<PAGE>
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------
FORM 10-K
----------------
FOR ANNUAL AND TRANSITIONAL REPORTS PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
For the fiscal year ended July 31, 2000
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 jurisdictionof (I.R.S. Employer Identification Number)
incorporation or organization)
400 Minuteman Road
Andover, Massachusetts 01810
(Address of principal executive (Zip Code)
offices)
(978) 682-8300
(Registrant's telephone number, including area code)
----------------
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period than the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [_]
The aggregate market value of the registrant's common stock, $.01 par value
per share, held by non-affiliates of the registrant was approximately
$148,989,880, based on the last reported sale price of the registrant's common
stock on the Nasdaq National Market as of the close of business on October 25,
2000.
As of October 25, 2000 there were 58,595,344 shares outstanding of the
registrant's common stock, par value $.01 per share.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive proxy statement for its annual
meeting of stockholders for the fiscal year ended July 31, 2000, which will be
filed with the Securities and Exchange Commission within 120 days after the end
of the registrant's fiscal year, are incorporated by reference into Part III
hereof.
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
<PAGE>
NAVISITE, INC.
2000 ANNUAL REPORT
ON FORM 10-K
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C> <C>
PART I
Item 1. Business............................................................................... 3
Item 2. Properties............................................................................. 20
Item 3. Legal Proceedings...................................................................... 21
Item 4. Submission of Matters to a Vote of Security Holders.................................... 21
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.................. 22
Item 6. Selected Consolidated Financial Data................................................... 23
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.. 23
Item 7A. Quantitative and Qualitative Disclosure about Market Risk.............................. 30
Item 8. Financial Statements and Supplementary Data............................................ 30
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure... 56
PART III
Item 10. Directors and Executive Officers of Registrant......................................... 56
Item 11. Executive Compensation................................................................. 56
Item 12. Security Ownership of Certain Beneficial Owners and Management......................... 56
Item 13. Certain Relationships and Related Transactions......................................... 56
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K....................... 56
Signatures...................................................................................... 57
</TABLE>
2
<PAGE>
PART I
Special Note Regarding Forward-Looking Statements
This Form 10-K 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.
Item 1. Business
Company Overview
NaviSite is a leading provider of managed website and application hosting
services. Our managed application hosting services allow businesses to
outsource the deployment, configuration, hosting, management and support of
their Web sites and Internet applications in a cost-effective and rapid manner.
Our focus on enhanced management services, beyond basic co-location services,
allows us to meet the expanding needs of businesses as their Web sites and
Internet applications become more complex. We also provide our customers with
access to our state-of-the-art data centers and the benefit of our direct
private transit Internet connections to multiple leading Internet backbone
providers. We only use direct private transit Internet connections, which
increases reliability and download speeds.
The scalability of our infrastructure and cost-effectiveness of our
solutions allow us to offer a comprehensive suite of services to meet the
current and future hosting and management needs of our customers. Our suite of
service offerings includes:
. Web site and Internet application hosting, which includes access to our
state-of-the-art data centers, bandwidth and basic back-up, storage and
monitoring services;
. Enhanced server management, which includes custom reporting, hardware
options, load balancing, system security, advanced back-up options,
managed storage solutions and the services of our business solution
managers;
. Specialized application management, which includes management of e-
commerce and other sophisticated applications and their underlying
services, including ad-serving, streaming media production, encoding and
broadcast, databases and transaction processing; and
. Professional services, application rentals and related consulting.
Industry Background
Growth of Business Use of the Internet. The dramatic growth in Internet
usage in recent years, combined with enhanced functionality, accessibility and
security, has made the Internet increasingly attractive to businesses as a
medium for communication and commerce.
3
<PAGE>
As business use of the Internet grows, we believe those businesses which are
utilizing the Internet are seeking to identify and implement increasingly
sophisticated Internet applications. These new applications permit businesses
to:
. increase the efficiencies of running their business;
. engage in business-to-business and business-to-consumer e-commerce;
. enhance business sales efforts through Web-based technologies such as
online training, e-commerce enablement, and streaming;
. build and enhance customer relationships by providing Internet-based
customer service and technical support; and
. communicate and conduct business more rapidly and cost-effectively with
customers, suppliers and employees worldwide.
As a result, the proliferation of business Web sites and Internet
applications has created a strong worldwide demand for specialized information
technology support and application expertise.
Movement Toward Outsourcing. A growing number of businesses using the
Internet as part of their business strategy have chosen to outsource Internet
application development, implementation and support, particularly the hosting
and management of their Web sites and Internet applications. This follows an
overall movement toward outsourcing of information technology services.
According to Forrester Research, businesses in the United States are now
spending approximately 25% of their overall information technology budgets on
outsourced services. We believe that the growth in outsourced hosting and
management of Web sites and Internet applications is driven by a number of
factors, including:
.the desire of businesses to improve the reliability, availability and
overall performance of their Web sites and Internet applications as those
applications increase in complexity and importance;
. the desire of businesses to reduce time to market;
. the challenges faced by businesses in hiring, training and retaining
application engineers and information technology employees with Internet
expertise;
. the increasing complexity of managing the operations of Web sites.
. deployment risk and the risk of technological obsolescence as businesses
attempt to capitalize on leading-edge technologies.
Forrester Research has estimated that the market for managed Web site
hosting in the United States will grow from less than $1.0 billion in 1998 to
over $19.7 billion in 2004.
Need for Providers of Managed Application Hosting Services. An increasing
number of businesses are outsourcing the hosting and management of their Web
sites and Internet applications. However, many Web site hosting providers lack
the requisite expertise to implement and manage increasingly sophisticated
Internet applications. Moreover, many of these providers lack the scalable
capacity, high-speed connectivity, monitoring capabilities and levels of
reliability and availability which businesses demand. System integrators and
application developers often have the requisite expertise and resources to
supply businesses with highly customized application solutions, but these
solutions are expensive and time consuming to implement. Some businesses
attempt to reduce cost and shorten time to deployment by utilizing multiple
vendors, each of which provides only a partial solution. This has created
significant opportunity for managed application hosting providers who can offer
Web site and Internet application deployment, configuration, hosting,
management and support.
4
<PAGE>
The NaviSite Solution
We provide a range of integrated, scalable Web site and Internet application
hosting and management services that can be deployed in a cost-effective and
rapid manner. Our managed application hosting services allow customers to
outsource the deployment, configuration, hosting, management and support of Web
sites and select Internet applications. 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. Key components of our services include:
Cost-Effective Application Management Services. The scalable nature of our
infrastructure, the repeatability of our Internet application services and our
hosting and management expertise allow us to provide our customers with web
site and Internet application hosting and management services on a cost-
effective basis, offloading our customers from the resource and time-intensive
management of web operations. This in turn frees our customers to focus on
their core business. We believe that our customers would otherwise be required
to make significant expenditures to replicate our performance, reliability and
expertise either internally or by using outside vendors.
Rapid Deployment. We offer our customers the ability to rapidly deploy
Internet applications, often in a matter of days or weeks, rather than months.
We believe that we can deploy sophisticated Internet Web sites much more
rapidly than businesses can deploy the same applications in-house. This is
crucial as some of our customers are just developing a Web presence and need to
have their Web sites and Internet applications online as quickly as possible.
High-Performance, World-Class Infrastructure. Our infrastructure has been
designed expressly to meet the more demanding technical and skill set
requirements of providing managed application hosting, compared to "co-
location' hosting services. Our high-performance infrastructure, together with
our trained and experienced staff enable us to offer levels of service which
are backed by service level guarantees which we believe are among the highest
and most comprehensive in the industry.
Strategy
NaviSite's objective is to be the leading managed application hosting
service provider. We plan to achieve this goal by continuing to enhance and
leverage our expertise, service offerings and infrastructure to provide
customers with integrated, reliable and secure Internet-based business
solutions. Key components of our strategy include:
Expand Our Suite of Internet Applications. We intend to both increase the
number and vary the kind of applications and application management services we
offer. NaviSite provides horizontal application services that have broad appeal
across most market segments, including a wide range of industry segments, as
well as ISV (Independent Software Vendors), enterprises, and "new economy'
companies. We plan to continue to provide these horizontal services to more and
more applications, and we also plan to increase the number of horizontal
services we provide. We continue to introduce Internet business applications,
which are intended to enable customers to develop a Web-based business
presence. Currently, we offer our customers e-commerce and other applications
and supporting services, including streaming, databases and transaction
processing services. We focus on application services which are repeatable,
meaning services that we can provide to customers with minimal additional
customization and integration. We believe that this repeatability decreases our
time to market, reduces our operating risks and produces a higher return on our
investment.
Offer Multiple Service Offerings to Meet the Evolving Needs of Customers. We
offer flexible service offerings, allowing customers to choose how much of
their web operations they would like to outsource. This also creates an
environment that makes it easy for customers to purchase more service offerings
over time. We offer multiple service levels to customers so that we can meet
their needs for Internet application services at
5
<PAGE>
each stage in the development of their Web-based operations. For example, a
customer initially may use our Web site or Internet application hosting
services or enhanced server management. Later, as its operations grow and the
Internet becomes more of an integral part of its business strategy, the
customer may use our specialized application management services or application
rentals. We believe we have created a competitive advantage by offering
multiple service levels to meet the evolving needs of Customers.
Increase Brand Awareness. We intend to increase awareness of the NaviSite
brand in key business markets and associate the NaviSite brand with the highest
quality managed Web site and application hosting services, high performance and
superior customer service. We believe that this awareness and association is
essential to the continued expansion of our customer base. We plan to
aggressively build the NaviSite brand through our industry relationships and
the use of marketing and co-marketing programs.
Enhance Our Expertise and Technological Capabilities. We have acquired, and
intend to continue to enhance, the expertise and technological capabilities
required to conduct and grow our business ahead of customer demand. This means
hiring and training application experts before introducing a new application to
customers. This also means expanding existing data centers, adding data
centers, keeping current with key technological trends and increasing
bandwidth. We intend to enhance our expertise by training existing personnel
and by hiring and retaining new Internet IT professionals. We believe the
combination of our Web site and Internet application hosting and management
expertise and our scalable infrastructure provides us with a competitive
advantage.
Continue to Develop and Leverage Industry Relationships. We believe our
industry relationships with Internet application software vendors and
developers, application and system integrators, hardware suppliers and others
provide us with enhanced market opportunities. Through these relationships, we
purchase, license or lease services or products to expand our application
service offerings and infrastructure. We also intend to expand our channel
sales capability by working with an increasing number of system integrators and
Internet application software developers and providers. By leveraging our
current and future industry relationships, we intend to not only increase our
market visibility and credibility but also offer our clients more fully
integrated Web site and Internet application hosting and management services.
Access Foreign Markets. We continually assess the demand for foreign
operations based on opportunities in specific geographic locations. NaviSite is
developing partnerships with companies that have established strong presence in
local markets, and it is our intention, by partnering with them, to enable
NaviSite, barring unforeseen circumstances, to rapidly and effectively provide
managed application hosting services in those markets. As the needs of our
existing and prospective customers evolve, we intend, barring unforeseen
circumstances, to take advantage of foreign market opportunities as they arise.
Pursue Strategic Acquisitions. As opportunities arise, we intend to continue
to pursue strategic acquisitions that we believe should provide complementary
capabilities, technical personnel, established customer relationships and
geographic presence in domestic and international markets.
Services
We offer a comprehensive suite of services to meet the current and future
hosting and management needs of our customers.
Web Site and Application Management. We provide both enhanced server
management and specialized application management. Both types of management
services permit us to provide customers with a single point of problem
resolution management, from identification to resolution to post-resolution
analysis. To provide
6
<PAGE>
these services, our trained technical personnel utilize advanced network
monitoring and management tools for Web site and application troubleshooting,
together with internal policies and procedures designed to ensure rapid,
effective solutions to technical problems.
Our enhanced server management services includes such services as custom
reporting, hardware options, load balancing, system security, advanced back-up
options, remote management and the services of our business solution managers.
Application Rentals. We offer select Internet application rentals to
customers and application developers who need to access sophisticated Internet
applications or application components which can be customized by developers as
part of a complete software solution. We typically manage all or elements of
the applications we rent. In addition, these applications may require
experienced personnel to deploy and configure them.
Web Site and Internet Application Hosting. Our Web site and Internet
application hosting services provide customers with access to our state-of-the-
art data centers, bandwidth and basic back-up, storage and monitoring services.
Customers are able to access their servers 24 hours a day, seven days a week.
In fiscal 2000, less than 10% of our revenue was derived from basic co-location
customers to which we provide no enhanced or specialized management services.
However, this is an attractive entry point for some customers, from which they
can purchase more enhanced services from NaviSite. Through our Streaming Media
Division we offer managed streaming media services as an means of incorporating
streaming into e-business applications by providing companies with
comprehensive digital media production and distribution services. Our streaming
services include the production, encoding and broadcasting of customers
content, the immediate integration of live event and on-demand streaming media
into customers' Web sites and the enhancement of customers' Web sites with
high-speed multi-media features. Our streaming services complement current
customers' application management and service offerings centered on e-commerce
and enhance our customers' online marketing efforts.
Professional Services. We supply consulting and other professional services
such as, network and system configuration and architecture, scalability and
performance testing, project implementation, bandwidth planning and, in limited
cases, basic software development and system integration.
Sales and Marketing
Our sales and marketing objective is to leverage our Web site and Internet
application hosting and management expertise to become the leading provider of
managed application hosting services. We have developed a sales and marketing
strategy that initially targeted businesses that have adopted the Internet as
an integral part of their business strategy. We are increasingly providing
managed application hosting services to more traditional enterprises as they
incorporate the Internet into their business models.
Our sales efforts focus on direct sales, as well as channel sales through
various industry relationships. We plan to establish a leading position in our
target markets by expanding our sales force, continuing to establish programs
and leverage industry relationships to increase channel sales and expanding our
marketing staff.
7
<PAGE>
Direct Sales. Our direct sales professionals include:
. sales representatives, who conduct sales campaigns, identify targeted
prospects, oversee sales territories and manage customer relationships;
. sales engineers, who discuss prospective customers' Web site and Internet
application hosting and management business needs and technical
requirements; and
. telesales representatives, who qualify customer leads.
Our direct sales teams are currently located in: Andover, Massachusetts; New
York, New York; San Jose, San Diego and Los Angeles, California; Austin, Texas;
and Washington, D.C. We plan to continue to expand our sales force to establish
a geographic presence in other key markets.
Channel Sales. We have developed important industry relationships to enhance
our channel sales and marketing capabilities. We have developed a range of
partnerships, including relationships with many companies that have formally
joined NaviSite's Alliance program. Types of companies include web and
application developers, system integrators, consultants, ISV (Independent
Software Vendors), and technology partners. These partners provide
complementary services, allowing NaviSite customers to benefit from more
comprehensive solutions. Many of these partners also provide a significant
source of lead referrals to NaviSite and are also our customers. As a result,
many of their customers become NaviSite customers. We intend to continue to
leverage our industry relationships to develop customer referrals, mutual
referral relationships, enhanced service offerings, and in some cases, co-
selling and cross-selling and reselling opportunities. We also work together in
selling with such equipment suppliers as Cisco Systems, Dell Corporation,
Compaq Computer Corporation, BMC, Inc. and EMC Corporation.
Marketing. Our marketing group is responsible for corporate and product
marketing, corporate communications, public relations, lead generation and
marketing communications. As with our sales approach, our overall marketing
strategy focuses on supporting both direct sales and channel sales. We continue
to expand NaviSite's position as a leading managed application hosting
provider, including increasing our brand awareness internationally, as well as
within the enterprise, Fortune 500, B2B, and other target segments. Our
marketing activities include establishing a national and local awareness of the
NaviSite brand and our services, positioning ourselves as a leading managed
application hosting provider, developing and enhancing channel sales
relationships and demonstrating to potential customers how our services
differentiate us from our competition. Our marketing programs include:
. comprehensive lead generation through telemarketing, direct marketing,
direct mail programs, electronic and print advertising, electronic and
face-face seminars and targeted shows and events;
. interactive, online marketing programs;
. sponsorships of targeted partner and customer events;
. marketing communications and public relations materials to sustain press
coverage in both trade and business publications;
. market development activities targeted to Web site design firms, Internet
application developers and consultants;
. lead generation, referrals, mutual Web site links or co-marketing through
industry relationships with technology vendors such as Cisco Systems,
Dell Corporation, Compaq Computer Corporation, BMC, Inc. and EMC
Corporation.
We expect to make significant investments in these and other marketing
programs to increase awareness of the NaviSite brand.
8
<PAGE>
Industry Relationships
In our sales and marketing efforts, we are also pursuing industry
relationships targeted by our Alliance Partner Program. Our professional
service offerings also integrate services from the following categories:
Internet Application Software Vendors. We have developed relationships with
some of the leading Internet application software vendors. We target Internet
application software vendors with brand name recognition and established sales
and support channels. These relationships are mutually beneficial, providing us
with additional applications to sell or rent to our customers and the software
vendors with a distribution channel for their applications. We also benefit
from cross-selling and co-marketing opportunities and specialized product
training to enhance our application management expertise.
Web and Application Developers. We have developed relationships with
multiple Web site design firms, Internet application developers, consultants
and other similar companies. These companies generally lack the infrastructure
and expertise needed to offer their customers a complete, cost-effective
solution and, as a result, turn to us to provide hosting and management
services and expertise to enhance their own product and service offerings.
These relationships provide us with greater market reach through referrals,
without the related overhead costs. In return, we offer these companies
discounts on our services, participation in networking events and trade shows,
joint marketing and promotional campaigns and Web site linkage.
Application and System Integrators. We have developed relationships with
several high-end network integration companies and system integrators from whom
we receive assistance with complex development, integration and project
management and for whom we provide application hosting and management
solutions. These relationships enable us to deliver more comprehensive Internet
application solutions to meet the needs of our customers.
Customers
We were organized in 1996 by CMGI to support the networks and host the Web
sites of CMGI companies, and a number of CMGI affiliates. In the Fall of 1997,
we began supplying Web site hosting and management services to companies
unaffiliated with CMGI. As of July 31, 2000, we had approximately 362
customers, up from 126 as of July 31, 1999.
A representative list of our customers as of July 31, 2000 includes:
Anheuser-Busch Companies, Inc., Stop and Shop Supermarket Company, Optika,
Inc., Puma Technology, Inc, Senior.Com, Inc. and Fuel Spot, Inc.
Product Development
Our product development staff focuses on developing a broad range of
"horizontal' managed application services. This group identifies and evaluates
new Internet applications and technologies, develops monitoring and management
services specifically for these applications, and incorporates these
applications into our suite of service offerings. We focus on Internet
applications that permit us to offer our customers repeatable, scalable
services. Our goal is to introduce services capable of utilization by a large
number of customers, seeking to maximize revenue production and minimize the
incremental operating cost for each additional customer utilizing that service.
As new applications are introduced, our personnel integrate the application
into our management and billing systems, provide technical documentation and
training and ensure the security of the offering. This process is critical to
our ability to provide integrated, scalable applications to our customers and
is designed to result in increased operating margins, faster product delivery
and improved customer service.
9
<PAGE>
Our product development group also identifies, selects and implements the
various technologies, including network storage and back-up, that provide the
basic infrastructure for both our internal network and the solutions we offer
our customers.
