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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
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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
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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)
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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.
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NAVISITE, INC.
2000 ANNUAL REPORT
ON FORM 10-K
TABLE OF CONTENTS
Page
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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
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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.
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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.
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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
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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
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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.
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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.
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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.
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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.
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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;
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. 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
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
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
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
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
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
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
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
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
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
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
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.
Fiscal 2000
--------------
High Low
------- ------
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
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:
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
===========
23
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.
Period from
July 1, 1996
(inception)
through
2000 1999 1998 1997 July 31, 1996
-------- -------- ------- ------ -------------
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 -- -- --
======== ======== ======= ====== =====
24
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
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
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:
Year ended July 31,
------------------------
2000 1999 1998
------ ------ ------
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)%
====== ====== ======
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
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
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
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, fi