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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, 2001
OR
[_]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from to
Commission file number: 0-27597
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NAVISITE, INC.
(Exact name of registrant as specified in its charter)
Delaware 52-2137343
(State or other (I.R.S. Employer
jurisdiction of incorporation) Identification No.)
400 Minuteman Road 01810
Andover, Massachusetts (Zip Code)
(jurisdiction of incorporation)
(978) 682-8300
(Registrant's telephone number, including area code)
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Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which
N/A registered
N/A
Securities registered pursuant to section 12(g) of the Act:
Common Stock, par value $0.01 per share
(Title of class)
----------------
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. [X]
The aggregate market value of the registrant's common stock, $0.01 par value
per share, held by non-affiliates of the registrant was approximately
$19,153,378, 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 26,
2001.
As of October 26, 2001 there were 62,059,063 shares outstanding of the
registrant's common stock, par value $0.01 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, 2001, 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.
2001 ANNUAL REPORT
ON FORM 10-K
TABLE OF CONTENTS
Page
Number
------
PART I
Item 1. Business.................................................... 2
Item 2. Properties.................................................. 18
Item 3. Legal Proceedings........................................... 18
Item 4. Submission of Matters to a Vote of Security Holders......... 19
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters........................................ 21
Item 6. Selected Consolidated Financial Data........................ 22
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations.................................. 23
Item 7A. Quantitative and Qualitative Disclosures about Market Risk.. 31
Item 8. Financial Statements and Supplementary Data................. 32
Item 9. Changes in and Disagreements With Accountants on Accounting
and Financial Disclosure................................... 58
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 58
Item 11. Executive Compensation...................................... 58
Item 12. Security Ownership of Certain Beneficial Owners and
Management................................................. 58
Item 13. Certain Relationships and Related Transactions.............. 58
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form
8K......................................................... 58
Signatures............................................................ 60
1
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 for businesses who operate mission critical Internet applications. Our
managed application hosting services allow businesses to outsource the
deployment, configuration, hosting, management and support of their Internet
applications and Web sites in a cost-effective and rapid manner. This
outsourcing allows customers to control IT resources and capital expenses. Our
focus on enhanced management services, beyond basic co-location hosting
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, increasing reliability, download speeds and providing
extremely high levels of redundancy.
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:
Managed Applications--for customers who want to outsource the end-to-end
management of their e-business application.
Managed Servers--for customers who intend to manage the application, but
want to outsource the management of the infrastructure software--OS, web
servers, database servers, application servers--to a trusted third party.
Managed Infrastructure--for customers who want to be able to select value
added security, network and storage options on an a la carte basis, knowing
that they are designed to be used either alone or together.
Managed Facilities--for customers with significant IT resources who want a
vendor to manage the underlying data center and bandwidth facilities.
Professional Services--for customers who want to leverage industry experts
to design and implement solutions that address their unique business needs,
enable execution of their e-strategy and exploit the full advantages of their
managed hosting environment.
Recent Developments
On October 29, 2001, we entered into an agreement under which we will
receive a total of $65 million in financing from Compaq Financial Services
Corporation, or CFS, a wholly owned subsidiary of Compaq Computer Corporation,
and CMGI. Under the terms of the agreement, CFS and CMGI will provide us with
cash investments of $20 million and $10 million respectively in exchange for
convertible notes. Additionally,
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CFS has agreed to restructure certain outstanding NaviSite lease obligations.
We have agreed to purchase equipment from CFS leased under operating leases in
exchange for a six-year, $35 million convertible note. As a result, we expect
to substantially reduce cash expenditures on operating leases over the next two
fiscal years. This note also allows us to finance past due lease payments, the
sales tax on the equipment purchase and the outright purchase of the equipment.
The notes bear interest at 12% and will require payment of interest only for
the first three years from the date of issuance and then repayment of interest
and principal, on a straight-line basis, over the next three years until
maturity on the sixth anniversary of the date of issuance. The principal amount
may be convertible into our common stock at the option of the noteholders at
any time prior to or at maturity. Should CFS convert its notes into NaviSite
common stock, they would own a controlling stake in NaviSite. Additionally, the
agreement includes a provision for non-voting participation rights by CFS on
our board of directors.
As a part of this agreement, CMGI has also agreed to convert its existing
$80 million in outstanding notes into approximately 14.5 million shares of our
common stock and an additional $16.2 million of other amounts due CMGI into
approximately 9.9 million shares of our common stock. The result of this
agreement is that $7 million in remaining interest payments due to CMGI, $9.2
million in unamortized debt issuance costs and the repayment of the $80 million
principal amount due in December 2003 will be converted to equity.