Customer Service and Support
We believe customer service and support is critical to our future success
and growth. Our customer care staff is focused on direct and indirect customer
service and support. We have developed a customized, life-cycle project
management approach to our operations. For some of our customers, we assign a
single business solutions manager who services the customer from deployment
through the entire customer relationship. This approach is designed to enhance
our responsiveness to customer requests, problem troubleshooting and technology
upgrades.
NaviSite acts as the single point of problem resolution management for all
of our customers. Problems with a customer's web sites can occur in any one of
six layers. NaviSite can diagnose, identify and rapidly fix problems at each of
these levels, from the network to the operating system, from the server
hardware to the database, from the application-server to selected end-user
applications. The result is a single point of problem resolution management for
customers, a key value added service where NaviSite takes responsibility for
fixing problems or managing the process of getting problems fixed.
To do this, we utilize a number of state-of-the-art automated systems,
including a knowledge-based problem resolution and trouble ticketing system, an
enterprise system monitoring platform, sophisticated data storage, an
enterprise tape backup system and a corporate intranet with a built-in document
management and source control system. We believe that our approach to customer
service and support and our ability to rapidly respond to customer needs
provides us with a significant competitive advantage.
Network Infrastructure, Technology, and Operations
NaviSite entered the Internet application service market with the advantage
of a well-developed infrastructure established by CMGI to support CMGI and a
number of its affiliates. We have differentiated our infrastructure from
competing application service providers and co-location hosting providers
through our direct private transit Internet connections to six major Internet
backbone providers. We designed our infrastructure specifically to provide
superior performance for our Web site and Internet application hosting and
management services, including multi-level network redundancy to provide the
highest levels of network uptime, reliable and customized network security and
fast, guaranteed response time and availability of customers' content, which we
deliver through our private transit Internet connections. Our infrastructure is
also designed to scale to support continued growth. We believe that our
sophisticated and highly redundant infrastructure provides us with a
competitive advantage over other hosting vendors and most Internet service
providers. Key elements of our infrastructure include:
Data Centers. Our strategy is to build a select number of high performance
data centers in order to provide our customers with a critical mass of
expertise in Internet applications and management services from each data
center, while capturing the benefits of centralized infrastructure and
staffing. We currently have four data centers; two located in Andover,
Massachusetts, one in San Jose and one in Scotts Valley, California. These
state-of-the-art data centers incorporate technically sophisticated components
which are designed to be fault-tolerant. The components used in our data
centers include Cisco redundant core routers, Cisco redundant core switching
hubs and secure, virtual local area networks. We obtain the equipment and tools
necessary for our data center operations, including our infrastructure
hardware, networking and software products, from industry leaders such as BMC,
Cisco Systems, Compaq Computer Corporation, Dell, EMC, Microsoft Corporation,
Oracle, and Sun Microsystems.
10
<PAGE>
We also have contracted domestically for data center space with Level 3
Communications, Inc. This relationship provides us with the ability to access
additional data center space without building new data centers.
Private Transit Internet Connectivity. Our use of direct private transit
Internet connections to seven major Internet backbone providers differentiates
our network infrastructure from those of our competitors. We have redundant
high-capacity Internet connections to UUNet, Sprint, CERFnet and Cable and
Wireless on the East Coast and UUNet, Genuity, InterNAP and SprintLink on the
West Coast. We have deployed direct private transit Internet connections
specifically to avoid congestion and data loss at public Internet exchange
points and the resulting degradation of performance. Our private transit system
enables us to provide fast, reliable access for our customers' Web sites and
Internet applications. Because we have direct private transit links to Internet
providers, we can directly monitor the capacity of all of our connections and
intend that we will have the aggregate bandwidth to move large quantities of
data at high transmission speeds. We believe that our private transit Internet
connections also enable us to more effectively launch new applications, such as
streaming, which require high bandwidth availability and run more effectively
in a private transit model.
Service Level Agreements. The combination of our state-of-the-art
infrastructure, our customer-focused operations group and our hosting and
management expertise enable us to offer our customers service levels backed by
guarantees that we believe are among the highest and most comprehensive in the
industry. For example, we offer our customers 99.99% guarantees for network
segments, our facility and facility components. These guarantees translate into
no more than five minutes of consecutive, unscheduled downtime per month.
Network Security. Our network incorporates host-based security with
CheckPoint back-end firewalls and Cisco router access control lists, as well as
SecurID token-based authentication. In addition to these physical security
measures, we have a formal security policy in place, including employee
training, that governs all facets of our business and guidelines governing
internal and external access to information housed in our network system.
Network Operations Centers. We monitor the operations of our infrastructure
and customer Web Sites using our own network operations centers. Each network
operations center is fully staffed 24 hours a day, seven days a week with
Windows NT, UNIX, application and support personnel. Our network operations
centers perform first-level problem identification and resolution. The design
of our network operations centers allows network engineers and support
personnel to be promptly alerted to problems, and we have established
procedures for rapidly resolving any technical issues that arise. Network
management and monitoring tools continuously monitor the network and server
performance.
Competition
We compete in the managed application hosting service market. The overall
hosting market is evolving rapidly, is highly competitive and is likely to be
characterized by an increasing number of market entrants and by industry
consolidation. We believe that NaviSite's focus on higher-level managed
application services provides significant differentiation from traditional co-
location hosting providers, and provides significantly higher customer value.
We believe that participants in this market must grow rapidly and achieve a
significant presence to compete effectively. We believe that managed
applications services are difficult to provide well and require an
infrastructure, work processes and management systems tuned to this business
model. We believe that the primary competitive factors determining success in
our market include:
. quality of service delivered;
. Web site and Internet application hosting and management expertise;
. fast and reliable Internet connectivity;
. a state-of-the-art infrastructure providing availability, speed,
scalability and security;
11
<PAGE>
. a reputation for high-quality service and superior customer service and
support;
. numerous and diverse service offerings and timely addition of value-added
services;
. brand recognition;
. competitive pricing; and
. adequate capital to permit continued investment in infrastructure,
customer service and support and sales and marketing.
Our current and prospective competitors include:
. other providers of co-location or high-end Web site hosting and related
services, including AboveNet Communications, Inc., Digex Corporation,
Exodus Communications, Inc., Globix Corporation, Genuity, Inc., Data
Return Corporation, Interliant, Inc. and a large number of local and
regional hosting providers;
. national and regional Internet service providers, including Concentric
Network Corporation, MindSpring Enterprises, Inc., PSINet Inc., UUNet,
WorldCom and Verio Inc.;
. companies that focus on customized Internet application services,
including AppNet Systems, Inc., CORIO, Inc., IBM Global Services,
USinternetworking, Inc., LoudCloud, and USWeb/CKS;
. large system integrators and information technology outsourcing firms,
including Electronic Data Systems Corporation and International Business
Machines Corporation; and
. global telecommunications companies, including AT&T Corp., MCI WorldCom,
Inc. and Sprint Corporation, and regional and local telecommunications
companies, including AT&T Broadband and regional Bell operating
companies, such as Verizon Communications and SBC Communications, Inc.
Many of our competitors may be able to develop and expand their network
infrastructures and service offerings more rapidly, adapt to new or emerging
technologies and changes in customer requirements more quickly, take advantage
of acquisitions and other opportunities more readily, devote greater resources
to the marketing and sale of their services and adopt more aggressive pricing
policies than we can. Because of these competitive factors and due to our
comparatively small size and our lack of financial resources, we may be unable
to successfully compete in the Internet application service market.
In addition, we believe that there will be continued consolidation within
the Internet hosting market in which we compete. Our competitors may
consolidate with one another, or acquire software application vendors or
technology providers, enabling them to more effectively compete with us. This
consolidation could affect prices and other competitive factors in ways which
would impede our ability to compete successfully in the Internet application
service market.
Proprietary Rights
We rely on a combination of trademark, service mark, copyright and trade
secret laws and contractual restrictions to establish and protect our
proprietary rights and promote our reputation and the growth of our business.
We do not own any patents that would prevent or inhibit competitors from using
our technology or entering our market. While it is our practice to require all
of our employees, consultants and independent contractors to enter into
agreements containing non-disclosure, non-competition and non-solicitation
restrictions and covenants, and while our agreements with some of our customers
and suppliers include provisions prohibiting or restricting the disclosure of
proprietary information, we can not assure you that these contractual
arrangements or the 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
12
<PAGE>
proprietary assets. In addition, we provide our services in other countries
where the laws may not afford adequate protection for our proprietary rights.
We license or lease most technologies used in our Internet application
services. Our technology suppliers may become subject to third-party
infringement claims, which could result in their inability or unwillingness to
continue to license their technology to us. The loss of certain of our
technologies could impair our ability to provide services to our customers or
require us to obtain substitute technologies of lower quality or performance
standards or at greater cost. 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 use of our service marks infringes
the trademark rights of third parties. Although we do not believe that any of
these allegations have merit, or that our technologies or services otherwise
infringe the proprietary rights of any 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 be time-consuming, result in costly
litigation, cause delays in service, installation or upgrades, adversely impact
our relationships with suppliers or customers or require us to enter into
royalty or licensing agreements.
Government Regulation
While there currently are few laws or regulations directly applicable to the
Internet or to managed application hosting service providers, due to the
increasing popularity of the Internet and Web-based applications it is likely
that such laws and regulations may be adopted. These laws may cover a variety
of issues including, for example, 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 future growth of our business or expose us to unanticipated liabilities.
Moreover, the applicability of existing laws to the Internet and managed
application hosting 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 in the United Kingdom, and we facilitate the activities
of our customers in those 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
or employees or property there. The application of existing laws and
regulations to the Internet or our business, or the adoption of any new
legislation or regulations applicable to the Internet or our business, could
materially adversely affect our financial condition and operating results.
Employees
As of July 31, 2000, we had 473 employees. Of these employees, 262 were
principally engaged in operations, 110 were principally engaged in sales and
marketing, 31 were principally engaged in product development and 70 were
principally engaged in finance and administration. None of our employees is
party to a collective bargaining agreement and we believe our relationship with
our employees is good. We also employ consultants and independent contractors
on a regular basis to assist in the completion of projects. It is our practice
to require all of our employees, consultants and independent contractors to
enter into agreements containing non-disclosure, non-competition and non-
solicitation restrictions or covenants.
Certain 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.
13
<PAGE>
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 July 31, 2000, we had an accumulated deficit of $92.65
million. We anticipate increased expenses as we continue to expand and improve
our infrastructure, introduce new services, enhance our application management
expertise, expand our sales and marketing efforts, expand internationally and
pursue additional industry relationships. As a result, we expect to incur
operating losses for at least the next 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: continued market demand and acceptance for our
Web site and Internet application hosting and management services; our ability
to develop, market and introduce new services on a timely basis; downward price
adjustments by our competitors; changes in the mix of services provided by our
competitors; technical difficulties or system downtime affecting the Internet
generally or our hosting operations specifically; our ability to meet any
increased technological demands of our customers; the amount and timing of
costs related to our marketing efforts and service introductions; and economic
conditions specific to the Internet application service provider industry. Our
operating results for any particular quarter may fall short of our expectations
or those of investors or securities analysts. In this event, the market price
of our common stock would be likely to fall.
CMGI is a majority stockholder, and CMGI may have interests that conflict
with the interests of our other stockholders. As of July 31, 2000, CMGI
beneficially owned approximately 68.73% 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.
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 50% of our revenue in the fiscal year ended July 31, 2000,
approximately 68% of our revenue in the fiscal year ended July 31, 1999, and
approximately 96% of our revenue in fiscal year ended July 31, 1998. 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.
14
<PAGE>
Our ability to grow our business would be substantially impaired if we were
unable to obtain, on commercially reasonable terms, certain equipment that is
currently provided under leases executed or guaranteed by CMGI. Certain of the
equipment that we use or provide to our customers for their use in connection
with our services is provided under leases executed or guaranteed by CMGI prior
to our October 1999 initial public offering. We do not expect CMGI to continue
this practice, and accordingly, we or our customers will have to obtain this
equipment for new leases and renewal of existing leases directly, on a stand
alone basis. Our ability to grow our business would be substantially impaired
if we were unable to obtain, on commercially reasonable terms, leases for this
equipment. We cannot assure you that it or its customers can do so on similar
financial terms.
If the growth of the market for Internet commerce and communication does not
continue, or it decreases, there may be insufficient demand for our services,
and as a result, our business strategy may not be successful. The increased use
of the Internet for retrieving, sharing and transferring information among
businesses and consumers has developed only recently, and the market for the
purchase of products and services over the Internet is new and emerging. If
acceptance and growth of the Internet as a medium for commerce and
communication does not continue, our business strategy may not be successful
because there may not be a continuing market demand for our Web site and
Internet application hosting and management services. Our growth could be
substantially limited if the market for Internet application services fails to
continue to develop or if we cannot continue to achieve broad market
acceptance. The market for Internet application services has only developed
recently and is evolving rapidly.
Our ability to successfully market our services could be substantially
impaired if we are unable to deploy new Internet applications or if new
Internet applications deployed by us prove to be unreliable, defective or
incompatible. We cannot assure you that we will not experience difficulties
that could delay or prevent the successful development, introduction or
marketing of Internet application services in the future. If any newly
introduced Internet applications suffer from reliability, quality or
compatibility problems, market acceptance of our services could be greatly
hindered and our ability to attract new customers could be adversely affected.
We cannot assure you that new applications deployed by us will be free from any
reliability, quality or compatibility problems. If we incur increased costs or
are unable, for technical or other reasons, to host and manage new Internet
applications or enhancements of existing applications, our ability to
successfully market our services could be substantially impaired.
The market we serve is highly competitive, and as a rapidly growing company,
we may lack the financial and other resources, expertise or capability needed
to capture increased market share. We compete in the Internet application
service market. This market is rapidly evolving, highly competitive and likely
to be characterized by an increasing number of market entrants and by industry
consolidation. We believe that participants in this market must grow rapidly
and achieve a significant presence to compete effectively. As a rapidly growing
company, our business is not as developed as that of many of our competitors.
For example, we estimate that the growth capacity of our facilities may be
sufficient only for the next two fiscal years. Insufficient growth capacity in
our facilities or the lack of availability of non-owned facilities could impair
our ability to achieve rapid growth through an increase in our customer base.
Moreover, many of our competitors have substantially greater financial,
technical and marketing resources, greater name recognition and more
established relationships in the industry than we have. We may lack the
financial and other resources, expertise or capability needed to capture
increased market share in this environment in the future.
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.
15
<PAGE>
Increased costs associated with our private transit Internet connections could
result in the loss of customers or significant increases in operating
costs. Our private transit Internet connections are already more costly than
alternative arrangements commonly utilized to move Internet traffic. If
providers increase the pricing associated with utilizing their bandwidth, we
may be required to identify alternative methods to distribute our customers'
digital content. We cannot assure you that our customers will continue to be
willing to pay the higher costs associated with direct private transit or that
we could effectively move to another network approach. If we are unable to
access alternative networks to distribute our customers' digital content on a
cost-effective basis or to pass any additional costs on to our customers, our
operating costs would increase significantly.
If we are unable to maintain existing and develop additional relationships
with Internet application software vendors, the sale, marketing and provision
of our Internet application services may be unsuccessful. We believe that to
penetrate the market for Web site and Internet application hosting and
management services we must maintain existing and develop additional
relationships with industry-leading Internet application software vendors and
other third parties. We license or lease select software applications from
Internet application software vendors. The loss of our ability to continually
obtain any of these applications could materially impair our ability to provide
services to our customers or require us to obtain substitute software
applications of lower quality or performance standards or at greater cost. In
addition, because we generally license applications on a non-exclusive basis,
our competitors may license and utilize the same software applications. In
fact, many of the companies with which we have strategic relationships
currently have, or could enter into, similar license agreements with our
competitors or prospective competitors. We cannot assure you that software
applications will continue to be available to us from Internet application
software vendors on commercially reasonable terms. If we are unable to identify
and license software applications which meet our targeted criteria for new
application introductions, we may have to discontinue or delay introduction of
services relating to these applications.
We purchase from a limited number of suppliers key components of our
infrastructure, including networking equipment, that are available only from
limited sources in the quantities and with the quality that we demand. For
example, we purchase most of the routers and switches used in our
infrastructure from Cisco Systems Inc. We cannot assure you that we will have
the necessary hardware or parts on hand or that our suppliers will be able to
provide them in a timely manner in the event of equipment failure. Our
inability or failure to obtain the necessary hardware or parts on a timely
basis could result in sustained equipment failure and a loss of revenue due to
customer loss or claims for service credits under our service level guarantees.
Our inability to scale our infrastructure or otherwise manage our
anticipated growth and the related expansion of our operations could result in
decreased revenue and continued operating losses. We have experienced rapid
growth in our service offerings and our customer base. We were a Web site
hosting provider with approximately 126 customers as of July 31, 1999. As of
July 31, 2000, we were providing Web site and Internet application hosting and
management services to 362 customers. In order to service our growing customer
base, we will need to continue to improve and expand our network
infrastructure. Our ability to continue to meet the needs of a substantial and
growing number of customers while maintaining superior performance is largely
unproven. If our network infrastructure is not scalable, we may not be able to
provide our services to additional customers, which would result in decreased
revenue.
In addition, between July 31, 1999 and July 31, 2000, we increased the
number of our employees from 201 to 473. This growth has placed, and likely
will continue to place, a significant strain on our financial, management,
operational and other resources. To effectively manage our anticipated growth,
we will be required to continue to enhance our operating and financial
procedures and controls, to upgrade or replace our operational, financial and
management information systems and to attract, train, motivate, manage and
retain key employees. If we are unable to effectively manage our rapid growth,
we could experience continued operating losses.
16
<PAGE>
Our customer base includes a significant number of dot.com businesses that
face increased risk of loss of funding depending upon the availability of the
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 Website operations hosted by us. If this
occurs, we could experience a loss of revenue associated with these customers
and will then have to increase sales to other businesses using the Internet in
order to preserve and grow our revenue.
You may experience dilution because our historical source of funding is
expected to change, and other funding may not be available to us on favorable
terms, if at all. Until the completion of our initial public offering, CMGI
funded our operations as needed, increasing our obligations to CMGI and
allowing us to maintain a zero-balance cash account. Upon completion of our
initial public offering, our net obligations to CMGI, together with all
convertible preferred stock held by CMGI, were converted into common stock.
Subsequent to July 31, 2000, CMGI committed to advance NaviSite, if needed by
July 31, 2001, the sum of $50.0 million, subject to negotiation of a mutually
acceptable vehicle and related terms and conditions and approval of both
companies' respective board of directors. We may need to raise additional funds
from time to time and in fact in June 2000 we completed a $30 million sale-
leaseback transaction with a bank and a $50 million private placement sale of
common stock to CMGI in this regard. We cannot assure you that additional
financing will be available on terms favorable to us, if at all. If adequate
funds were not available or were not available on acceptable terms, our ability
to respond to competitive pressures would be significantly limited. Moreover,
if additional funds are raised through the issuance of equity or convertible
debt securities, your percentage ownership in us will be reduced, and you may
experience additional dilution.
Our network infrastructure could fail, which would impair our ability to
provide guaranteed levels of service and could result in significant operating
losses. To provide our customers with guaranteed levels of service, we must
operate our network infrastructure 24 hours a day, seven days a week without
interruption. In order to operate in this manner, we must protect our network
infrastructure, equipment and customer files against damage from human error,
natural disasters, unexpected equipment failure, power loss or
telecommunications failures, sabotage or other intentional acts of vandalism.
