVAILABLE TO
US ON FAVORABLE TERMS, IF AT ALL. We currently anticipate that our available
cash resources at April 30, 2002 will be sufficient to meet our anticipated
needs, barring unforeseen circumstances and subject to the impact of the factors
noted below, for working capital and capital expenditures over the next twelve
months. Our projected cash usage could be significantly impacted by: (1) our
ability to maintain our current revenue levels through retaining existing
customer accounts and acquiring revenue growth at levels greater than customer
revenue churn; (2) our ability to achieve our projected operating results; (3)
our ability to collect amounts receivables in a timely manner; (4) our ability
to collect amounts due from Engage related to the termination of our contract
with them; (5) our ability to achieve expected cash expense reductions; and (6)
our ability to sell our assets which are held for sale at fair-market value.
However, we may need to raise additional funds in order to develop new, or
enhance existing, services or products, to respond to competitive pressures, to
acquire complementary businesses, products or technologies or to continue as a
going concern, and we cannot assure you that the additional financing will be
available on terms favorable to us, if at all. In addition, pursuant to our
financing arrangements with CFS as of October 29, 2001, we may need to obtain
approval from CFS for incremental funding, and we may not obtain this approval
from CFS.
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. Certain of the equipment that we use or provide
to our customers for their use in connection with our services is provided under
lease. 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 business would
be substantially impaired if we were unable to obtain or continue these leases
on commercially reasonable terms.
OUR DECISION TO DISCONTINUE OUR PRACTICE, ON A PROSPECTIVE BASIS, OF OBTAINING
EQUIPMENT UNDER LEASES AND SUBSEQUENTLY RENTING THE EQUIPMENT TO OUR CUSTOMERS
MAY HAVE A MATERIAL ADVERSE EFFECT ON OUR FUTURE RESULTS AND BUSINESS
OPERATIONS. New customers and current customers seeking to renew their
agreements will have to obtain equipment directly from equipment vendors. We may
not be successful in attracting new customers who would prefer to obtain
equipment from us. Current customers may not renew their agreements and seek a
hosting provider who would also rent equipment directly to them to satisfy their
equipment needs. If we are unable to keep our current customers and attract new
customers, our future results and business operations could be materially
harmed.
OUR COMMON STOCK MAY NOT BE TRANSFERRED BACK TO THE NASDAQ NATIONAL MARKET OR
COULD BE DELISTED FROM THE NASDAQ SMALLCAP MARKET. On February 14, 2002, we
received a deficiency notice from Nasdaq indicating that our common stock had
not maintained a minimum market value of publicly held shares of $15,000,000 and
had failed to maintain a minimum bid price per share of $3.00 over the previous
30 consecutive trading days, and that we had until May 15, 2002 to regain
compliance with the Nasdaq National Market's listing requirements. Nasdaq
informed us that if we failed to demonstrate compliance with Nasdaq's listing
requirements on or before May 15, 2002, Nasdaq would provide us with written
notification that it had determined that we did not meet the standards for
continued listing, and our securities would be delisted from the Nasdaq National
Market. On May 10, 2002, we applied to transfer voluntarily to the Nasdaq
SmallCap Market. On June 4, 2002, Nasdaq approved our transfer application, and
our common stock was transferred to the Nasdaq SmallCap Market at the opening of
business on June 10, 2002. Although we are eligible to transfer back to the
Nasdaq National Market if, among other things, our common stock's bid price is
at least $1.00 for 30 consecutive trading days by February 10, 2003 and we have
maintained compliance with the Nasdaq National Market's continued listing
requirements while listed on the Nasdaq SmallCap Market, excluding bid price, we
may not meet these requirements. If we are unable to regain compliance with the
Nasdaq National Market's requirements, our common stock will remain on the
Nasdaq SmallCap Market. Moreover, if we fail to meet the Nasdaq SmallCap
maintenance standards, we could be delisted to the over-the-counter electronic
bulletin board (OTCBB), which is operated by the National Association of
Securities Dealers, Inc. If our common stock is not eligible to transfer back to
the Nasdaq National Market in the future or is delisted to the OTCBB, among
other things, this could result in a number of negative implications, including
continued reduced liquidity in our common stock as a result of the loss of
market efficiencies associated with the Nasdaq National Market and the loss of
federal preemption of state securities laws as well as the potential loss of
confidence by suppliers, customers and employees, the loss of analyst coverage
and institutional investor interest, fewer business development opportunities
and greater difficulty in obtaining financing.