This agreement has been approved by the boards of directors of each of
NaviSite, CMGI and CFS. Certain NaviSite terms relating to the authorization
and issuance of shares of our common stock upon conversion of the senior
secured convertible notes issued under the agreements will be subject to
approval by our stockholders.
Industry Background
Growth of Internet Business Applications. The dramatic growth in Internet
usage combined with enhanced functionality, accessibility and security, has
made the Internet increasingly attractive to businesses as a medium for
communication and commerce. Initial use of the Internet was, for the most part,
focused on consumer applications. Businesses are now deploying Internet
applications on a large scale, to enhance their core business operations.
As business use of the Internet grows, we believe that businesses utilizing
the Internet are seeking to identify and implement increasingly sophisticated
Internet applications. These new applications permit businesses to:
. Increase operating efficiencies and reduce SG&A costs;
. Engage in business-to-business and business-to-consumer e-commerce;
. Build and enhance customer relationships by providing Internet-based
customer service and technical support;
. Manage vendor and supplier relationships through Web-based technologies
such as online training, e-commerce enablement, and streaming; 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 underlying 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. According to
Gartner Dataquest, hosting will rise from 6% of the IT management services
market to better than 13% by 2004, and a Forrester Research report revealed
that 62% of the Global 3500 companies surveyed hire hosters to run their Web
sites. We believe that the growth in outsourced hosting and management of Web
sites and Internet applications is driven by a number of factors, including:
. Need to improve the reliability, availability and overall performance of
their Internet applications and Web sites as those applications increase
in importance and complexity;
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. Requirements for rapid time to market, and a reduced time to deploy
operationally efficient Internet applications;
. Challenges faced by businesses in hiring, training and retaining
application engineers and information technology employees with the
requisite range of IT expertise;
. Increasing complexity of managing the operations of Web sites; and
. 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 $1.4 billion in 1999 to $19.8 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 companies
developed their businesses to provide co-location hosting services and 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, and project-oriented integrators
and developers are not focused on supporting customer's applications on an
ongoing basis. Some businesses attempt to reduce costs 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.
The NaviSite Solution
NaviSite provides a range of integrated, scalable Internet application and
Web site hosting and application management services that can be deployed in a
cost-effective and rapid manner. We specialize in deploying and managing
dedicated, mission critical web solutions for our customers. We serve as the
single point of management for their Internet applications and focus on
enhanced management services that allow us to meet the expanding set of
customer needs as Web sites and their applications become more complex. Key
advantages of our solution include:
Comprehensive and Integrated Solutions. We provide an integrated suite of
products and services that span the full application stack including data
center, bandwidth, storage, servers, security, databases, OS and Web and
application servers. We provide our services across both Unix and Windows
platforms and in highly secure, highly available and redundant environments.
Cost-Effective Management Services. The combination of our scalable
infrastructure, the repeatability of our management processes and our extensive
base of expertise allows us to provide our customers with Web site and Internet
application hosting and management services on a cost-effective basis. Because
NaviSite has already deployed state-of-the-art infrastructure from the
industry's leading providers, our customers can immediately leverage equipment
and services that would typically not be cost effective for them to purchase
and deploy themselves. Second, we have made significant investments in our
operating platform and our automation capabilities. Furthermore, we have
refined these processes over time and across a large base of customers. By
leveraging this expertise, we can more efficiently configure, deploy and manage
complex applications and, thus, save our customers from hiring or developing
that same expertise in-house. By off-loading these resource and time-intensive
Web site operations, we allow 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,
scale and adapt their Internet applications, often in a matter of days or
weeks, rather than months. Because NaviSite has already deployed sophisticated
infrastructure components and has the experience of deploying similar
applications for hundreds
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of customers, we believe that we can deploy sophisticated Web sites much more
rapidly than businesses can in-house. This is especially important to many of
our customers who deploy mission critical applications for revenue enhancement
or cost improvement objectives. These applications need to be in place
immediately.
High-Performance, World-Class Infrastructure. Our infrastructure has been
built by integrating "best of breed' components and designed specifically to
meet the more demanding technical 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 we believe are among the highest and most comprehensive in the
industry.