Even if we take precautions, the occurrence of a natural disaster, equipment
failure or other unanticipated problem at one or more of our data centers could
result in interruptions in the services we provide to our customers. We cannot
assure you that our disaster recovery plan will address all, or even most, of
the problems we may encounter in the event of such a disaster.
We have experienced service interruptions in the past, and any future
service interruptions could: require us to spend substantial amounts of money
to replace equipment or facilities; entitle customers to claim service credits
under our service level guarantees; cause customers to seek damages for losses
incurred; or make it more difficult for us to attract new customers or enter
into additional strategic relationships. Any of these occurrences could result
in significant operating losses.
The misappropriation of our proprietary rights could result in the loss of
our competitive advantage in the market. We rely on a combination of trademark,
service mark, copyright and trade secret laws and contractual restrictions to
establish and protect our proprietary rights. We do not own any patents that
would prevent or inhibit competitors from using our technology or entering our
market. We cannot assure you that the contractual arrangements or other steps
taken by us to protect our proprietary rights will prove sufficient to prevent
misappropriation of our proprietary rights or to deter independent, third-party
development of similar proprietary assets. In addition, we provide our services
in other countries where the laws may not afford adequate protection for our
proprietary rights.
Third-party infringement claims against our technology suppliers, customers
or us could result in disruptions in service, the loss of customers or costly
and time consuming litigation. We license or lease most technologies used in
the Internet application services that we offer. Our technology suppliers may
become subject to third-party infringement claims which could result in their
inability or unwillingness to continue to license their technology to us. We
expect that we and our customers increasingly will be subject to third-party
infringement claims as the number of Web sites and third-party service
providers for Web-based businesses grows. In addition, we have received notices
alleging that our service marks infringe the trademark rights of third parties.
We cannot assure you that third parties will not assert claims against us in
the future or that these
17
<PAGE>
claims will not be successful. Any infringement claim as to our technologies or
services, regardless of its merit, could result in delays in service,
installation or upgrades, the loss of customers or costly and time-consuming
litigation, or require us to enter into royalty or licensing agreements.
The loss of key officers and personnel could impair our ability to
successfully execute our business strategy, because we substantially rely on
their experience and management skills, or could jeopardize our ability to
continue to provide service to our customers. We believe that the continued
service of key personnel, including Joel B. Rosen, our Chief Executive Officer,
is a key component of the future success of our business. None of our key
officers or personnel is currently a party to an employment agreement with us.
This means that any officer or employee can terminate his or her relationship
with us at any time. In addition, we do not carry life insurance for any of our
key personnel to insure our business in the event of their death. In addition,
the loss of key members of our sales and marketing teams or key technical
service personnel could jeopardize our positive relations with our customers.
Any loss of key technical personnel would jeopardize the stability of our
infrastructure and our ability to provide the guaranteed service levels our
customers expect.
If we fail to attract and retain additional skilled personnel, our ability
to provide Web site and Internet application management and technical support
may be limited, and as a result, we may be unable to attract customers and our
business. Our business requires individuals with significant levels of Internet
application expertise, in particular to win consumer confidence in outsourcing
the hosting and management of mission-critical applications. Competition for
such personnel is intense, and qualified technical personnel are likely to
remain a limited resource for the foreseeable future. Locating candidates with
the appropriate qualifications, particularly in the desired geographic
location, can be costly and difficult. We may not be able to hire the necessary
personnel to implement our business strategy, or may need to provide higher
compensation to such personnel than we currently anticipate.
Any future acquisitions we make of companies or technologies may result in
disruptions to our business or distractions of our management due to
difficulties in assimilating acquired personnel and operations. Our business
strategy contemplates future acquisitions of complementary businesses or
technologies. If we do pursue additional acquisitions, our risks may increase
because our ongoing business may be disrupted and management's attention and
resources may be diverted from other business concerns. In addition, through
acquisitions, we may enter into markets or market segments in which we have
limited prior experience.
Once we complete an acquisition, we will face additional risks. These risks
include: difficulty assimilating acquired operations, technologies and
personnel; inability to retain management and other key personnel of the
acquired business; and changes in management or other key personnel that may
harm relationships with the acquired business's customers and employees. We
cannot assure you that any acquisitions will be successfully identified and
completed or that, if one or more acquisitions are completed, the acquired
business, assets or technologies will generate sufficient revenue to offset the
associated costs or other adverse effects.
The market for our services in international territories is unproven, and as
a result, the revenue generated by any future international operations may not
be adequate to offset the expense of establishing and maintaining those
operations. One component of our strategy is to expand into international
markets. We cannot assure you that we will be able to market, sell and provide
our services successfully outside the United States. We could suffer
significant operating losses if the revenue generated by any current or future
international data center or other operations adequate to offset the expense of
establishing and maintaining those international operations. Our present
international strategy is based upon the creation of alliances with foreign
telecommunications companies that own or operate data centers into which we
intend to place our infrastructure and to service our current customers as well
as the customers of those telecommunications companies desiring our services.
In the event that are unable to negotiate favorable agreements with or
successfully market our services together with such telecommunications
companies, our international strategy will be significantly impaired, curtailed
or eliminated.
We face risks inherent in doing business in international markets that could
adversely affect the success of our international operations. There are risks
inherent in doing business in international markets, including
18
<PAGE>
different regulatory requirements, trade barriers, challenges in staffing and
managing foreign operations, currency risk, different technology standards,
different tax structures which may adversely impact earnings, different
privacy, censorship and service provider liability standards and regulations
and foreign political and economic instability, any of which could adversely
affect the success of our international operations.
The emergence and growth of a market for our Internet application services
will be impaired if third parties do not continue to develop and improve the
Internet infrastructure. The recent growth in the use of the Internet has
caused frequent periods of performance degradation, requiring the upgrade of
routers and switches, telecommunications links and other components forming the
infrastructure of the Internet by Internet service providers and other
organizations with links to the Internet. Any perceived degradation in the
performance of the Internet as a means to transact business and communicate
could undermine the benefits and market acceptance of our Web site and Internet
application hosting and management services. Our services are ultimately
limited by, and dependent upon, the speed and reliability of hardware,
communications services and networks operated by third parties. Consequently,
the emergence and growth of the market for our Internet application services
will be impaired if improvements are not made to the entire Internet
infrastructure to alleviate overloading and congestion.
We could be subject to increased operating costs, as well as claims,
litigation or other potential liability, in connection with risks associated
with Internet security and the security of our systems. A significant barrier
to the growth of e-commerce and communications over the Internet has been the
need for secure transmission of confidential information. Several of our
Internet application services utilize encryption and authentication technology
licensed from third parties to provide the protections necessary to ensure
secure transmission of confidential information. We also rely on security
systems designed by third parties and the personnel in our network operations
centers to secure those data centers. Any unauthorized access, computer
viruses, accidental or intentional actions and other disruptions could result
in increased operating costs. For example, we may incur significant costs to
protect against these interruptions and the threat of security breaches or to
alleviate problems caused by such interruptions or breaches, and we expect to
expend significant financial resources in the future to equip our new and
existing data centers with state-of-the-art security measures. If a third party
were able to misappropriate a consumer's personal or proprietary information,
including credit card information, during the use of an application solution
provided by us, we could be subject to claims, litigation or other potential
liability.
We may become subject to burdensome government regulation and legal
uncertainties that could substantially impair the growth of our business or
expose us to unanticipated liabilities. It is likely that laws and regulations
directly applicable to the Internet or to Internet application service
providers may be adopted. These laws may cover a variety of issues, including
user privacy and the pricing, characteristics and quality of products and
services. The adoption or modification of laws or regulations relating to
commerce over the Internet could substantially impair the growth of our
business or expose us to unanticipated liabilities. Moreover, the applicability
of existing laws to the Internet and Internet application service providers is
uncertain. These existing laws could expose us to substantial liability if they
are found to be applicable to our business. For example, we provide services
over the Internet in many states in the United States and in the United Kingdom
and facilitate the activities of our customers in these jurisdictions. As a
result, we may be required to qualify to do business, be subject to taxation or
be subject to other laws and regulations in these jurisdictions, even if we do
not have a physical presence, employees or property there.
We may be subject to legal claims in connection with the information
disseminated through our network which could have the effect of diverting
management's attention and require us to expend significant financial
resources. We may face potential direct and indirect liability for claims of
defamation, negligence, copyright, patent or trademark infringement, violation
of securities laws and other claims based on the nature and content of the
materials disseminated through our network. For example, lawsuits may be
brought against us claiming that content distributed by some of our current or
future customers may be regulated or banned. In these and other instances, we
may be required to engage in protracted and expensive
19
<PAGE>
litigation which could have the effect of diverting management's attention and
require us to expend significant financial resources. Our general liability
insurance may not necessarily cover any of these claims or may not be adequate
to protect us against all liability that may be imposed.
In addition, on a limited number of occasions in the past, businesses,
organizations and individuals have sent unsolicited commercial e-mails from
servers hosted at our facilities to massive numbers of people, typically to
advertise products or services. This practice, known as "spamming," can lead to
complaints against service providers that enable such activities, particularly
where recipients view the materials received as offensive. We have in the past
received, and may in the future receive, letters from recipients of information
transmitted by our customers objecting to such transmission. Although we
prohibit our customers by contract from spamming, we cannot assure you that our
customers will not engage in this practice, which could subject us to claims
for damages.
The market price of our common stock may experience extreme price and volume
fluctuations. The market price of our common stock may fluctuate substantially
due to a variety of factors, including: any actual or anticipated fluctuations
in our financial condition and operating results; public announcements
concerning us or our competitors, or the Internet industry; the introduction or
market acceptance of new service offerings by us or our competitors; changes in
industry research analysts' earnings estimates; changes in accounting
principles; sales of our common stock by existing stockholders; and the loss of
any of our key personnel.
In addition, the stock market has experienced extreme price and volume
fluctuations. The market prices of the securities of technology and Internet-
related companies have been especially volatile. This volatility often has been
unrelated to the operating performance of particular companies. In the past,
securities class action litigation often has been brought against companies
that experience volatility in the market price of their securities. Whether or
not meritorious, litigation brought against us could result in substantial
costs and a diversion of management's attention and resources.
Item 2. Properties
Facilities
Our executive offices are located at 400 Minuteman Road, Andover,
Massachusetts, in a newly constructed 150,000 square foot facility leased
pursuant to an agreement which expires in 2011. The 400 Minuteman facility is
also partly utilized as a data center (52,000 square feet of raised floor).
Data centers
We currently have four domestic data center locations, with a total of
approximately 88,000 square feet of raised data center floor. In addition to
the 400 Minuteman Road data center, we also occupy approximately 22,000 square
feet at 300 Federal Street, Andover, Massachusetts (10,000 square feet of
raised floor), pursuant to an agreement that expires in 2007. This facility is
utilized as a data center. We also occupy approximately 14,100 square feet at
1700 Greens Hill Road, Scotts Valley, California (4,000 square feet of raised
floor), part of which is utilized as a data center, pursuant to an agreement
that expires in 2002. Our fourth location is a newly constructed 66,000 square
foot facility located in the Valley Technology Centre, 2720 Zanker Road, San
Jose, California (22,000 square feet of raised floor), part of which is
utilized as a data center, leased pursuant to an agreement which expires in
2006. In addition to our existing data centers, we presently utilize
approximately 10,000 square feet of space in Sunnyvale, CA and approximately
5,000 square feet of space in New York, New York through our relationship with
Level 3.
We believe that our existing facilities will be adequate for at least the
next fiscal year and that we will be able to obtain additional space as needed
on commercially reasonable terms.
20
<PAGE>
Sales and Marketing Space:
In connection with our sales and marketing efforts, we occupy offices at 100
Congress Avenue, Suite 1800, Austin, Texas; 11601 Wilshire Boulevard, Suite
500, Los Angeles, California; 622 Third Avenue 10th Floor, New York, New York;
2720 Zanker Road, San Jose, California; 8300 Boone Boulevard, Suite 540,
Vienna, Virginia; 1700 Green Hills Road, Scotts Valley, California; 5330
Carroll Canyon Road, Suite 203, San Diego, California; and 400 Minuteman Road,
Andover, Massachusetts.
Streaming Media Division
Our Streaming Media Division currently occupies approximately 16,800 square
feet at 4225 Executive Square, LaJolla, California, pursuant to an agreement
that expires November 2006. This location is used as both the production
facility and as the administrative offices of the Streaming Media Division.
Item 3. Legal Proceedings
We are subject to legal proceedings and claims which arise in the ordinary
course of our 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 our company.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the fourth
quarter of fiscal year ended July 31, 2000.
NaviSite Executive Officers
Joel B. Rosen, age 42, has served as NaviSite's Chief Executive Officer and
President and as one of NaviSite's directors since April 1999. From January
1996 to August 1998, Mr. Rosen served as Executive Vice President of Aspen
Technology, Inc., an enterprise software and services provider, where he was
responsible for managing two of Aspen Technology's three business units. From
August 1988 to January 1996, Mr. Rosen held several management positions within
Aspen Technology, including Director of Marketing, Vice President of Marketing
and Senior Vice President of Marketing and New Businesses. From 1984 to 1988,
Mr. Rosen was a Consultant and Manager at Bain & Company.
Kenneth W. Hale, age 47, has served as NaviSite's Chief Financial Officer
since March 1997 and as NaviSite's Treasurer since March 1998. From March 1998
to August 2000, Mr. Hale served as NaviSite's Secretary. From May 1989 to
September 1996, Mr. Hale served as Chief Financial Officer and Treasurer of
Media/Communications Partners, a telecommunications and media venture capital
firm, where he was responsible for overseeing the financial management of
multiple venture capital funds and related entities. From June 1980 to April
1989, Mr. Hale was a Senior Manager, Audit and Tax, at Ernst & Whinney, which
merged with Arthur Young & Co. to form Ernst & Young LLP. Mr. Hale is a
Certified Public Accountant.
Patricia Gilligan, age 49, has served NaviSite's Chief Operating Officer
since June 2000. From January 1999 to June 2000, Ms. Gilligan served as Vice
President of Worldwide Services of Incentive Systems, an incentive compensation
application developer. From April 1997 to January 1999, Ms. Gilligan served as
Vice President of East Coast Operations of Razorfish, Inc., a digital solutions
provider. From January 1992 to April 1997, Ms. Gilligan served as Chief
Information Officer of Cahners Publishing Company, a business information
company.
Peter C. Kirwan, Jr., age 36, has served as NaviSite's Chief Technology
Officer since October 1998. From June 1998 to October 1998, Mr. Kirwan served
as Vice President of Applications of NaviSite. From March 1997 to June 1998,
Mr. Kirwan was President of Servercast Communications, LLC, application
21
<PAGE>
management and hosting company founded by Mr. Kirwan which was acquired by
NaviSite in July 1998. From January 1994 to January 1997, Mr. Kirwan served as
Chief Executive Officer of Media Access Systems, Inc., a high-speed Internet
service provider and web hosting provider which he founded.
Neil Gardner, age 40, has served as NaviSite's Vice President of Technical
Operations since May 2000. From June 1996 to May 2000, Mr. Gardner served as
Vice President of Operations of Fidelity Investments, a financial services
company. From April 1991 to June 1996, Mr. Gardner served as Director of
Technical Services of NEC Corporation, an electronics, information and
communications systems provider.
Jeff Loeb, age 41, has served as NaviSite's Vice President of Professional
Services since February 2000 From February 1999 to February 2000, Mr. Loeb
served as Senior Practice Director, e-Business Consulting of Oracle
Corporation, a database software company. From July 1996 to February 1999, Mr.
Loeb served as Director of Business Consulting of Dataworks. From June 1993 to
July 1996, Mr. Loeb served as Manager, Systems Implementation of Instron, Inc.
Jonathan Rodin, age 43, has served as NaviSite's Vice President of Product
Development since February 1999. From October 1997 to July 1998, Mr. Rodin
served as Vice President of Engineering at ADSmart Corporation, a developer and
marketer of online ad sales and ad-serving solutions and a subsidiary of CMGI,
Inc. From July 1991 to September 1997, Mr. Rodin served in various positions,
including as the Vice President of Engineering, at FTP Software, Inc., an
independent vendor of software and related applications for the personal
computer market.
Jay S. Seaton, age 46, has served as NaviSite's Vice President of Marketing
since December 1997. From October 1996 to December 1997, Mr. Seaton served as
Vice President of Sales and Marketing at Radnet, Inc., a provider of
application tools. From June 1991 to October 1996, Mr. Seaton served as
Director of Marketing at Banyan Systems Inc., a provider of distributed
networking software.
J. Andrew Sherman, age 45, has served as NaviSite's Vice President of Sales
since August 1997. From March 1996 to August 1997, Mr. Sherman served as Vice
President of U.S. Sales for Fulcrum Technologies, Inc., a software firm focused
on providing knowledge management capabilities to large enterprises on intranet
platforms. From September 1994 to March 1996, Mr. Sherman served as Regional
Manager at Sybase, Inc., a database and application development tools company.
Prior to 1994, Mr. Sherman also held senior positions at Apple Computer, Inc.
and MCI WorldCom, Inc.
22
<PAGE>
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
Price Range of Common Stock
Our common stock commenced trading on the Nasdaq National Market on October
22, 1999 and is traded under the symbol "NAVI." As of July 31, 2000, there were
57 holders of record of our common stock. Because many of such shares are held
by brokers and other institutions on behalf of stockholders, we are unable to
estimate the total number of stockholders represented by these record holders.
The following table sets forth for the periods indicated the high and low sales
prices for our common stock as reported on the Nasdaq National Market, adjusted
to reflect the effect of the April 5, 2000 two-for-one stock split.
<TABLE>
<CAPTION>
Fiscal 2000
--------------
High Low
------- ------
<S> <C> <C>
October 22, 1999 through October 31, 1999.................... $ 25.50 $14.06
November 1, 1999 through January 31, 2000.................... 63.25 21.50
February 1, 2000 through April 30, 2000...................... 164.94 26.50
May 1, 2000 through July 31, 2000............................ 58.88 34.00
</TABLE>
We believe that a number of factors may cause the market price of our common
stock to fluctuate significantly. See "Item 1. Business--Certain Factors That
May Affect Future Results."
We have never paid cash dividends on our capital stock. We currently
anticipate retaining all available funds, if any, to finance internal growth
and product development. Payment of dividends in the future will depend upon
our earnings and financial condition and such other factors as the directors
may consider or deem appropriate at the time.
Recent Sales of Unregistered Securities
On June 8, 2000, we sold 980,873 shares of our common stock to CMGI for an
aggregate offering price of $50,000,000. These shares were issued on June 13,
2000, representing the number of shares of common stock equal to $50,000,000
divided by the average of the closing prices per share of common stock as
reported on the Nasdaq National Market on June 6, 7, 8, 9 and 12, 2000, rounded
up to the nearest whole share. The common stock was 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.