IF THE MARKET FOR INTERNET COMMERCE AND COMMUNICATION DOES NOT CONTINUE, OR IT
CONTINUES TO DECREASE, 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 impaired if the market
for Internet application services fails to continue to develop or if we cannot
continue to achieve broad market acceptance. The market for Internet application
services has recently developed and is evolving.
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, WE MAY LACK THE FINANCIAL AND OTHER
RESOURCES, EXPERTISE OR CAPABILITY NEEDED TO CAPTURE INCREASED MARKET SHARE OR
MAINTAIN MARKET SHARE. We compete in the Internet application service market.
This market is rapidly evolving, highly competitive and likely to be
characterized by over capacity and industry consolidation. We believe that
participants in this market must grow rapidly and achieve a significant presence
to compete effectively. Our business is not as developed as that of many of our
competitors. Many of our
competitors have substantially greater financial, technical and market
resources, greater name recognition and more established relationships in the
industry. We may lack the financial and other resources, expertise or capability
needed to capture increased market share in this environment in the future.
ANY INTERRUPTIONS IN, OR DEGRADATION OF, OUR 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 were 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 lease select software applications from Internet application
software vendors. The loss of our ability to continually obtain and utilize 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. 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
dependency to obtain and continue to maintain 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 manage our customer growth and the
related expansion of our operations could result in decreased revenue and
continued operating losses. In order to service our 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 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.
OUR CUSTOMER BASE INCLUDES A SIGNIFICANT NUMBER OF DOT.COM 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. We have experienced and may continue
to 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 OF OUR RECENT FINANCING ARRANGEMENTS WITH
CFS AND CMGI. The financing arrangement, as of October 29, 2001, with CFS and
CMGI includes terms that allow CFS and CMGI at their discretion, to convert the
debt obligation of $65 million into our common stock at a conversion price of
$0.26 per share, subject to our stockholder approval. This conversion would
increase the number of shares of our common stock issued by approximately 250
million shares. In addition, we may pay a portion of interest due to CFS and all
interest due to CMGI with our common shares. Moreover, if additional funds are
raised through the issuance of additional equity or convertible debt securities,
your percentage of ownership in us will be reduced and you may experience
additional dilution. In certain circumstances, if we issue equity or convertible
debt securities at values below those provided to CFS, we must issue CFS
additional shares of our common stock which will further dilute existing
stockholders.
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, retain current
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.
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 or other claims and assertions, 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, KEY MANAGEMENT AND OTHER 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 Tricia Gilligan, our President and 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. On July 31, 2001, we initiated a reduction
in force eliminating 126 full-and part-time employees, representing
approximately 25 percent of our total staff. We also announced the departure of
7 of 13 vice presidents, in the areas of sales, human resources, international,
strategic planning, managed services, marketing and technology planning, as well
as our general counsel. In addition, since July 31, 2001, Joel B. Rosen, our
then Chief Executive Officer, and Kenneth W. Hale, our then Chief Financial
Officer, have left our company. We cannot assure you that future reductions or
departures will not occur.
IF WE FAIL TO ATTRACT OR RETAIN 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. 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. Qualified technical personnel are likely to
remain a limited resource for the foreseeable future. We may not be able to
retain or 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 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.
ANY FUTURE DIVESTITURES WE MAKE OF COMPANIES OR TECHNOLOGIES MAY RESULT IN
DISRUPTIONS TO OUR BUSINESS OR DISTRACTIONS OF OUR MANAGEMENT DUE TO
DIFFICULTIES DISASSIMILATING PERSONNEL, TECHNOLOGIES OR OPERATIONS. Our business
strategy may include divestiture of certain technologies. If we do pursue
divestitures, our risks may increase because our ongoing business may be
disrupted and management's attention and resources may be diverted from other
business concerns.
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 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 additional 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 additional
financial resources in the future to equip our data centers with enhanced
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 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 our business. For example, we provide services over the Internet in many
states in the United States and elsewhere and facilitate the activities of our
customers in such 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 that 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 a number 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.
IN THE EVENT WE WERE TO CHANGE OUR BUSINESS STRATEGY WHEREBY THE FACILITY
COMPONENT OF OUR SERVICE DELIVERY WOULD BE OUTSOURCED TO DATA CENTERS OWNED BY
THIRD PARTIES RATHER THAN NAVISITE AND ARE NOT SUCCESSFUL, OUR BUSINESS COULD BE
MATERIALLY ADVERSELY AFFECTED. We are currently evaluating our business model
whereby we would provide integrated managed hosting services in data centers
owned by third parties in addition to our own data centers. We believe that this
approach could augment our existing management expertise, software and operating
processes with third-party infrastructure and geographic reach. The evaluation
is in the preliminary stages, and the outcome is uncertain at this point in
time, however, in the event we pursue such a strategy, this new business
strategy may not be successful due to failures of such third-party data center
providers. We would rely on these providers to supply critical components of our
business, and we may not have direct control over the facility or any of these
components. We may not be able to attract new customers or renew current
customers as such customers may require us to own the facility being utilized.