Use of Proceeds from Sales of Registered Securities
On October 27, 1999, we sold 5,500,000 shares of our common stock in an
initial public offering (plus an additional 825,000 shares upon the exercise of
an overallotment option granted to the underwriters) pursuant to a Registration
Statement on Form S-1 (File No. 333-83501) that was declared effective by the
Securities and Exchange Commission on October 21, 1999. During the period from
the offering to July 31, 2000, we have used the proceeds as follows:
<TABLE>
<S> <C>
Construction of new data centers and fixed asset acquisitions ..... $49,615,000
Working capital requirements ...................................... 29,785,000
Repayment of notes payable......................................... 1,000,000
-----------
Total............................................................. $80,400,000
===========
</TABLE>
23
<PAGE>
Item 6. Selected Consolidated Financial Data
The following selected consolidated financial data should be read in
conjunction with our consolidated financial statements and related notes and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" included elsewhere in this Form 10-K. The consolidated statement of
operations data for the fiscal years 1998-2000 are derived from the
consolidated financial statements that have been audited by KPMG LLP,
independent auditors, and are included elsewhere in this Form 10-K. The
consolidated statement of operations data for the 1997 fiscal year and the
period from July 1, 1996 (inception) through July 31, 1996 are derived from our
audited consolidated financial statements that are not included herein.
Historical results are not necessarily indicative of results of any future
period.
<TABLE>
<CAPTION>
Period from
July 1, 1996
(inception)
through
2000 1999 1998 1997 July 31, 1996
-------- -------- ------- ------ -------------
<S> <C> <C> <C> <C> <C>
Revenue:
Revenue.................. $ 24,870 $ 3,461 $ 158 $ -- $ --
Revenue, related
parties................. 24,893 7,058 3,871 3,361 --
-------- -------- ------- ------ -----
Total revenue.......... 49,763 10,519 4,029 3,361 --
Cost of revenue............ 68,496 20,338 8,876 3,494 6
-------- -------- ------- ------ -----
Gross margin........... (18,733) (9,819) (4,847) (133) (6)
Operating expenses:
Selling and marketing.... 22,805 6,888 2,530 347 --
General and
administrative.......... 12,270 4,823 1,412 467 21
Product development...... 5,197 2,620 287 -- --
-------- -------- ------- ------ -----
Total operating
expenses:............. 40,272 14,331 4,229 814 21
Loss from operation........ (59,005) (24,150) (9,076) (947) (27)
Other income (expense):
Interest income.......... 2,027 4 -- -- --
Interest expense......... (1,001) (347) (85) (1) --
Other income/(expense),
net..................... 9 (39) (11) -- --
-------- -------- ------- ------ -----
Net loss................... (57,970) (24,532) (9,172) (948) (27)
Accretion of dividends on
Series C and D convertible
redeemable preferred
stock..................... -- (172) -- -- --
-------- -------- ------- ------ -----
Net loss applicable to
common stockholders....... (57,970) (24,704) (9,172) (948) (27)
======== ======== ======= ====== =====
Basic and diluted net loss
per common share.......... (1.37) (3.71) (.57) (.12) --
======== ======== ======= ====== =====
Basic and diluted weighted
average number of common
shares outstanding........ 42,270 6,663 16,034 8,000 --
======== ======== ======= ====== =====
Unaudited pro forma basic
and diluted net loss per
share..................... (1.08) (.75) -- -- --
======== ======== ======= ====== =====
Pro forma weighted average
number of basic and
diluted shares
outstanding............... 53,829 32,814 -- -- --
======== ======== ======= ====== =====
</TABLE>
24
<PAGE>
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
In March 2000, our board of directors approved a two-for-one common stock
split, effected in the form of a stock dividend of one share of common stock
for each share of common stock outstanding. The stock dividend was paid on
April 5, 2000 to stockholders of record at the close of business on March 22,
2000. Accordingly, the consolidated financial statements have been
retroactively adjusted for all periods presented to reflect this event. Unless
otherwise indicated, all share information in this Management's Discussion and
Analysis of Financial Condition and Results of Operations reflects the two-for-
one stock split.
Overview
We provide enhanced, integrated hosting and management services for business
Web sites and Internet applications. We also provide application rentals to
customers and developers and supply related consulting services. Our Internet
application service offerings allow businesses to outsource the deployment,
configuration, hosting, management and support of their Web sites and Internet
applications in a cost-effective and rapid manner. Our focus on enhanced
management services, beyond basic co-location services, allows us to meet the
expanding needs of businesses as their Web sites and Internet applications
become more complex. The cost for our services varies from customer to customer
based on the number of hosted or managed servers and the nature and level of
services provided.
We were incorporated in Delaware in December 1998 as a wholly owned
subsidiary of NaviSite Internet Services Corporation as part of a corporate
reorganization of NaviSite Internet Services Corporation. At that time, we
received a contribution of assets from NaviSite Internet Services Corporation
in exchange for 60,589 shares of our common stock and 1,323,953 shares of our
Series A convertible preferred stock. At the same time, NaviSite Internet
Services Corporation contributed the remainder of its assets to NaviNet, Inc.,
another newly formed subsidiary of NaviSite Internet Services Corporation.
Effective as of October 1, 1999, NaviSite Internet Services Corporation was
merged with and into CMGI, leaving NaviSite and NaviNet, Inc. as direct
subsidiaries of CMGI.
Our predecessor, NaviSite Internet Services Corporation, was incorporated in
Delaware in February 1997 under the name CMG Information Technology, Inc. and
changed its name to NaviSite Internet Services Corporation in May 1997. We
commenced operations in July 1996, funded by CMGI, to support the networks and
host the Web sites of CMGI and a number of CMGI affiliates. CMGI affiliates
include all entities in which CMGI holds an equity interest. We began providing
Web site hosting and Internet application management services to companies
unaffiliated with CMGI in the Fall of 1997.
All financial information presented here refers only to NaviSite, including
the hosting and Internet application management segments of NaviSite Internet
Services Corporation, and does not include the financial condition or results
of operations of NaviNet, Inc., including the dial-up operations of NaviSite
Internet Services Corporation.
In July 1998, we 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 bridge notes receivable of
$25,000 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. for consideration valued at approximately $4,693,000, including
approximately $50,000 of direct costs of the acquisition. We acquired ClickHear
principally for its expertise in streaming media management and development.
We intend to expand domestically and internationally. During fiscal year
2000, we opened two new data center facilities, one at Zanker Road, San Jose,
California and one at 400 Minuteman Road, Andover, Massachusetts. In addition
to our new domestic data centers, during fiscal year 2000, we entered into an
agreement with Level 3 to provide domestic data center space, as needed.
25
<PAGE>
As of January 31, 2000, our corporate headquarters are 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.
We derive our revenue from a variety of services, including: Web site and
Internet application hosting, which includes access to our state-of-the-art
data centers, bandwidth and basic back-up, storage and monitoring services;
enhanced server management, which includes custom reporting, hardware options,
load balancing, system security, advanced back-up options, and the services of
our business solution managers; specialized application management, which
includes management of e-commerce and other sophisticated applications support
services, including ad-serving, streaming, databases and transaction processing
services; and application rentals and related consulting and other professional
services. Revenue also includes income from the rental of equipment to
customers and one-time installation fees. Revenue is recognized in the period
in which the services are performed and installation fees are recognized in the
period of installation. Our contracts generally are a one to three year
commitment.
Our revenue from sales to related parties principally consists of sales of
services to CMGI and other customers that are CMGI affiliates. In general, in
pricing the services provided to CMGI and its affiliates, we have: negotiated
the services and levels of service to be provided; calculated the price of the
services at those service levels based on our then-current, standard prices;
and, in exchange for customer referrals provided to us by CMGI, discounted
these prices by 10%. In fiscal 2000, we sold services to CMGI and CMGI
affiliates totaling approximately $24.9 million, or 50% of revenue. Three of
these customers accounted for approximately 12.05%, 9.96% and 9.35% of revenue,
respectively. As of July 31, 2000, CMGI owned approximately 68.73% of our
outstanding common stock, the balance of the common stock owned by the public.
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 four data centers, such as
rent and utilities. We expect these costs to increase in dollar terms, but
decline on a percentage of revenue basis, with the growth of our overall
business. We also expect to achieve economies of scale as a result of spreading
more volume over fixed assets, increasing productivity and using new
technological tools.
Selling and marketing expenses consist primarily of salaries and related
benefits, commissions and marketing expenses such as advertising, product
literature, trade shows, marketing and direct mail programs. We expect selling
and marketing expenses to increase in dollar terms, but decline on a percentage
of revenue basis, as we continue to invest in these areas to promote brand
recognition and to acquire new customers. We intend to accomplish this by
hiring additional sales and marketing personnel, opening additional sales
offices and increasing spending on public relations, advertising and marketing
programs.
General and administrative expenses include the costs of financial, leasing,
human resources, IT and administrative personnel, professional services and
corporate overhead. Also included are intercompany charges from CMGI for
facilities (prior to our move to our new headquarters in January 2000), human
resource support and business development. We expect the dollar value of these
expenses to increase in future periods, but decline on a percentage of revenue
basis, as we hire additional personnel and incur additional costs related to
the growth of our business and our operations as a public company.
Product development expenses consist mainly of salaries and related costs.
Our product development staff focuses on Internet applications and network
architecture. This group identifies new Internet application software
offerings, incorporates these new offerings into our suite of service offerings
and positions these new offerings for marketing, sale and deployment. Our
product development group also identifies, selects and implements the various
technologies, including network storage and back-up, that provide the basic
26
<PAGE>
infrastructure for both our internal network and the solutions we offer our
customers. As with sales and marketing, we believe that increased investment in
product development is critical to attaining our strategic objectives and
maintaining our competitive edge. We expect the dollar value of product
development expenses to increase significantly in future periods, but decline
on a percentage of revenue basis.
We have incurred significant net losses and negative cash flows from
operations since our inception and, as of July 31, 2000, had an accumulated
deficit of approximately $92.6 million. These losses primarily have been funded
by CMGI through the issuance of common stock, preferred stock and convertible
debt, our initial public offering and related underwriters' over-allotment in
October 1999 and November 1999, respectively, and the sale-leaseback of certain
assets. We intend to continue to invest heavily in sales, marketing, promotion,
technology and infrastructure development as we grow. As a result, we believe
that we will continue to incur operating losses and negative cash flows from
operations for at least the next fiscal year and that the rate at which such
losses will be incurred may increase.
Results of Operations
The following table sets forth the consolidated statement of operations data
for the periods indicated as a percentage of revenues:
<TABLE>
<CAPTION>
Year ended July 31,
------------------------
2000 1999 1998
------ ------ ------
<S> <C> <C> <C>
Revenue:
Revenue............................................ 50.0% 32.9% 3.9%
Revenue, related parties........................... 50.0 67.1 96.1
------ ------ ------
Total revenue.................................... 100.0 100.0 100.0
Cost of revenue...................................... 137.6 193.3 220.3
------ ------ ------
Gross margin (37.6) (93.3) (120.3)
------ ------ ------
Operating expenses:
Selling and marketing.............................. 45.8 65.5 62.8
General and administrative......................... 24.7 45.9 35.0
Product development................................ 10.4 24.9 7.1
------ ------ ------
Total operating expenses......................... 80.9 136.3 104.9
------ ------ ------
Loss from operations................................. (118.6) (229.6) (225.2)
Other income (expense):
Interest income.................................... 4.1 0.1 --
Interest expense................................... (2.0) (3.3) (2.1)
Other income/(expense), net........................ -- (0.4) (0.3)
------ ------ ------
Total other income (expense)..................... 2.1 (3.6) (2.4)
------ ------ ------
Net loss............................................. (116.5)% (233.2)% (227.6)%
====== ====== ======
</TABLE>
Comparison of Fiscal Years Ended July 31, 2000 and 1999
Revenue
Total revenue increased 373% to approximately $49.8 million in fiscal 2000,
from approximately $10.5 million in fiscal 1999. The increase in revenue is due
primarily to both the increase in the number of unaffiliated customers and
additional business with existing unaffiliated customers, CMGI and CMGI
affiliates. Revenue from unaffiliated customers increased to approximately
$24.9 million or 50% of total revenue in fiscal year 2000 as compared to
approximately $3.5 million or 33% of total revenue in fiscal year 1999.
27
<PAGE>
Cost of Revenue
Cost of revenue in dollars increased 237% to approximately $68.5 million in
fiscal 2000, from approximately $20.3 million in fiscal 1999. As a percentage
of revenue, cost of revenue decreased to 138% in fiscal 2000, from 193% in
fiscal 1999. The dollar-value increase in each period is due primarily to the
costs associated with increased investment in our data centers. These costs
principally include labor and headcount expenses, additional equipment and
maintenance costs and increased bandwidth.
Operating Expenses
Selling and Marketing. Selling and marketing expenses increased 231% to
approximately $22.8 million in fiscal 2000, from approximately $6.9 million in
fiscal 1999. As a percentage of revenue, selling and marketing expenses
decreased to 46% in fiscal 2000, from 65% in fiscal 1999. The dollar-value
increase is due primarily to increased headcount, salaries and commissions and
expenses for marketing programs, advertising and product literature.
General and Administrative. General and administrative expenses increased
154% to approximately $12.3 million in fiscal 2000, from approximately $4.8
million in fiscal 1999. As a percentage of revenue, general and administrative
expenses decreased to 25% in fiscal 2000, from 46% in fiscal 1999. The dollar-
value increase in general and administrative expenses is primarily due to an
increase in headcount, salaries and related costs, to approximately $4.3
million in fiscal 2000, from approximately $1.7 million in fiscal 1999,
resulting from the hiring of additional administrative, legal, human resource,
IT and finance personnel to support our growing and expanding operations.
Product Development. Product development expenses increased to $5.2 million
in fiscal 2000, from approximately $2.6 million in fiscal 1999. As a percentage
of revenue, product development expenses decreased to 10% in fiscal 2000, from
25% in fiscal 1999. The dollar-value increase in product development expenses
is primarily related to the headcount and related costs resulting from the
increase in product development personnel to 31 at July 31, 2000 from 20 at
July 31, 1999. This growth in product development personnel reflects our
increased service offerings and emphasis on application services.
Interest Income
Interest income increased to approximately $2.1 million in fiscal 2000, from
approximately $4,000 in fiscal 1999. The increase is due primarily to the funds
available for investment resulting from our various fiscal year 2000 financing
activities, including our $80.4 million initial public offering, a $50.0
million private placement of common stock and a $30.0 million sale-leaseback of
certain assets.
Interest Expense
Interest expense increased to approximately $1.0 million in fiscal 2000,
from approximately $347,000 in fiscal 1999. This increase is due primarily to
interest incurred on capital lease obligations.
Comparison of Fiscal Years Ended July 31, 1999 and 1998
Revenue
Total revenue increased 161% to approximately $10.5 million in fiscal 1999,
from approximately $4.0 million in fiscal 1998. The increase in revenue was due
to additional business with CMGI and CMGI affiliates and the increase in the
number of non-affiliated customers to 106 as of July 31, 1999 from 37 as of
July 31, 1998 (including customers of Servercast, acquired by us on July 1,
1998). Customers of Servercast accounted for $1,143,000, or 11%, of total
revenue in fiscal 1999.
28
<PAGE>
Cost of Revenue
Cost of revenue increased 129% to approximately $20.3 million in fiscal
1999, from approximately $8.9 million in fiscal 1998. As a percentage of
revenue, cost of revenue decreased to 193% in fiscal 1999, from 220% in fiscal
1998. The dollar-value increase in each period was due primarily to the costs
associated with increased investment in our existing data centers. These costs
principally included labor and headcount expenses, additional equipment and
maintenance costs and increased bandwidth and connectivity charges.
Operating Expenses
Selling and Marketing. Selling and marketing expenses increased 172% to
approximately $6.9 million in fiscal 1999, from approximately $2.5 million in
fiscal 1998. This increase was due primarily to the development of NaviSite's
sales and marketing capability in connection with the commencement of sales to
unaffiliated customers. These costs primarily included salaries and commissions
and expenses for marketing programs, advertising and product literature.
General and Administrative. General and administrative expenses increased
242% to approximately $4.8 million in fiscal 1999, from approximately $1.4
million in fiscal 1998. The dollar-value increase in general and administrative
expenses was due to both an increase in salaries and related costs, to
approximately $1.7 million in fiscal 1999, from approximately $752,000 in
fiscal 1998, resulting from the hiring of additional administrative and finance
personnel to support our growing operations and an increase in intercompany
charges from CMGI to approximately $494,000 in fiscal 1999, from approximately
$161,000 in fiscal 1998, for human resource support, business development and
corporate overhead. Other expenses contributing to the dollar-value increase
include moving and rental costs associated with the occupation of our current
corporate headquarters and legal and professional fees, which increased to
approximately $1.1 million in fiscal 1999, from approximately $221,000 in
fiscal 1998, associated with: Year 2000 consultants and contract labor; legal
review of operating contracts, leases, option plans and the NaviSite Internet
Services Corporation corporate reorganization; and accounting and finance
contract labor. General and administrative expenses associated with Servercast
(acquired by us on July 1, 1998) increased to approximately $517,000 in fiscal
1999, from approximately $19,000 in fiscal 1998.
Product Development. Product development expenses increased to $2.6 million
in fiscal 1999, from approximately $287,000 in fiscal 1998. This increase was
due primarily to the costs associated with an increase in product development
personnel by July 31, 1999 to 20, from one person at the inception of our
product development operations in 1998. This growth in product development
personnel reflects our increased service offerings and emphasis on application
services.
Interest Expense, Net
Interest expense, net increased to approximately $347,000 in fiscal 1999,
from $85,000 in fiscal 1998. This increase was due primarily to the inclusion
in interest expense, net in fiscal 1999 of approximately $303,000 of interest
on intercompany debt at a rate of seven percent per annum pursuant to an
arrangement entered into between NaviSite and CMGI in the second half of fiscal
1998. Interest expense associated with the issuance of term notes in connection
with our acquisition, in July 1998, of Servercast totaled approximately $55,000
during fiscal 1999. Interest expense on long-term capital lease obligations was
also included in interest expense, net in fiscal 1999.
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, our
initial public offering the issuance of preferred stock to strategic investors
and related underwriters' over-allotment in October 1999 and November 1999,
respectively.
Net cash used in operating activities amounted to $30.2 million, $20.2
million and $7.9 for fiscal 2000, fiscal 1999 and fiscal 1998, respectively.
The increase in cash used in operations over the three year period has
primarily been caused by increasing net operating losses and increases in
accounts receivable, which have been partially offset by non-cash depreciation
and amortization charges included in the applicable net loss and increases in
accounts payable and
29
<PAGE>
accrued expenses. The increases in accounts receivable are a direct result of
the related increases in revenue for the periods. The available for collection
days sales outstanding is approximately 47, 25, and 94 at July 31, 2000, 1999,
and 1998, respectively. Available for collection days sales outstanding
represents the weighted average number of days sales are outstanding based on
the date that services rendered during the period are billed.
Net cash used in investing activities amounted to $66.3 million, $9.8
million and $1.2 million during fiscal 2000, fiscal 1999 and fiscal 1998,
respectively. The net cash used for investing activities in fiscal year 2000
was primarily used to build and equip two new data centers and to acquire
property and equipment required to support the growth of the business. The net
cash used for investing activities for fiscal years 1999 and 1998 was utilized
to acquire property and equipment required to support the growth of the
business and to expand data center infrastructure.
Net cash provided by financing activities amounted to $171.1 million, $33.3
million and $9.1 million for fiscal 2000, fiscal 1999 and fiscal 1998,
respectively.
Cash provided by financing activities in fiscal year 2000 included our
initial public offering and related exercise of an over-allotment option
granted to the underwriters, $80.4 million, a private placement of common
stock, $50.0 million, and a sale-leaseback of certain assets, $30.0 million.
Cash provided for financing activities in fiscal year 1999 included funds
advanced from CMGI, totaling $19.0 million, to fund our operations in 1999. In
addition, cash provided by financing activities in fiscal 1999 included $8.0
million in net proceeds from the issuance of Series C convertible preferred
stock to Dell Computer Corporation and $7.2 million in net proceeds from the
issuance of Series D convertible preferred stock to Microsoft Corporation. Cash
provided by financing activities in fiscal 1998 primarily was related to funds
advanced from CMGI to fund our operations. Non-cash financing transactions
included capital lease financing for equipment and a software vendor payable in
fiscal 1999 and fiscal 1998.
Until the completion of our initial public offering on October 27, 1999,
CMGI funded our operations as needed, increasing our obligations to CMGI and
allowing us to maintain a zero-balance cash account. Customer and other
receipts were remitted to CMGI and applied to reduce our obligations to CMGI.
We issued a secured convertible demand note to CMGI in exchange for the
cancellation of all outstanding intercompany debt incurred by us to CMGI prior
to April 30, 1999. This note also provided for additional advances by CMGI to
us after April 30, 1999. Prior to the completion of our initial public
offering, the amount of each borrowing represented by the note was convertible
from time to time into the number of shares of Series B convertible preferred
stock equal to one-tenth of the quotient of the aggregate amount of principal
and interest to be so converted, divided by the applicable conversion price for
that fiscal quarter. The conversion price applicable to advances made during
the fiscal quarter in which our initial public offering occurred was determined
by the offering price of the initial public offering.
Under this note, CMGI converted intercompany debt in the aggregate amount of
approximately $12.3 million, representing funds advanced during the period
subsequent to July 31, 1999 through October 21, 1999 (the effective date of the
registration statement relating to our initial public offering), into 175,096
shares of Series B convertible preferred stock (based upon a conversion price
of $70.00, ten times the initial public offering price of $7.00 per share).
Upon the closing of our initial public offering, each issued and outstanding
share of Series B convertible preferred stock converted into 20 shares of
common stock, or 12,588,140 shares of common stock in the aggregate.
On June 8, 2000, we sold 980,873 shares of our common stock to CMGI for the
sum of $50.0 million, in a private placement transaction. The number of shares
was determined by dividing $50.0 million by the average of the closing prices
per share of our common stock as reported on the Nasdaq National Market System
on June 6, 7, 8, 9 and 12, 2000, rounded up to the nearest whole share.
In June 2000, we sold certain of our equipment and leasehold improvements in
our two new data centers in a sale-leaseback transaction to a bank for
approximately $30.0 million. We entered into a capital lease (the "Capital
Lease") upon the leaseback of those assets. The Capital Lease bears interest at
a nominal rate of
30
<PAGE>
9.15% and an effective interest rate of 12.49% and is payable in monthly
installments ending June 2004. The Capital Lease contains a mandatory balloon
payment, for repurchase by us, equal to 10% of the bank's acquisition cost of
the equipment. The Capital Lease also contains certain financial covenants,
including the maintenance of $15 million of cash or cash equivalents and the
maintenance of not less than $1 billion of market capitalization. We were in
compliance with such covenants as of July 31, 2000. However, as of October ,
2000, we were no longer in compliance with the market capitalization covenant.
This constitutes a breach of the market capitalization covenant and, if, due to
that, the lessor chooses to notify us of a default and the market
capitalization does not return to at least $1 billion within ten days of our
receipt of such a notice, then the $24.0 million obligation classified as a
non-current liability as of July 31, 2000, would be immediately payable.
We are currently negotiating with the lessor to obtain a waiver of the
market capitalization covenant. Should we fail to obtain a waiver or other
modification, the lessor has the right to terminate the lease and require that
all amounts outstanding under the lease become immediately due and payable.
While we are seeking to cure the covenant violation within the allotted time
period, or obtain satisfactory waivers and/or modification of the necessary
lease covenants, failure to cure such violations or obtain waivers or
modifications could have a material impact on our financial position and
liquidity.
Subsequent to July 31, 2000, CMGI committed to advance us, if needed by July
31, 2001, $50.0 million for working capital and an additional $30.0 million to
cover any amounts that may come due and payable under our capital lease
arrangement in the event of default under the lease covenants, subject to
negotiation of a mutually acceptable vehicle and related terms and conditions
and approval of both companies' respective board of directors.
We have experienced a substantial increase in our expenditures since
inception consistent with our growth in operations and staffing. We anticipate
that expenditures will continue to increase as we grow our business.
Additionally, we will continue to evaluate investment opportunities in
businesses that management believes will complement our technologies and market
strategies.
We currently anticipate that our available cash resources at July 31, 2000
combined with the cash to be received from CMGI, as described above and our
ability to obtain additional lease financing credit lines, will be sufficient
to meet our anticipated needs, barring unforeseen circumstances, for working
capital and capital expenditures over the next twelve months. However, we may
need to raise additional funds in order to fund more rapid expansion, to fund
our domestic and international expansion, to develop new, or enhance existing,
services or products, to respond to competitive pressures or to acquire
complementary businesses, products or technologies. In addition, on a long-term
basis, we may require additional external financing for working capital and
capital expenditures through credit facilities, sales of additional equity or
other financing vehicles. If additional funds are raised through the issuance
of equity or convertible debt securities, the percentage ownership of our
stockholders will be reduced and our stockholders may experience additional
dilution. We cannot assure you that additional financing will be available on
terms favorable to us, if at all. If adequate funds are not available or are
not available on acceptable terms, our ability to fund our expansion, take
advantage of unanticipated opportunities, develop or enhance services or
products or otherwise respond to competitive pressures would be significantly
limited.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Our exposure to market rate risk for changes in interest rates relates
primarily to our cash equivalents. We invest our cash primarily in money market
funds. An increase or decrease in interest rates would not significantly
increase or decrease interest expense on capital lease obligations due to the
fixed nature of such obligations. We do not currently have any foreign
operations and thus are not exposed to foreign currency fluctuations.
31
<PAGE>
Item 8. Financial Statements and Supplementary Data.
NAVISITE, INC.
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Independent Auditors' Report.......................................... 33
Consolidated Balance Sheets as of July 31, 2000 and 1999.............. 34
Consolidated Statements of Operations for the years ended July 31,
2000, 1999 and 1998.................................................. 35
Consolidated Statements of Stockholders' Equity (Deficit) for the
years ended July 31, 2000, 1999 and 1998............................. 36
Consolidated Statements of Cash Flows for the years ended July 31,
2000, 1999 and 1998 ................................................. 37
Notes to Consolidated Financial Statements............................ 38
Independent Auditors' Report on Financial Statement Schedule.......... 55
Financial Statement Schedule II-Valuation and Qualifying Accounts..... 56
</TABLE>
32
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
NaviSite, Inc. and Subsidiary:
We have audited the accompanying consolidated balance sheets of NaviSite,
Inc. and subsidiary as of July 31, 2000 and 1999, and the related consolidated
statements of operations, stockholders' equity (deficit), and cash flows for
each of the years in the three-year period ended July 31, 2000. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of NaviSite, Inc. and
subsidiary as of July 31, 2000 and 1999, and the results of its operations and
its cash flows for each of the years in the three-year period ended July 31,
2000, in conformity with accounting principles generally accepted in the United
States of America.
/s/ KPMG LLP
September 19, 2000
Boston, Massachusetts
33
<PAGE>
NAVISITE, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
July 31,
------------------
2000 1999
-------- --------
(In thousands,
except par value)
<S> <C> <C>
ASSETS
------
Current assets:
Cash and cash equivalents.................................. $ 77,947 $ 3,352
Accounts receivable, less allowance for doubtful accounts
of $1,219 and $262 at July 31, 2000 and 1999,
respectively.............................................. 14,025 1,881
Due from CMGI and affiliates............................... 5,985 77
Prepaid expenses........................................... 3,201 628
Deferred IPO costs......................................... -- 831
-------- --------
Total current assets..................................... 101,158 6,769
-------- --------
Property and equipment, net................................. 70,651 13,159
Deposits.................................................... 3,051 389
Goodwill, net of accumulated amortization of $424 and $220
at July 31, 2000 and 1999, respectively.................... 601 794
-------- --------
Total assets............................................. $175,461 $ 21,111
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
----------------------------------------------
Current liabilities:
Capital lease obligations, current portion................. $ 5,689 $ 229
Due to CMGI................................................ 5,310 --
Accounts payable........................................... 13,457 2,224
Accrued expenses and deferred revenue...................... 27,776 3,963
Software vendor payable, current portion................... 767 708
Notes payable, current portion............................. -- 1,000
-------- --------
Total current liabilities................................ 52,999 8,124
-------- --------
Capital lease obligations, less current portion............. 23,999 178
Software vendor payable, less current portion............... 989 1,757
-------- --------
Total liabilities........................................ 77,987 10,059
-------- --------
Series C Convertible Redeemable Preferred Stock, $.01 par
value, 0 and 1,095 shares issued and outstanding at July
31, 2000 and July 31, 1999, respectively (at liquidation
value)..................................................... -- 8,088
Series D Convertible Redeemable Preferred Stock, $.01 par
value, 0 and 993 shares issued and outstanding at July 31,
2000 and July 31, 1999, respectively (at liquidation
value)..................................................... -- 7,333
-------- --------
Total redeemable preferred stock......................... -- 15,421
-------- --------
Commitments and contingencies
Stockholders' equity (deficit):
Series A Convertible Preferred Stock, $.01 par value, 0
shares authorized; 0 and 1,324 shares issued and
outstanding at July 31, 2000 and July 31, 1999............ -- 13
Series B Convertible Preferred Stock, $.01 par value, 0
shares authorized; 0 and 542 shares issued and
outstanding at July 31, 2000 and July 31, 1999............ -- 5
Preferred Stock, $.01 par value, 5,000 shares authorized:
0 shares issued and outstanding at July 31, 2000.......... -- --
Common Stock, $.01 par value, 150,000 shares authorized;
58,364 and 138 shares issued and outstanding at July 31,
2000 and July 31, 1999, respectively...................... 584 1
Deferred compensation...................................... (762) --
Additional paid-in capital................................. 190,301 30,291
Accumulated deficit........................................ (92,649) (34,679)
-------- --------
Total stockholders' equity (deficit)..................... 97,474 (4,369)
-------- --------
Total liabilities and stockholders' equity (deficit)... $175,461 $ 21,111
======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
34
<PAGE>
NAVISITE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Year ended July 31,
----------------------------------------
2000 1999 1998
------------ ------------ ------------
(In thousands, except per share data)
<S> <C> <C> <C>
Net Revenue:
Revenue............................ $ 24,870 $ 3,461 $ 158
Revenue, related parties........... 24,893 7,058 3,871
------------ ------------ -----------
Total net revenue................ 49,763 10,519 4,029
Cost of revenue...................... 68,496 20,338 8,876
------------ ------------ -----------
Gross margin..................... (18,733) (9,819) (4,847)
------------ ------------ -----------
Operating expenses:
Selling and marketing.............. 22,805 6,888 2,530
General and administrative......... 12,270 4,823 1,412
Product development................ 5,197 2,620 287
------------ ------------ -----------
Total operating expenses......... 40,272 14,331 4,229
------------ ------------ -----------
Loss from operations................. (59,005) (24,150) (9,076)
Other income (expense):
Interest income.................... 2,027 4 --
Interest expense .................. (1,001) (347) (85)
Other income/(expense), net........ 9 (39) (11)
------------ ------------ -----------
Net loss............................. (57,970) (24,532) (9,172)
Accretion of dividends on Series C
and D Convertible Redeemable
Preferred Stock..................... -- (172) --
------------ ------------ -----------
Net loss applicable to common
stockholders........................ $ (57,970) $ (24,704) $ (9,172)
============ ============ ===========
Basic and diluted net loss per common
share............................... $ (1.37) $ (3.71) $ (.57)
============ ============ ===========
Basic and diluted weighted average
number of common shares
outstanding......................... 42,270 6,663 16,034
============ ============ ===========
Unaudited pro forma basic and diluted
net loss per share.................. $ (1.08) $ (.75) $ (.51)
============ ============ ===========
Pro forma weighted average number of
basic and diluted shares
outstanding......................... 53,829 32,814 18,056
============ ============ ===========
</TABLE>
See accompanying notes to consolidated financial statements.
35
<PAGE>
NAVISITE, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
Series B
Series A Convertible
Convertible Preferred
Preferred Stock Stock Common Stock Additional Stockholders'
------------------ ------------- --------------- Deferred Paid-In Accumulated Equity
Shares Amount Shares Amount Shares Amount Compensation Capital Deficit (Deficit)
--------- ------- ------ ------ ------- ------ ------------ ---------- ----------- -------------
(In thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Beginning at July 31,
1997................. -- $ -- -- $-- 16,000 $ 80 $ -- $ -- $ (975) $ (895)
Exercise of stock
options.............. -- -- -- -- 102 1 -- -- -- 1
Net loss.............. -- -- -- -- -- -- -- -- (9,172) (9,172)
--------- ------ ---- --- ------- ---- ------ -------- -------- -------
Balance at July 31,
1998................. -- -- -- -- 16,102 81 -- -- (10,147) (10,066)
Reorganization........ 1,324 13 -- -- (16,000) (80) -- 15,755 -- 15,688
Conversion of Debt to
CMGI Convertible
Preferred Stock...... -- -- 542 5 -- -- -- 14,708 -- 14,713
Exercise of stock
options.............. -- -- -- -- 36 -- -- -- -- --
Accretion of dividends
on Series C and D
Convertible
Preferred Stock...... -- -- -- -- -- -- -- (172) -- (172)
Net loss.............. -- -- -- -- -- -- -- -- (24,532) (24,532)
--------- ------ ---- --- ------- ---- ------ -------- -------- -------
Balance at July 31,
1999................. 1,324 13 542 5 138 1 -- 30,291 (34,679) (4,369)
Conversion of Debt to
CMGI into Series B
Convertible
Preferred Stock...... -- -- 88 -- -- -- -- 12,257 -- 12,257
Conversion of Series
B, C and D
Convertible
Redeemable Preferred
Stock into Common
Stock................ (1,324) (13) (630) (5) 43,244 432 -- 15,006 -- 15,420
Issuance of common
stock in conjunction
with initial public
offering, net of
offering
costs of $8,169...... -- -- -- -- 13,631 137 -- 130,054 -- 130,191
Issuance of common
stock in connection
with employee stock
purchase plan and
exercise of stock
options.............. -- -- -- -- 1,283 13 -- 1,105 -- 1,118
Deferred stock
compensation related
to acquisition....... -- -- -- -- 68 1 (1,589) 1,588 -- --
Amortization of
deferred stock
compensation......... -- -- -- -- -- -- 827 -- -- 827
Net loss.............. -- -- -- -- -- -- -- -- (57,970) (57,970)
--------- ------ ---- --- ------- ---- ------ -------- -------- -------
Balance at July 31,
2000................. -- $ -- -- $-- 58,364 $584 $ (762) $190,301 $(92,649) $97,474
========= ====== ==== === ======= ==== ====== ======== ======== =======
</TABLE>
See accompanying notes to consolidated financial statements.
36
<PAGE>
NAVISITE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Years ended July 31,
----------------------------
2000 1999 1998
--------- -------- -------
(In thousands)
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss........................................ $ (57,970) $(24,532) $(9,172)
Adjustments to reconcile net loss to net cash
used for operating activities:
Depreciation and amortization.................. 9,081 2,081 574
Loss on disposal of assets..................... -- 39 11
Provision for bad debts........................ 957 275 8
Amortization of deferred compensation.......... 827 -- --
Changes in operating assets and liabilities,
net of impact of acquisitions:
Accounts receivable.......................... (12,786) (1,667) (155)
Due from CMGI and affiliates................. (5,908) (77) --
Due to CMGI.................................. 5,310 -- --
Prepaid expenses............................. (1,738) 739 (334)
Deferred IPO costs........................... -- (335) --
Deposits..................................... (2,660) (232) (43)
Accounts payable............................. 11,049 1,000 (17)
Accrued expenses............................. 23,618 2,553 1,271
--------- -------- -------
Net cash used for operating activities..... (30,220) (20,156) (7,857)
--------- -------- -------
Cash flows from investing activities:
Net cash acquired/(paid) in acquisition......... 7 -- (45)
Purchases of property and equipment............. (66,328) (9,767) (1,181)
--------- -------- -------
Net cash used for investing activities..... (66,321) (9,767) (1,226)
--------- -------- -------
Cash flows from financing activities:
Proceeds from increase in debt to CMGI, net..... 12,257 18,962 9,166
Proceeds from issuance of Series C and D
Convertible Redeemable Preferred Stock, net of
financing costs of $109 and $99, respectively.. -- 15,249 --
Proceeds from exercise of stock options and
employee stock purchase plan................... 1,118 -- 1
Proceeds from issuance of common stock, net of
offering costs of $8,169....................... 130,190 -- --
Proceeds from sale-leaseback.................... 30,000 -- --
Repayment of note payable....................... (1,000) -- --
Payments of capital lease obligations........... (720) (122) (46)
Payments of software vendor obligations......... (709) (814) (38)
--------- -------- -------
Net cash provided by financing activities.. 171,136 33,275 9,083
--------- -------- -------
Net increase in cash............................. 74,595 3,352 --
Cash, beginning of period........................ 3,352 -- --
--------- -------- -------
Cash, end of period.............................. $ 77,947 $ 3,352 $ --
========= ======== =======
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest......................................... $ 676 $ 77 $ 15
========= ======== =======
</TABLE>
See accompanying notes to consolidated financial statements.
37
<PAGE>
NAVISITE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) Description of Business
NaviSite, Inc. (the "Company" or "NaviSite") is a provider of business
critical Internet outsourcing solutions, specializing in high-end Web hosting
and application services for companies conducting business on the Internet.
Substantially all revenues are generated from customers in the United States.
(2) Summary of Significant Accounting Policies
(a) Basis of Presentation
The Company is a majority owned subsidiary of CMGI, Inc. ("CMGI" or
"Parent"). The Company commenced operations in July 1996 and was incorporated
on February 3, 1997 as CMG Information Technology, Inc. (subsequently renamed
NaviSite Internet Services Corporation). On December 28, 1998, the assets and
liabilities of the Company were contributed to a newly-formed subsidiary,
NaviSite, Inc. The assets and liabilities were recorded at historical amounts
as the entities were under common control. The accompanying consolidated
financial statements, which have been prepared as if the Company had operated
as a separate stand-alone entity for all periods presented, include only
revenue and expenses attributable to the Company since it commenced operations
in July 1996.
The consolidated financial statements include certain allocations from CMGI
for certain general and administrative expenses such as rent, legal services,
insurance, and employee benefits. Allocations are based primarily on headcount.
Management believes that the method used to allocate the costs and expenses is
reasonable; however, such allocated amounts may or may not necessarily be
indicative of what actual expenses would have been incurred had the Company
operated independently of CMGI.
(b) 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. During
fiscal year 2000, Servercast Communications, L.L.C. ("Servercast"), previously
a subsidiary, was legally dissolved and all of its accounts were combined with
those of the Company.
(c) Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect certain reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting periods. Actual results could differ from those estimates.