If the third-party data center providers are inadequate or if our present or
potential customers prefer that we own the data centers, our business could be
materially adversely affected.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Our exposure to market risk primarily relates to interest rates related to our
cash and cash equivalents and our fixed rate long term debt. As of April 30,
2002, we had approximately $27.9 million in cash and cash equivalents primarily
invested in money market accounts which bear interest at market rates. As of
April 30, 2002, we had approximately $65 million of fixed rate convertible debt
with CMGI and CFS. Interest rate changes affect the fair value of this fixed
rate debt but do not impact earnings or cash flows. We estimate that a one
percentage point decrease or increase in interest rates would increase or
decrease the fair value of the debt by $2.2 million or $2.1 million,
respectively.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
Not applicable.
Item 2. Changes in Securities and Use of Proceeds
(c) Recent Sales of Unregistered Securities
On November 8, 2001, in connection with an agreement dated October 29, 2001
among NaviSite, CMGI, Inc. (CMGI) and Compaq Financial Services Corporation
(CFS), a wholly-owned subsidiary of Compaq Computer Corporation, we purchased
certain equipment
previously leased by NaviSite from CFS under operating lease agreements expiring
through 2003 in exchange for a note payable in the face amount of approximately
$35 million. Additionally, we received $20 million and $10 million in cash from
CFS and CMGI, respectively, in exchange for six-year convertible notes payable
in the face amounts of $20 million and $10 million to CFS and CMGI,
respectively, making the total notes payable issued by NaviSite to CFS and CMGI
approximately $55 million and $10 million, respectively. The notes require
payment of interest only, at 12% per annum, for the first three years from the
date of issuance and then repayment of principal and interest, on a
straight-line basis, over the next three years until maturity on the sixth
anniversary of the date of issuance. At NaviSite's option, we may make interest
payments (i) 100% in shares of NaviSite common stock, in the case of amounts
owed to CMGI, through December 2007 and (ii) approximately 16.67% in shares of
NaviSite common stock, in the case of amounts owed to CFS, through December
2003. The convertible notes payable are secured by substantially all of the
assets of NaviSite and cannot be prepaid.
The principal balances may be converted into NaviSite common stock at the option
of the holders at any time prior to or at maturity at a conversion rate of $0.26
per share. CMGI also converted its $80 million in aggregate principal
outstanding under its existing notes payable, plus the accrued interest thereon,
into approximately 14,724,481 shares of NaviSite common stock. CMGI also
converted approximately $16.2 million in other amounts due by NaviSite to CMGI
into approximately 9,905,419 shares of NaviSite common stock.
Holders of the convertible notes payable are entitled to both demand and
"piggyback" registration rights, and CFS is entitled to anti-dilution protection
under certain circumstances. The agreement with CFS also contains certain
restrictive covenants, including but not limited to limitations on the issuance
of additional debt, the sale of equity securities to affiliates and certain
acquisitions and dispositions of assets.
On April 1, 2002, NaviSite paid $300,000 in accrued interest owed to CMGI under
a convertible note by issuing to CMGI 1,094,891 shares of NaviSite common stock.
Also on April 1, 2002, NaviSite paid $275,522 in accrued interest owed to CFS
under a convertible note by issuing to CFS 1,005,553 shares of NaviSite common
stock.
The convertible notes and the shares of NaviSite common stock issued as interest
payments under the convertible notes were issued in reliance upon the exemptions
from registration under Section 4(2) of the Securities Act and Regulation D
promulgated thereunder, relative to sales by an issuer not involving a public
offering. No underwriters were involved in the sale of these securities.
Item 3. Defaults Upon Senior Securities.
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders.
Not applicable.
Item 5. Other Information.
Not applicable.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
None.
(b) Reports on Form 8-K
None.
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 hereunto duly authorized.
NAVISITE, INC.
Date: June 14, 2002 By /s/ Kevin Lo
----------------------------
Kevin Lo
Chief Financial Officer
(Principal Financial and
Chief Accounting Officer)