(d) Revenue Recognition
Revenue consists of monthly fees for Web site and Internet application
management, application rentals, and hosting. Revenue (other than installation
fees)is generally billed and recognized over the term of the contract,
generally one to three years, based on actual usage. Installation fees are
typically recognized at the time that installation occurs. Payments received in
advance of providing services are deferred until the period such services are
provided.
(e) Cash
Cash equivalents consists of a money market fund which invests in high
quality short-term debt obligations, including commercial paper, asset-backed
commercial paper, corporate bonds, U.S. government agency obligations, taxable
municipal securities and repurchase agreements.
From the Company's inception until its initial public offering, October 22,
1999, the Company maintained a zero balance cash account under an arrangement
with CMGI. For this period, cash required by the Company
38
<PAGE>
NAVISITE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued
for the funding of its operations was provided as needed with a corresponding
increase to the "Debt to CMGI" account. This arrangement ended upon the
Company's initial public offering.
Subsequent to July 31, 2000, CMGI committed to advance NaviSite, if needed
by July 31, 2001, the sum of $80.0 million, subject to negotiation of a
mutually acceptable vehicle and related terms and conditions and approval of
both companies' respective board of directors.
During Fiscal 2000, non-cash investing activities included the acquisition
of ClickHear (see note 3) in exchange for common stock totaling $4,643,000.
During Fiscal 2000, non-cash financing activities included the issuance of
175,096 shares of the Company's Series B Convertible Preferred Stock ("Series B
Preferred Stock") in exchange for a $12,256,694 reduction in debt to CMGI (see
note 5).
During fiscal 2000, in connection with the closing of the Company's initial
public offering on October 27, 1999, all of the outstanding shares of Series A,
Series B, Series C and Series D convertible preferred stock, par value $0.01
per share, of the Company automatically converted into 43,244,630 shares of
common stock, $.01 par value per share (the "Common Stock").
During fiscal 1999, non-cash financing activities included the issuance of
1,323,953 shares of the Company's Series A Convertible Preferred Stock ("Series
A Preferred Stock") in exchange for 8,000,000 shares of the Company's Common
Stock and $15,767,600 reduction in debt to CMGI and the issuance of 541,859
shares of the Company's Series B Convertible Preferred Stock ("Series B
Preferred Stock") in exchange for a $14,713,000 reduction in debt to CMGI (see
note 9). Non-cash financing activities also included a software licensing
arrangement, including services and maintenance of $923,000, for an aggregate
of $2.5 million, payable over a three-year period. The Company has recorded
deferred IPO costs of $496,000, which are included in accrued expenses at July
31, 1999.
During fiscal 1998, non-cash investing activities included the acquisition
of Servercast (see note 3) in exchange for term notes totaling $1,000,000.
The Company purchased $ 0 and $378,000 of equipment under capital lease
obligations during the fiscal years ended July 31, 2000 and 1999, respectively.
(f) Software Development Costs
Software development costs are accounted for under Statement of Financial
Accounting Standard ("SFAS") No. 86, Accounting for Costs of Computer Software
to be Sold, Leased or Otherwise Marketed ("SFAS 86"). Capitalization of
software development costs commences upon the establishment of technological
feasibility. To date, all such amounts have been insignificant, and,
accordingly, the Company has charged all such costs to product development
expense.
The Company accounts for costs incurred for computer software developed or
obtained for internal use in accordance with AICPA Statement of Position 98-1,
"Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use."
(g) Property and Equipment
Property and equipment are stated at cost. Depreciation is computed using
the straight-line method over the estimated useful lives of the assets.
Leasehold improvements and assets acquired under capital leases are amortized
using the straight-line method over the shorter of the lease term or estimated
useful life of the asset. Assets acquired under capital leases in which title
transfers to the Company at the end of the agreement are amortized over the
useful life of the asset. Expenditures for maintenance and repairs are charged
to expense as incurred.
39
<PAGE>
NAVISITE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued
(h) Goodwill
Goodwill relates to the Company's purchase of Servercast in July 1998 (see
note 3) and the Company's purchase of its wholly owned subsidiary ClickHear in
February 2000 (see note 3). Such costs are being amortized on a straight-line
basis over five years, the period expected to be benefited.
(i) Accounting for Impairment of Long-Lived Assets
The Company assesses the need to record impairment losses on long-lived
assets used in operations when indicators of impairment are present. On an
ongoing basis, management reviews the value and period of amortization or
depreciation of long-lived assets, including goodwill. During this review, the
significant assumptions used in determining the original cost of long-lived
assets are reevaluated. Although the assumptions may vary from transaction to
transaction, they generally include revenue growth, operating results, cash
flows and other indicators of value. Management then determines whether there
has been a permanent impairment of the value of long-lived assets by comparing
future undiscounted cash flows to the asset's carrying value. If the estimated
future undiscounted cash flows are less than the carrying value of the asset, a
loss is recorded as the excess of the asset's carrying value over fair value.
(j) Income Taxes
The Company accounts for income taxes under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases and operating loss and tax credit carryforwards. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date.
Previous to the fiscal year ended July 31, 2000, the Company was greater
than 80% owned by CMGI, and as such, CMGI realized the full benefit of all
federal and part of the state net operating losses that had been incurred by
the Company for those periods before the fiscal year ended July 31, 2000.
Therefore, such net operating losses incurred by the Company were not available
to the Company. The tax sharing agreement between the Company and CMGI required
the Company to reimburse CMGI for the amounts it contributed to the
consolidated tax liability of the CMGI group; however, under the policy, CMGI
was not obligated to reimburse the Company for any losses utilized in the
consolidated CMGI group. After the Company's public offering, CMGI's ownership
fell below 80% and the Company is no longer included in the federal
consolidated group of CMGI. Thus, the Company's federal and state net operating
losses can be carried forward to offset its future taxable income.
(k) Advertising Costs
The Company recognizes advertising costs as incurred. Advertising expense
was approximately $1,462,000, $417,000 and $266,000 for the fiscal years ended
July 31, 2000, 1999 and 1998, respectively, and is included in the accompanying
statement of operations as a component of selling and marketing expenses.
(l) Stock-Based Compensation Plans
The Company applies the intrinsic value-based method of accounting
prescribed by Accounting Principles Board ("APB") Opinion No. 25, "Accounting
for Stock Issued to Employees," and related interpretations, in accounting for
its fixed plan stock options. As such, compensation expense would be recorded
on the date of grant only if the current market price of the underlying stock
exceeded the exercise price. SFAS No. 123,
40
<PAGE>
NAVISITE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued
"Accounting for Stock-Based Compensation," established accounting and
disclosure requirements using a fair value-based method of accounting for
stock-based employee compensation plans. As allowed by SFAS No. 123, the
Company has elected to continue to apply the intrinsic value-based method of
accounting described above, and has adopted the disclosure requirements of SFAS
No. 123.
(m) Financial Instruments
The Company's financial instruments include cash, accounts receivable,
obligations under capital leases, accounts payable and accrued expenses. As of
July 31, 2000, the carrying cost of these instruments approximated their fair
value.
(n) Historical and Unaudited Pro Forma Basic and Diluted Net Loss per 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 diluted
common equivalent shares outstanding during the period, using either the "if-
converted" method for convertible preferred stock or the treasury stock method
for options, unless amounts are anti-dilutive.
For fiscal years ended July 31, 2000 and 1999, 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 fiscal years ended July 31, 2000 and 1999, a pro forma basic and
diluted loss per share calculation, assuming the conversion of all amounts due
to CMGI and all outstanding shares of preferred stock into Common Stock using
the "if-converted" method form the later of the date of issuance or beginning
of the period, is presented. The following table provides a reconciliation of
the denominators used in calculating the pro forma basic and diluted earnings
(loss) per share for the fiscal years ended July 31, 2000, 1999 and 1998.
<TABLE>
<CAPTION>
Fiscal Year Ended
July 31,
--------------------------
2000 1999 1998
-------- -------- ------
<S> <C> <C> <C>
Numerator:
Net loss...................................... $(57,970) $(24,704) (9,172)
-------- -------- ------
Denominator:
Common shares outstanding..................... 42,270 6,663 16,034
Assumed conversion of preferred stock......... 11,559 26,151 2,022
-------- -------- ------
Weighted average number of pro forma basic
and diluted shares outstanding............. 53,829 32,814 18,056
======== ======== ======
Pro forma basic and diluted net loss per share.. $ (1.08) $ (.75) (.51)
======== ======== ======
</TABLE>
(o) Segment Reporting
The Company has adopted the provisions of SFAS No. 131, Disclosures About
Segments of an Enterprise and Related Information ("SFAS 131"). SFAS 131
establishes standards for the way that public business enterprises report
selected information about operating segments in annual and interim financial
statements. It also establishes standards for related disclosures about
products and services, geographic areas and major customers. SFAS 131 requires
the use of the "management approach" in disclosing segment information, based
largely on how senior management generally analyzes the business operations.
The Company currently operates in only one segment, and as such, no additional
disclosures are required.
41
<PAGE>
NAVISITE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued
(p) New Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 133, Accounting for Derivative
Instruments and Hedging Activities ("SFAS 133"). SFAS 133 was amended by SFAS
138 in June 2000. The Company will adopt these statements on August 1, 2000.
SFAS 133 will require that the Company record all derivatives in the balance
sheet at fair value. The Company does not believe adoption of SFAS 133 and SFAS
138 will have a material impact on its consolidated financial statements.
In December 1999, the SEC issued Staff Accounting Bulletin No. 101, "Revenue
Recognition in Financial Statements" ("SAB 101"). SAB 101 expresses the views
of the SEC staff in applying generally accepted accounting principles to
certain revenue recognition issues and is effective to be adopted by the fourth
quarter of fiscal 2001. The Company does not expect the provisions of SAB 101
to have a material impact on its consolidated financial statements.
In March 2000, the Financial Accounting Standards Board issued FASB
Interpretation No. 44, "Accounting for Certain Transactions involving Stock
Compensation"--an interpretation of APB Opinion No. 25 ("FIN 44"). FIN 44
applies prospectively to new stock option awards, exchanges of awards in a
business combination, modifications to outstanding awards, and changes in
grantee status that occur on or after July 1, 2000. The adoption of FIN 44 did
not have a material impact on the Company's financial position or its results
of operations.
(3) Business Combinations
In July 1998, the Company acquired Servercast, a leading provider of high-
performance Internet outsourcing solutions. The Company issued $1,000,000 in
term notes, with interest at 5.5%, with principal payable on January 2, 2000,
which was repaid on schedule. The total purchase price for Servercast was
$1,045,000, including acquisition costs of $20,000, and bridge notes receivable
of $25,000.
On February 22, 2000, NaviSite acquired ClickHear for consideration valued
at approximately $4,693,000, including approximately $50,000 of direct costs of
the acquisition. The consideration for the acquisition consisted of 41,968
shares of CMGI common stock valued at the closing price of CMGI common stock on
February 22, 2000, resulting in consideration value of approximately
$4,643,000. On February 22, 2000, CMGI contributed their ClickHear common stock
to NaviSite in exchange for 67,906 shares of NaviSite Common Stock. NaviSite's
direct costs of acquisition were recorded as a component of the purchase price.
Based on the terms of the acquisition agreement, the value of the CMGI shares
issued were recorded as deferred compensation by NaviSite. The CMGI shares
issued are subject to forfeiture by the ClickHear stockholders based on
employment criteria as well as performance goals. The deferred compensation
component of the consideration initially valued at $4,643,000 is accounted for
on a variable basis at market value at the end of each reporting period, and
will be amortized to compensation expense over the eleven month performance
contingency period. Compensation expense of 827,000 was recognized in fiscal
2000. As CMGI and NaviSite are entities under common control, upon settlement
of the employment and performance contingencies, NaviSite will record the
difference in fair value between the value of NaviSite's common shares issued
to CMGI and the value of the CMGI common shares issued to the ClickHear
shareholders as an equity transaction.
The acquisitions have been accounted for using the purchase method, and,
accordingly, the purchase price has been allocated to the assets purchased and
liabilities assumed based upon their fair values at the dates of acquisition.
The results of operations of the acquired companies have been included in the
Company's consolidated financial statements from the acquisition dates.
42
<PAGE>
NAVISITE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued
The portion of the purchase prices allocated to goodwill are being amortized
on a straight-line basis over five years. Amortization of goodwill was
approximately $204,000, $203,000 and $17,000 for the fiscal years ended July
31, 2000, 1999 and 1998.
The following table represents the unaudited pro forma results of operations
of the Company for the year ended July 31, 2000 and 1999, as if the ClickHear
purchase had occurred at the beginning of period. These pro forma results
include adjustments for the amortization of goodwill and recognition of
compensation expense. They have been prepared for comparative purposes only and
do not purport to be indicative of what would have occurred had the acquisition
been made at the beginning of the respective periods or of results that may
occur in the future.
<TABLE>
<CAPTION>
Fiscal Year
Ended July 31,
------------------
2000 1999
-------- --------
(unaudited)
(In thousands)
<S> <C> <C>
Revenue................................................ $ 50,291 $ 10,625
======== ========
Net loss............................................... (57,107) (29,350)
======== ========
Basic and diluted net loss per common share............ $ (1.35) $ (4.36)
======== ========
Basic and diluted weighted average number of common
shares outstanding.................................... 42,304 6,732
======== ========
</TABLE>
(4) Property and Equipment
<TABLE>
<CAPTION>
July 31,
----------------
Estimated Useful Life 2000 1999
--------------------------- ------- -------
(In thousands)
<S> <C> <C> <C>
Office furniture and
equipment.................. 5 years $ 4,335 $ 341
Computer equipment.......... 3 years 21,558 2,520
Software licenses........... 3 years or life-of-license 11,941 4,213
Leasehold improvements...... 4 years or life-of-lease 42,101 2,760
Leasehold improvements in
progress................... -- 5,838
------- -------
79,935 15,672
Less: Accumulated
depreciation and
amortization............... (9,284) (2,513)
------- -------
$70,651 $13,159
======= =======
</TABLE>
The cost and related accumulated amortization of property and equipment held
under capital leases is as follows:
<TABLE>
<CAPTION>
July 31,
------------
2000 1999
------- ----
(In
thousands)
<S> <C> <C>
Cost........................................................... $28,728 $573
Accumulated amortization....................................... 2,719 186
------- ----
$26,009 $387
======= ====
</TABLE>
43
<PAGE>
NAVISITE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued
(5) Debt to CMGI
Commencing in February 1998, advances made by CMGI to the Company accrued
interest at the annual rate of 7%. In December 1998, advances of $15,767,600
from CMGI, including accrued interest thereon, were converted into 1,323,953
shares of Series A Preferred Stock. These advances were made by CMGI to the
Company from inception through October 1998. In May 1999, the Company
formalized its borrowing arrangement with CMGI and executed a secured
convertible demand note with CMGI dated as of May 1, 1999 (the "Secured
Convertible Demand Note"). The Secured Convertible Demand Note covers advances
made by CMGI to the Company for periods commencing in November 1998. Under the
Secured Convertible Demand Note, advances and accrued interest may be prepaid
without penalty. Advances outstanding under this note are secured by
substantially all assets and intellectual property of the Company, and
principal and accrued interest may be converted at the option of CMGI into
shares of Series B Preferred Stock. The number of Series B Preferred shares to
be issued upon conversion of each borrowing represented by the note is based on
the estimated fair value of the Company at the end of the quarter in which such
borrowing is made. (The conversion price applicable to advances made and
interest accrued during a fiscal quarter in which an offering triggering
automatic conversion into Company Common Stock of Series B Preferred Stock
occurs is equal to the public offering price per share, and the conversion
price applicable to advances made and interest accrued during a fiscal quarter
in which CMGI elects to connect those advances or that interest prior to the
end of that fiscal quarter is the conversion price in effect for the
immediately preceding fiscal quarter). Effective June 4, 1999, CMGI elected to
convert advances and accrued interest outstanding at May 31, 1999 in the amount
of $14,713,000 into 541,859 shares of Series B Convertible Preferred Stock.
Effective October 27, 1999, CMGI elected to convert advances and accrued
interest outstanding at October 21, 1999 in the amount of $12,256,594 into
$175,096 shares of Series B Convertible Preferred Stock. All shares of Series B
Convertible Preferred Stock were converted to Common Stock on October 27, 1999.
See also Note 9.
(6) Accrued Expenses
Accrued expenses and deferred revenue consist of the following:
<TABLE>
<CAPTION>
July 31,
--------------
2000 1999
------- ------
(In thousands)
<S> <C> <C>
Accrued payroll, benefits and commissions..................... $ 6,503 $1,157
Accrued equipment costs ...................................... 9,289 --
Accrued accounts payable...................................... 3,099 423
Deferred revenue.............................................. 697 701
Accrued IPO costs ............................................ -- 496
Other ........................................................ 8,188 1,186
------- ------
$27,776 $3,963
======= ======
</TABLE>
(7) Commitments and Contingencies
(a) Leases
The Company is obligated under various capital and operating leases for
facilities and equipment. CMGI has entered into noncancelable operating and
capital leases on behalf of the Company covering certain of its office
facilities and equipment which expire through 2007. In addition, until the
Company moved its headquarters in January 2000, the Company paid CMGI for
office facilities used as the Company's headquarters for which it was charged
based upon an allocation of the total costs for the facilities at market rates.
Prior to the Company's IPO substantially all leases for real property were
guaranteed by CMGI. CMGI charges the Company the actual lease fees under these
arrangements. Total rent expense amounted to $18,509,000, $5,983,000 and
$3,567,000 for the fiscal years ended July 31, 2000, 1999 and 1998,
respectively.
44
<PAGE>
NAVISITE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued
In June 2000, the Company completed its financing of certain of its data
center infrastructure and capital equipment under a sale-leaseback arrangement.
The transaction has been accounted for as a financing arrangement, wherein the
property remains on the Company's books and will continue to be depreciated.
The total proceeds of $30 million was recorded as a capital lease obligation
and is being reduced based on payments under the lease. The lease bears
interest at a nominal rate of 9.15% and an effective interest rate of 12.49%
and has a term of 4 years. The Company is required to repurchase the leased
assets at the end of the agreement at an amount equal to 10% of the banks
acquisitions cost of the equipment. Borrowings under the lease are secured by
the leased property. The lease contains certain ongoing financial covenants,
including the maintenance of not less than $15,000,000 of cash and cash
equivalents and the maintenance of not less than $1,000,000,000 in market
capitalization. The Company was in compliance with these covenants as of July
31, 2000. However, subsequent to July 31, 2000, the Company is no longer in
compliance with the market capitalization covenant. This constitutes a breach
of the lease agreement, that, if uncured, could result in the $23,999,000
classified as a long-term obligation at July 31, 2000 to become immediately due
and payable. The Company is currently negotiating a waiver of the market
capitalization covenant through July 31, 2001. Failure to obtain such a waiver
could have a significant negative impact on the Company's financial position
and liquidity.
Minimum annual rental commitments under operating and capital leases are as
follows as of July 31, 2000:
<TABLE>
<CAPTION>
Operating Capital
Leases Leases
--------- -------
(In thousands)
<S> <C> <C>
2001....................................................... $24,058 $ 9,076
2002....................................................... 21,920 9,028
2003....................................................... 11,580 8,985
2004....................................................... 5,860 11,257
2005 ...................................................... 4,530 --
Thereafter ................................................ 11,190 --
------- -------
$79,138 38,346
=======
Less amounts representing interest......................... 8,658
-------
Present value of future minimum lease payments............. 29,688
Less: current portion of capital lease obligations......... 5,689
-------
Long-term portion of capital lease obligations............. $23,999
=======
</TABLE>
(b) Litigation
The Company is subject to 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.
(8) Income Taxes
No provision for federal or state income taxes has been recorded as the
Company incurred net operating losses for all periods presented. Prior to the
Company's initial public offering on October 21, 1999, the Company was included
in the federal consolidated group of CMGI. As a result, substantially all of
the federal
45
<PAGE>
NAVISITE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued
and state net operating losses incurred prior to the public offering are only
available to the parent. After the Company's public offering, CMGI's ownership
in NaviSite fell below 80% and NaviSite is no longer included in the federal
consolidated group of CMGI. Thus, the Company's federal and state net operating
losses can be carried forward to offset its future taxable income. The Company
has recorded a full valuation allowance against its deferred tax assets since
management believes that, after considering all the available objective
evidence, both positive and negative, historical and prospective, with greater
weight given to historical evidence, it is more likely than not that these
assets will be realized. No income tax benefit has been recorded for all
periods presented because of the valuation allowance.
Temporary differences between the financial statement carrying and tax bases
of assets and liabilities that give rise to significant portions of deferred
tax assets (liabilities) are comprised of the following:
<TABLE>
<CAPTION>
July 31,
---------------
2000 1999
-------- -----
(In thousands)
<S> <C> <C>
Deferred tax assets:
Accruals and reserves..................................... $ 1,451 $ 300
Loss carryforwards........................................ 18,279 --
Depreciation and amortization ............................ 2,263 182
-------- -----
Total deferred tax assets................................... $ 21,993 482
Less: valuation allowance................................... (21,993) (482)
-------- -----
Net deferred taxes.......................................... $ -- $ --
======== =====
</TABLE>
The valuation allowance increased by $21.5 million and 0.2 million for the
years ended July 31, 2000 and 1999, respectively. Reported tax benefits related
to approximately $4.0 million of the valuation allowance at July 31, 2000 will
be recorded as an increase to paid-in capital, if realized, as it related to
tax benefits from stock-based compensation.
The Company has a net operating loss carryforward for federal tax purposes
of approximately $44.4 million, expiring in 2020. The Company also has state
net operating loss carryforwards of approximately $44.5 million, expiring from
2003 to 2005. The utilization of these net operating losses may be limited
pursuant to Internal Revenue Code Section 382 as a result of ownership changes.
(9) Stockholders' Equity
(a) Sale of Common Stock
On October 21, 1999, the Company's Registration Statement for an initial
public offering was declared effective. The Company sold 11,000,000 shares of
its Common Stock par value $0.01 per share at $7 per share. On November 18,
1999, the underwriters of the Company's initial public offering exercised their
over-allotment option in full to purchase an additional 1,650,000 shares of
Common Stock at $7 per share. The closing in connection with the exercise of
the over-allotment option was held on November 23, 1999. The Company received
proceeds of approximately $80.4 million, net of offering costs of approximately
$8.2 million from its initial public offering and the subsequent exercise by
the underwriters of the over-allotment option.
In connection with the closing of the Company's initial public offering on
October 27, 1999, all of the outstanding shares of Series A, Series B, Series C
and Series D convertible preferred stock, par value $0.01 per share, of the
Company automatically converted into 43,244,630 shares of Common Stock.
Immediately following the automatic conversion of all of the Company's
outstanding shares of convertible preferred stock,
46
<PAGE>
NAVISITE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued
the Company filed an amended and restated certificate of incorporation. Under
the amended and restated certificate of incorporation, the Company is
authorized to issue 150,000,000 shares of Common Stock and 5,000,000 shares of
preferred stock, par value $0.01 per share. There currently are no shares of
preferred stock issued and outstanding.
On June 8, 2000, the Company sold 980,873 shares of its Common Stock to CMGI
for the sum of $49.8 million, net of offering costs, in a private placement
transaction. The number of shares was determined by dividing $50.0 million by
the average of the closing prices per share of the Company's Common Stock as
reported on the Nasdaq National Market System five-day, rounded up to the
nearest whole share.
(b) Two-For-One Stock Split
The consolidated financial statements have been retroactively adjusted to
reflect the two-for-one stock split, effected in the form of a stock dividend
of one share of Common Stock for each share of Common Stock outstanding. The
stock dividend was paid on April 5, 2000 to stockholders of record at the close
of business on March 22, 2000.
(c) Preferred Stock
In October 1998, the Company's stockholders authorized 5,000,000 shares of
preferred stock of which 1,323,953 shares have been designated as Series A
Preferred Stock. In May 1999, the Company's Board of Directors designated
1,000,000 shares as Series B Preferred Stock, 1,095,472 shares to be designated
as series C Convertible Preferred Stock ("Series C Preferred Stock") and
993,243 shares to be designated as Series D Convertible Preferred Stock
("Series D Preferred Stock"). The remaining shares have not been designated.
Series A Preferred Stock
In December 1998, the Board of Directors authorized and issued 1,323,953
shares of Series A Preferred Stock in exchange for 8,000,000 shares of Common
Stock and $15,767,600 in principal amount of Debt to CMGI. The Series A
Preferred Stock entitled to receive annual dividends at 7% commencing November
1, 1998, as and if declared. No cash dividends were declared or paid by the
Company. The Series A Preferred Stock was voting and convertible into 10 shares
of Common Stock subject to certain adjustments. In the event of any
liquidation, dissolution or winding up of the Company, the Series A Preferred
Stock had a liquidation preference of $11.91 per share plus dividends of 7%
compounded annually beginning on November 1, 1998. The Series A Preferred Stock
was convertible into Common Stock immediately at the option of the holder, and
was automatically converted in October 1999 into Common Stock upon the
completion of the Company's initial public offering.
In October 1999, all of the Series A preferred shares were converted into
13,259,530 shares of Common Stock.
Series B Preferred Stock
In May 1999, the Board of Directors approved the designation of 1,000,000
shares of the Company's preferred stock as Series B Preferred Stock. Effective
June 4, 1999, CMGI elected to convert the advances and accrued interest
outstanding under the Secured Convertible Demand Note as of January 31, 1999,
April 30 and May 31, 1999, in the aggregate amount of $14,713,000 into 541,859
shares of Series B Preferred Stock. The conversion of advances and accrued
interest into Series B Preferred Stock was based on the estimated fair value of
the Company as of the end of each of the fiscal quarters in which such advances
were made, except with respect to the advances converted as of June 4, 1999,
prior to the end of the fiscal quarter. Under the terms of
47
<PAGE>
NAVISITE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued
the Secured Convertible Demand Note, advances converted prior to the end of
the fiscal quarter in which they were made are converted based upon the
conversion price in effect for the immediately preceding fiscal quarter. Based
on an enterprise valuation determined through a discounted cash flow analysis
for the fiscal quarter ended January 31, 1999, $5,347,705 of advances and
accrued interest were converted at a per share price of $12.74 into 419,738
shares of Series B Preferred Stock. Based on an enterprise valuation
determined through arms' length negotiations with, and subsequent sales of
Series C Preferred Stock and Series D Preferred Stock to, two unaffiliated
third parties on June 4, 1999, a per share valuation of $76.68 was utilized to
convert $5,413,117 and $3,952,110 of advances and accrued interest into 70,594
and 51,527 shares of Series B Preferred Stock, respectively.
The Series B Preferred Stock was entitled to received noncumulative annual
dividends at 7%, as and if declared. No cash dividends were declared or paid
by the Company. The Series B Preferred Stock was fully participating, voting
and convertible into 10 shares of Common Stock, subject to certain
adjustments. In the event of any liquidation, dissolution or winding up of the
Company, the Series B Preferred Stock ranked pari passu with the Series A
Preferred Stock, and had a liquidation preference equal to its purchase price
plus dividends computed at 7% per annum. The Series B Preferred Stock was
convertible into Common Stock immediately at the option of the holder and was
automatically converted into Common Stock in October 1999 upon the completion
of the Company's initial public offering.
In October 1999, all of the Series B preferred shares were converted into
5,418,590 shares of Common Stock.
Series C Preferred Stock
In May 1999, the Board of Directors approved the designation of 1,095,472
shares of the Company's preferred stock as Series C Preferred Stock. The
Series C Preferred Stock was entitled to receive noncumulative annual
dividends at 7%, as and if declared. No cash dividends were declared or paid
by the Company. The Series C Preferred Stock was fully participating, voting
and convertible at the option of the holder into shares of Common Stock at
$7.40 per share, subject to certain adjustments. In the event of any
liquidation, dissolution or winding up of the Company, the Series C Preferred
Stock ranked pari passu with the Series A and B Preferred Stock and had a
liquidation preference equal to its purchase price plus dividends computed at
7% per annum. On or after the fifth anniversary of the purchase date, the
Series C Preferred Stock was redeemable, either at the written election of a
majority of the holders of Series C Preferred Stock or at the option of the
Company, at a price equal to its purchase price plus dividends computed at 7%
per annum. Holders of Series C Preferred Stock would have been able to
participate in future issuances of equity instruments, as defined. In June
1999, the Company sold 1,095,472 Series C preferred shares for $7,997,493, net
of issuance costs of $109,000. The Series C Preferred Stock automatically
converted in October 1999 into Common Stock upon the completion of the
Company's initial public offering.
In October 1999, all of the Series C preferred shares were converted into
1,095,472 of Common Stock.
Series D Preferred Stock
In May 1999, the Board of Directors approved the designation of 993,243
shares of the Company's preferred stock as Series D Preferred Stock. The
Series D Preferred Stock was entitled to receive noncumulative annual
dividends at 7%, as and if declared. No cash dividends were declared or paid
by the Company. The Series D Preferred Stock was fully participating, voting
and convertible at the option of the holder into shares of Common Stock at
$7.40 per share, subject to certain adjustments. In the event of any
liquidation, dissolution or winding up of the Company the Series D Preferred
Stock ranked pari passu with the
48
<PAGE>
NAVISITE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued
Series A, B and C Preferred Stock and had a liquidation preference equal to its
purchase price plus dividends computed at 7% per annum. On or after the fifth
anniversary of the purchase date, the Series D Preferred Stock was redeemable,
either at the written election of a majority of the holders of Series D
Preferred Stock or at the option of the Company, at a price equal to its
purchase price plus dividends computed at 7% per annum. Holders of Series D
Preferred Stock would have been able to participate in future issuances of
equity instruments, as defined. In June 1999, the Company sold 993,243 Series D
preferred shares for $7,252,000, net of issuance costs of $99,000. The Series D
Preferred Stock automatically converted in October 1999 into Common Stock upon
the completion of the Company's initial public offering.
In October 1999, all of the Series D preferred Shares were converted into
993,243 of Common Stock.
(10) Stock Option Plans
(a) 1999 Employee Stock Purchase Plan
The 1999 Employee Stock Purchase Plan (the "Stock Purchase Plan") was
adopted by the Company's Board of Directors and Stockholders in October 1999.
The Stock Purchase Plan provides for the issuance of a maximum of 100,000
shares of the Company's Common Stock. During fiscal year 2000, 62,671 shares
were issued under this plan.
(b) Deferred Compensation Plan
A Deferred Compensation Plan (the "Deferred Compensation Plan") was adopted
by the Company's Board of Directors in October 1999. Under the terms of the
Deferred Compensation Plan, the Company's employees who are selected by the
Board of Directors (as well as certain of the Company's employees who
previously participated in a deferred compensation plan sponsored by CMGI) will
be able to elect to defer a portion of their compensation for the following
calendar year. The Company also may make discretionary contributions to a
participant's account, to which the participant generally will become entitled
after five years of service with the Company.
(c) 1999 Director Stock Option Plan
In October 1999, the Company ceased issuing options under the 1998 Director
Plan and the Board of Directors and the Stockholders approved and adopted the
1999 Stock Option Plan for Non-Employee Directors (the "1999 Director Plan"). A
total of 500,000 shares of Common Stock are reserved for issuance under the
1999 Director Plan. Directors who are not NaviSite employees or otherwise
affiliates, employees or designees of an institutional or corporate investor
that owns more than 5% of outstanding Common Stock will be eligible to receive
non-statutory stock options under the 1999 Director Plan. Under the 1999
Director Plan, the Company will grant an initial option to acquire 25,000
shares of Common Stock to each eligible director who is elected a director for
the first time.
The Company also will grant to eligible directors an additional option for
the purchase of 6,250 shares of Common Stock on the first, and each subsequent,
anniversary of the grant of each director's initial option if the director is
still serving as one of the Company's directors on that anniversary date. The
Board of Directors has discretion to increase to up to 100,000 shares the
number of shares of Common Stock subject to any initial option or additional
option covering any vesting period of up to 48 months that may be granted to an
eligible director after the date of the increase.
As of July 31, 2000, 30,000 options were granted and outstanding under the
1999 Director Plan with a weighted average exercise price of $45.64.
49
<PAGE>
NAVISITE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued
(d) 1998 Director Stock Option Plan
In December 1998, the Company's Board of Directors and Stockholders approved
the 1998 Director Stock Option Plan (the "1998 Director Plan"). In October 1999
the Company ceased issuing options under the 1998 Director Plan upon the
adoption of the 1999 Director Plan, each NaviSite director (who is not also an
employee of NaviSite, any subsidiary of NaviSite or of CMGI) was entitled to
receive, upon the date of his or her election, a non-statutory option to
purchase Common Stock as defined. A maximum number of 250,000 shares of Common
Stock were authorized for issuance under the 1998 Director Plan. Each automatic
grant had an exercise price equal to the current fair market value of the
Common Stock at the time of grant and a maximum term of ten years, subject to
earlier termination following the optionee's cessation of service on the board
of directors.
As of July 31, 2000, 150,000 options were granted and outstanding under the
1998 Director Plan with a weighted average exercise price of $2.4467.
(e) NaviSite 1998 Equity Incentive Plan
In December 1998, the Company's Board of Directors and Stockholders approved
the 1998 Equity Incentive Plan, as amended (the "1998 Plan"). The 1998 plan
replaced NaviSite Internet Services Corporation's 1997 Equity Incentive Plan
(the "1997 Plan"). All options outstanding under the 1997 Plan were cancelled
and replaced with an equivalent amount of options issued in accordance with the
1998 Plan. Under the original 1998 Plan, non-qualified stock options or
incentive stock options may be granted to the Company's or its affiliates'
employees, directors and consultants, as defined, up to a maximum number of
shares of Common Stock not to exceed 5,000,000 shares. In August 1999, the
Board of Directors approved an increase in the number of shares authorized
under the 1998 Plan to 11,124,424. The Board of Directors administers this
plan, selects the individuals who are eligible to be granted options under the
1998 Plan and determines the number of shares and exercise price of each
option. The Chief Executive Officer, upon authority, granted by the Board of
Directors, is authorized to approve the grant of options to purchase Common
Stock under the 1998 Plan to certain persons. Options are granted at fair
market value. Options granted under the 1998 Plan have a five-year maximum term
and typically vest over a four year period, with 25% of options granted
becoming exercisable one year from the date of grant and the remaining 75%
vesting monthly for the next thirty-six (36) months. The following table
reflects activity and historical exercise prices of stock options under the
Company's 1998 Plan for the three years ended July 31, 2000.
<TABLE>
<CAPTION>
2000 1999 1998
-------------------- -------------------- -------------------
Weighted Weighted Weighted
Average Average Average
Number of Exercise Number of Exercise Number of Exercise
Shares Price Shares Price Shares Price
---------- -------- ---------- -------- --------- --------
<S> <C> <C> <C> <C> <C> <C>
Options outstanding,
beginning of year...... 4,861,324 $ 1.27 3,091,500 $0.08 2,146,000 $0.01
Granted................. 4,936,774 46.01 2,868,458 2.15 1,685,000 0.16
Exercised............... (1,219,405) 0.43 (36,638) 0.01 (102,038) 0.01
Cancelled............... (564,762) 17.88 (1,061,996) 0.23 (637,462) 0.03
---------- ------ ---------- ----- --------- -----
Options outstanding, end
of year................ 8,013,931 $27.79 4,861,324 $1.27 3,091,500 $0.08
========== ====== ========== ===== ========= =====
Options exercisable, end
of year................ 1,453,370 $ 1.23 1,281,326 $0.05 593,104 $0.01
========== ====== ========== ===== ========= =====
Options available for
grant, end of year..... 1,752,412 -- 806,462
========== ========== =========
</TABLE>
50
<PAGE>
NAVISITE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued
The following table summarizes information about the Company's stock options
outstanding at July 31, 2000:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
------------------------------------- -----------------------
Weighted
Average
Remaining Weighted Weighted
Range of Contractual Average Average
Exercise Number Life Exercise Number Exercise
Prices Outstanding (years) Price Outstanding Price
-------- ----------- ----------- -------- ----------- --------
<S> <C> <C> <C> <C> <C>
$ 0.01--$ 3.70 3,368,031 3.56 $ 1.60 1,420,457 $ 1.07
$ 3.71--$ 7.00 826,500 4.10 $ 7.00 31,893 $ 7.00
$ 7.01--$25.00 57,000 4.27 $ 23.09 0 $ --
$25.01--$50.00 2,595,500 4.66 $ 42.72 1,020 $45.13
$50.01--$75.00 697,500 4.57 $ 66.08 0 $ --
$75.00 up 469,400 4.62 $113.41 0 $ --
--------- --------- ------
8,013,931 4.13 $ 27.79 1,453,370 $ 1.23
========= ========= ======
</TABLE>
(f) CMGI 1986 Stock Option Plan
Certain NaviSite employees have been granted options for the purchase of
CMGI Common Stock under the CMGI 1986 Stock Option Plan (the "1986 Plan").
Options under the 1986 Plan are granted at fair market value on the date of the
grant and are generally exercisable in equal cumulative installments over a
four-to-ten year period beginning one year after the date of grant. Outstanding
options under the 1986 Plan expire through 2007. Under the 1986 Plan, non-
qualified stock options or incentive stock options may be granted to CMGI's or
its subsidiaries' employees, as defined. The Board of Directors of CMGI
administers this plan, selects the individuals to whom options will be granted
and determines the number of shares and exercise price of each option. The
following table reflects activity and historical exercise prices of stock
options granted to Company employees under the 1986 Plan for the three years
ended July 31, 2000. Options held by employees who transferred to NaviSite from
CMGI or CMGI subsidiaries during fiscal year 2000 are shown as transfers into
the 1986 plan.
<TABLE>
<CAPTION>
2000 1999 1998
------------------ ------------------ ------------------
Weighted Weighted Weighted
Number Average Number Average Number Average
of Exercise of Exercise of Exercise
Shares Price Shares Price Shares Price
-------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Options outstanding,
beginning of year...... 773,538 $19.11 177,680 $ 1.13 41,760 $0.71
Granted................. -- -- 663,200 22.10 160,000 1.16
Transfers............... 36,000 15.81 -- -- -- --
Exercised............... (177,280) 4.04 (67,342) 1.12 (24,080) 0.55
Cancelled............... (121,335) 3.31 -- -- -- --
-------- ------ -------- ------ -------- -----
Options outstanding, end
of year................ 510,923 $27.85 773,538 $19.11 177,680 $1.13
======== ====== ======== ====== ======== =====
Options exercisable, end
of year................ 158,106 $27.36 14,000 $ 1.15 3,340 $0.89
======== ====== ======== ====== ======== =====
</TABLE>
51
<PAGE>
NAVISITE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued
The following table summarizes information about stock options granted to
Company employees under the 1986 Plan outstanding at July 31, 2000:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
------------------------------------- -----------------------
Weighted
Average
Remaining Weighted Weighted
Range of Contractual Average Average
Exercise Number Life Exercise Number Exercise
Prices Outstanding (years) Price Outstanding Price
-------- ----------- ----------- -------- ----------- --------
<S> <C> <C> <C> <C> <C>
$1.01--$ 5.00 291,038 3.10 $ 4.95 95,138 $ 4.90
$5.01--$20.00 11,885 3.27 $ 9.37 468 $ 9.20
$20.01 up 208,000 3.74 $60.96 62,500 $61.68
======== =======
510,923 3.36 $27.85 158,106 $27.36
======== =======
</TABLE>
SFAS No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"), sets
forth a fair-value based method of recognizing stock-based compensation
expense. As permitted by SFAS No. 123, the Company has elected to continue to
apply APB No. 25 to account for the stock-based compensation plans in which the
Company's employees participate. Had compensation cost for awards in fiscal
2000, 1999 and 1998 under the four stock-based compensation plans in which the
Company's employees participate been determined based on the fair value method
set forth under SFAS 123, the pro forma effect on the Company's net loss would
have been as follows:
<TABLE>
<CAPTION>
Year Ended Year Ended Year Ended
July 31, 2000 July 31, 1999 July 31, 1999
------------------- ------------------- ------------------
As As As
Reported Pro Forma Reported Pro Forma Reported Pro Forma
--------- --------- --------- --------- -------- ---------
<S> <C> <C> <C> <C> <C> <C>
Net loss applicable to
common stockholders (in
thousands)............. $(57,970) $(86,269) $(24,704) $(26,161) $(9,172) $(9,273)
========= ========= ========= ========= ======== ========
Net loss per share...... $ (1.37) $ (1.50) $ (3.71) $ (3.93) $ (0.57) $ (0.58)
========= ========= ========= ========= ======== ========
</TABLE>
The pro forma per share net loss reflects the fair-value compensation cost
associated with option grants to the Company's employees under the Company's
1998 Plan and the CMGI 1986 Plan.
The fair value of each stock option granted under the 1998 plan has been
estimated on the date of grant using the Black-Scholes option pricing model
with the following weighted average assumptions for fiscal 2000, 1999 and 1998,
respectively: volatility of 167.5%,100% and 75.5%; risk-free interest rate of
6.3%, 5.16% and 5.48%; 2.8 year expected life of options for all years; and 0%
dividend yield for all years. The weighted average fair value per share of
options granted during fiscal 2000, 1999 and 1998 was $46.2424, $1.3517 and
$.1811, respectively.
The fair value of each stock option granted under the 1986 Plan has been
estimated on the date of grant using the Black-Scholes option pricing model
with the following weighted average assumptions for fiscal 2000, 1999 and 1998,
Respectively: volatility of 103.4%, 100% and 90.10%; risk-free interest rate of
6.28%, 5.16% and 5.50%; expected life of options of 3.03, 4.3 and 4.2 years
respectively; and 0% dividend yield for all years. The weighted average fair
value per share of options granted during fiscal 2000, 1999 and 1998 was $0,
$31.58 and $1.58 respectively.
52
<PAGE>
NAVISITE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued
(11) Related Party Transactions
CMGI has provided the Company 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. The Company also occupied
facilities through January 2000 that are leased by CMGI, whereby CMGI charges
the Company for its share of rent and related facility costs for CMGI's
corporate headquarters through an allocation based upon the company's headcount
located on the premises in relation to total headcount for all CMGI companies
located in the premises. The Company has also purchased certain employee
benefits (including 401(k) plan participation by employees of the Company) and
insurance (including property and casualty insurance) through CMGI. CMGI also
has provided the Company with Internet marketing and business development
services. Amounts due to CMGI totaled approximately $5,310,000 as of July 31,
2000. The following table summarizes the expenses allocated to the Company by
CMGI for enterprise services, rent and facilities, human resources and benefits
and Internet marketing and business development:
<TABLE>
<CAPTION>
Year Ended July
31,
----------------
2000 1999 1998
------ ---- ----
(In thousands)
<S> <C> <C> <C>
Enterprise services......................................... $ 315 $240 $157
Rent and facilities......................................... $ 248 $251 $ 15
Human resources and benefits................................ $1,507 $530 $ 46
Internet marketing and business development. ............... $ 585 $325 $ 71
</TABLE>
The Company sells its 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 $24,893,000, $7,058,000 and
$3,871,000 for the fiscal years ended July 31, 2000, 1999 and 1998,
respectively. These related parties typically receive a 10% discount for
services provided by the Company. The related cost of revenue is consistent
with the costs incurred on similar transactions with unrelated parties.
The Company provides 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 is used by NaviSite.
As part of this agreement, CMGI provides administrative services for leases
that include equipment for both NaviSite and CMGI under which CMGI or a related
entity is the majority equipment user. The administrative services include the
payment of the lessor's monthly lease charges. In both cases, the entire
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 NaviSite is not financially obligated under the leases.
(12) Concentration of Credit Risk
Amounts included in the consolidated balance sheets for accounts receivable,
debt to CMGI, accounts payable, accrued expenses and notes payable approximate
their fair value due to their short maturities. Financial instruments that
potentially subject the Company to concentration of credit risk consist
primarily of trade receivables. The Company performs periodic credit
evaluations of its customers' financial condition and generally does not
require collateral or other security against trade receivable balances;
however, it does maintain an allowance for potential credit losses and such
losses have been within management's expectations.
For the fiscal year ended July 31, 2000, 50% (24,893,000) of the Company's
revenue was earned from related parties. Three of these related parties
accounted for 12.05%, 9.96%, and 9.35% of revenue earned for the fiscal year
ended July 31, 2000. For the fiscal year ended July 31, 1999, 67% ($7,058,000)
of the Company's revenue was earned from related parties. Two of these related
parties accounted for 22% and 16% of revenue earned during the fiscal year
ended July 31, 1999. For the fiscal year ended July 31, 1998, 96% ($3,871,000)
of the Company's revenue was earned from related parties. Three of these
related parties accounted for 40%, 19% and 11% of revenue earned for the fiscal
year ended July 31, 1998.
53
<PAGE>
NAVISITE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued
Accounts receivable at July 31, 2000 included 42% due from related parties,
with 3 related parties entity(ies) comprising 23%. Accounts receivable at July
31, 1999 included 30% due from related parties, with one related entity
comprising 13%. Accounts receivable at July 31, 1998 included 63% due from
related parties, with two related entities comprising 37% and 15%.
(13) Selected Quarterly Financial Data (Unaudited)
Financial information for interim periods were as follows:
<TABLE>
<CAPTION>
Fiscal Year Ended July 31, 2000
--------------------------------------
Q1 Q2 Q3 Q4
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Net sales........................... $ 5,866 $ 9,170 $ 14,195 $ 20,532
Gross margin........................ (3,203) (3,152) (5,966) (6,412)
Net loss............................ $(10,551) $(11,442) $(16,430) $(19,547)
Per share(a)........................ $ (1.75) $ (0.21) $ (0.29) $ (0.34)
Per share, pro forma(b)............. $ (0.24) -- -- --
<CAPTION>
Fiscal Year Ended July 31, 1999
--------------------------------------
Q1 Q2 Q3 Q4
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Net sales........................... $ 1,668 $ 2,166 $ 2,983 $ 3,702
Gross margin........................ (2,188) (1,769) (2,853) (3,079)
Net loss............................ $ (4,509) $ (4,163) $ (6,764) $ (9,096)
Per share(a)........................ $ (0.28) $ (0.41) $ (48.66) $ (65.44)
Per share, pro forma(b)............. $ (0.18) $ (0.14) $ (0.19) $ (0.23)
</TABLE>
--------
(a) Net loss per common share is computed independently for each of the
quarters based on the weighted average number of shares outstanding during
the quarter. Therefore, the aggregate per share amount for the quarters may
not equal the amount calculated for the full year.
(b) See note 2 (n).
54
<PAGE>
INDEPENDENT AUDITORS REPORT ON FINANCIAL STATEMENT SCHEDULE
The Board of Directors and Stockholders
NaviSite, Inc. and Subsidiary:
Under date of September 19, 2000, we reported on the consolidated balance
sheets of NaviSite, Inc. as of July 31, 2000 and 1999 and the related
consolidated statements of operations, stockholders' equity (deficit) and cash
flows for each of the fiscal years in the three-year period ended July 31,
2000, which are included in the Form 10-K for the year ended July 31, 2000. In
connection with our audits of the aforementioned consolidated financial
statements, we also audited the related consolidated financial statement
schedule of Valuation and Qualifying Accounts in the Form 10-K. This financial
statement schedule is the responsibility of the Company's management. Our
responsibility is to express an opinion on this financial statement schedule
based on our audits. In our opinion, such financial statement schedule when
considered in relation to the basic consolidated financial statements taken as
a whole, presents fairly in all material respects the information set forth
therein.
/s/ KPMG LLP
Boston, Massachusetts
September 19, 2000
55
<PAGE>
NAVISITE, INC.
VALUATION AND QUALIFYING ACCOUNTS
For the Years Ended July 31, 2000, 1999 and 1998
(in thousands)
<TABLE>
<CAPTION>
Balance at Additions Deductions Balance
Beginning Charged to from at End
of Year Expense Reserves Other (1) of Year
---------- ---------- ---------- --------- -------
<S> <C> <C> <C> <C> <C>
Year ended July 31, 1998:
Allowance for doubtful
accounts $ -- $ 8 $ (1) $ -- $ 7
Year ended July 31, 1999:
Allowance for doubtful
accounts $ 7 $ 275 $ (20) $ -- $ 262
Year ended July 31, 2000:
Allowance for doubtful
accounts $262 $1.069 $(269) $158 $1,219
</TABLE>
<TABLE>
<S> <C>
(1) Represents allowance for doubtful accounts of ClickHear (acquired in
fiscal 2000).
</TABLE>
56
<PAGE>
Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure.
None.
PART III
Certain information required by Part III of this Form 10-K is omitted
because we will file a definitive proxy statement pursuant to Regulation 14A
(the "Proxy Statement") not later than 120 days after the end of the fiscal
year covered by this Form 10-K, and certain information to be included therein
is incorporated herein by reference.
Item 10. Directors and Executive Officers of the Registrant
The information regarding directors and compliance with Section 16(a) of
the Securities and Exchange Act of 1934, as amended, required by Item 10 of
this Form 10-K is incorporated herein by reference to our Proxy Statement. The
information regarding executive officers is included in Part I of this Form
10-K under the section captioned "Election of Directors."
Item 11. Executive Compensation
The information required by Item 11 of Form 10-K is incorporated herein by
reference to our Proxy Statement under the section captioned "Executive
Compensation and Other Information." The information specified in Item 402 (k)
and (l) of Regulation S-K and set forth in our Proxy Statement is not
incorporated by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information required by Item 12 of Form 10-K is incorporated herein by
reference to our Proxy Statement under the section captioned "Security
Ownership of Certain Beneficial Owners and Management."
Item 13. Certain Relationships and Related Transactions
The information required by Item 13 of Form 10-K is incorporated herein by
reference to our Proxy Statement under the section captioned "Certain
Relationships and Related Transactions."
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a)(1) List of Financial Statements
Independent Auditors' Report
Consolidated Balance Sheets as of July 31, 2000 and 1999
Consolidated Statements of Operations for the Years Ended July 31, 2000,
1999 and 1998
Consolidated Statements of Stockholders' Equity (Deficit) for the Years
Ended July 31, 2000, 1999 and 1998
Consolidated Statements of Cash Flows for the Years Ended July 31, 2000,
1999 and 1998
Notes to Consolidated Financial Statements
(a)(2) List of Schedules
Schedule II--Valuation and Qualifying Accounts for the Years Ended July 31,
2000, 1999 and 1998
Independent Auditors Report on Financial Statement Schedule
All other financial statement schedules not listed have been omitted
because they are either not required, not applicable, or the information
has been included elsewhere in the consolidated financial statements or
notes thereto.
57
<PAGE>
(a)(3) Exhibits
The Exhibits listed in the Exhibit Index immediately preceeding such
exhibits are filed as part of this Annual Report on Form 10-K.
(b) Reports on Form 8-K
On May 8, 2000, we filed Amendment No. 1 to Current Report on Form 8-K under
Item 7 (Financial Statements, Pro Forma Financial Information and Exhibits) to
include the financial statements required to be filed in connection with the
consummation of a Stock Purchase Agreement for the acquisition of ClickHear,
Inc.
58
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Company has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
NAVISITE, INC.
October 30, 2000
/s/ Joel B. Rosen
By: _________________________________
Joel B. Rosen
President and Chief Executive
Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the Company
in the capacities indicated, on October 29, 2000.
<TABLE>
<CAPTION>
Signatures Title Date
---------- ----- ----
<S> <C> <C>
/s/ Joel B. Rosen President and Chief
______________________________________ Executive Officer
Joel B. Rosen (Principal Executive
Officer)
/s/ Kenneth W. Hale Vice President, Chief
______________________________________ Financial Officer and
Kenneth W. Hale Treasurer (Principal
Financial Officer and
Principal Accounting
Officer)
/s/ Chairman of the Board
______________________________________
David S. Wetherell
/s/ Director
______________________________________
Andrew J. Hajducky, III
/s/ James F. Moore Director
______________________________________
James F. Moore
/s/ Stephen D.R. Moore Director
______________________________________
Stephen D.R. Moore
/s/ Craig D. Goldman Director
______________________________________
Craig D. Goldman
</TABLE>
59
<PAGE>
Index to Exhibits
<TABLE>
<CAPTION>
Exhibit
No.: Description of Exhibit
------- ----------------------
<C> <S>
2.1(1) Asset Assignment Agreement, dated December 28, 1998, among
NaviSite Internet Services Corporation and the Registrant.
2.2(1) Purchase Agreement, dated as of July 1, 1998, among NaviSite
Internet Services Corporation, Neil Black, in his capacity as
Managing Member of Servercast Communications, L.L.C. and all of
the other members of Servercast Communications, L.L.C.
individually, as named therein.
2.3(2) Stock Purchase Agreement, dated as of February 16, 2000, by and
among CMGI, Inc., ClickHear, Inc., the Stockholders of ClickHear,
Inc. and the Registrant.
2.4(2) Inter-Company Agreement, dated February 22, 2000, between CMGI,
Inc. and the Registrant.
3.1(3) Amended and Restated Certificate of Incorporation.
3.2(3) Amended and Restated By-Laws.
4.1(1) Specimen certificate representing shares of common stock.
4.2(1) Series C Convertible Preferred Stock Purchase Agreement, dated as
of June 3, 1999, by and between Dell USA L.P. and the Registrant.
4.3(1) Series D Convertible Preferred Stock Purchase Agreement, dated as
of June 3, 1999, by and between Microsoft Corporation and the
Registrant.
4.4(3) Investor Rights Agreement, dated as of October 27, 1999, by and
between CMGI, Inc. and the Registrant.
10.1(1) Net Lease Agreement, dated as of March 20, 1997, by and between
CMG Information Technologies, Inc. and Borland International,
Inc., as amended by First Amendment dated June 1, 1998.
10.2(1) Lease, dated as of March 21, 1997, by and between William J.
Callahan and William J. Callahan, Jr., as trustees of Andover Park
Realty Trust, and CMG Information Services, Inc.
10.3(1) Lease, dated as of May 14, 1999, by and between 400 River Limited
Partnership and the Registrant.
10.4(1) Lease, made as of April 30, 1999, by and between CarrAmerica
Realty Corporation and the Registrant.
10.5(1) Term Note in favor of Peter C. Kirwan, Jr., dated July 1, 1998,
executed by NaviSite Internet Services Corporation.
10.6(1) Bonus Agreement, dated as of July 1, 1998, by and between NaviSite
Internet Services Corporation and Peter C. Kirwan, Jr.
10.7(1) Secured Convertible Demand Note issued by the Registrant to CMGI,
Inc., dated as of May 1, 1999.
10.8(1) Intellectual Property Security Agreement between the Registrant
and CMGI, Inc., dated as of May 1, 1999.
10.9(1) Security Agreement between the Registrant and CMGI, Inc., dated as
of May 1, 1999.
10.10(3)(*) Amended and Restated 1998 Equity Incentive Plan.
10.11(3)(*) Amended and Restated 1998 Director Stock Option Plan.
10.12(3)(*) 1999 Employee Stock Purchase Plan.
10.13(3)(*) 1999 Stock Option Plan for Non-Employee Directors.
10.14(3)(*) Deferred Compensation Plan.
10.15(3) Form of Director Indemnification Agreement, as executed by
Directors.
10.16(3) Facilities and Administrative Agreement, dated as of October 27,
1999, between CMGI, Inc. and the Registrant.
10.17(3) Tax Allocation Agreement, dated as of October 27, 1999, between
CMGI, Inc. and the Registrant.
10.18(3) Standard Form of Agreements, dated as of June 14, 1999, between
the Registrant, as Owner, and XL Construction, as Design/Builder,
for NaviSite, Inc. Zanker Road Data Center, San Jose, California.
10.19(3) Cost Plus Fee Standard Form of Agreement, dated as of April 12,
1999, between the Registrant, as Tenant, and Gilbane Building
Company, as Construction Manager.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Exhibit No.: Description of Exhibit
------------ ----------------------
<C> <S>
10.20(4) Irrevocable Standby Letter of Credit, dated as of December 3,
1999, between BankBoston, N.A. and the Registrant.
10.21(4) Security Agreement and Assignment of Account, dated December 3,
1999, between BankBoston, N.A. and the Registrant.
10.22(4) Severance Agreement and General Release, dated November 8, 1999,
and as amended on December 2, 1999, between Barbara Fortier and
the Registrant.
10.23(5) Common Stock Purchase Agreement, dated as of June 8, 2000, by and
between the Registrant and CMGI, Inc.
10.24(5) Amendment No. 1 to the Investors Right Agreement, dated as of
October 27, 1999, by and between CMGI, Inc. and the Registrant.
10.25(5) Master Equipment Lease Agreement No. 35076, dated as of May 26,
2000, by and between the Registrant and Fleet Capital
Corporation, along with the related schedules and transaction
documents.
10.26 Separation Agreement and General Release, dated as of July 18,
2000, by and between Robert B. Eisenberg and the Registrant.
21.1(1) Subsidiaries of the Registrant.
23.1 Consent of KPMG LLP.
27 Financial Data Schedule.
</TABLE>
--------
(1) Incorporated by reference to Exhibits to the Registrant's Registration
Statement on Form S-1 (File No. 333-83501).
(2) Incorporated by reference to Exhibits to the Registrant's Current Report on
Form 8-K dated February 22, 2000.
(3) Incorporated by reference to Exhibits to the Registrant's Quarterly Report
on Form 10-Q for the period ended October 31, 1999.
(4) Incorporated by reference to Exhibits to the Registrant's Quarterly Report
on Form 10-Q for the period ended January 31, 2000.
(5) Incorporated by reference to Exhibits to the Registrant's Quarterly Report
on Form 10-Q for the period ended April 30, 2000.
(*) Management contract or compensatory plan or arrangement required to be
filed as an Exhibit to this Annual Report on Form 10-K.