Strategy
NaviSite's objective is to service our customers by being the single point
of management for their outsourced IP applications. 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. Four key components of our strategy
include:
Deliver Industry-Leading Operational Metrics. NaviSite has developed, and
delivers to its customers, consistently high levels of operational metrics
across the areas that are most critical to businesses, including the
performance of customer applications, network elements, and service levels.
NaviSite's operating metrics are believed to be among the highest metrics in
the managed services industry. Because the quality and service level of our
managed services is transparent, we believe that our operating metrics are a
critical differentiator in the marketplace. NaviSite plans to continue driving
improvements in its operating metrics and corresponding improvements in the
quality of its customer service.
Focus on High Value-Added Managed Services. NaviSite currently provides
horizontal infrastructure and application services that have broad appeal
across most market segments, including a wide range of industry segments,
including enterprises, ISV (Independent Software Vendors) and E-commerce
companies. To meet the changing needs of our current and prospective customer
base, we intend to augment our current service offerings by focusing on a sub-
set of complex, scale and expertise driven services that build on our value
proposition of outsourced IT operations. As a practice, we focus on network
and application services that are repeatable, meaning that they require
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 and provides higher levels of
consistency to our customers.
Partner to Deliver Customized Application Solutions. We believe that
companies will require an increasingly diverse range of capabilities and point
technologies as their applications increase in complexity. While NaviSite
specializes in delivering highly scalable management services for the
infrastructure, network and foundation application layers of the application
stack, we intend to leverage relationships with key system integration and
technology partners for services that extend beyond our product range. Driven
by differences in economic models, these are services that we will not perform
ourselves, but rather, will leverage partners in order to deliver integrated,
customized and complete solutions to our end-user customers.
Leverage Distribution Channels with Strategic Partners. Historically,
NaviSite built strong industry relationships with leading technology companies
including hardware vendors, software manufacturers and system integrators. We
work closely with a small and select group of partners to jointly develop
higher value proposition offerings and distribute them through joint marketing
and sales efforts. By leveraging our industry relationships, and our partners'
distribution capabilities, we are able to increase visibility and sales
productivity.
Services
We offer a comprehensive suite of services to meet the current and future
hosting needs of our customers.
Internet Application and Web Site Management. We provide both enhanced
server management and specialized application management. Both types of
management services permit us to provide customers with a
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single point of problem resolution management, from identification to
resolution to post-resolution analysis and reporting. To provide 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
include custom reporting, hardware options, network and application 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. In addition, these applications may require experienced
personnel to deploy and configure them. Additionally, customers benefit from
the "one-stop shopping" aspect of procuring their applications in this manner.
Basic Web Site and Application Hosting. Our Web site and Internet
application hosting services provide customers with the ability to leverage our
state-of-the-art data centers, redundant bandwidth and back-up, storage,
monitoring and reporting services. Customers are able to access their servers
24 hours a day, seven days a week. In fiscal 2001, less than 17% of our revenue
was derived from basic co-location customers to whom 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, and migrate to enhanced managed services.
Comprehensive Streaming Media Services. Through our Streaming Media Division
we offer managed streaming media services as a 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. These comprehensive streaming services are
now also being adopted by enterprises and other businesses seeking to use
streaming services for traditional business applications.
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 strategy is to achieve broad market penetration by
focusing on market segments that deploy mission critical Web sites and are
structured to realize the economic value of outsourcing. While NaviSite
initially focused on companies that adopted the Internet as an integral part of
their business strategy, the focus has evolved to include more traditional
enterprises as they incorporate the Internet in their business operations.
Here, NaviSite has been able to leverage its extensive experience and expertise
in delivering complex managed services to service the needs of evolving
enterprises.
We sell our services through a direct sales force and we receive referrals
through an extensive network of business and channel partners.
Direct Sales. Our direct sales professionals are organized into three
groups:
. 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.
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Our direct sales teams are currently located in: Andover, Massachusetts; New
York, New York; San Francisco, San Jose and Los Angeles, California; Atlanta,
Georgia; and Vienna, Virginia.
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 and, thus, allow NaviSite customers to benefit from more
comprehensive solutions, and this allows NaviSite to focus on its core value-
added services. Many of these partners also provide a significant source of
lead referrals to NaviSite and in some cases are also our customers. As a
result, many of our partners' customers become NaviSite customers.
Historically, we have worked closely with our partners. Going forward, we
intend to strengthen these relationships to develop customer referrals, mutual
referral relationships, enhanced service offerings, and in some cases, co-
selling, cross-selling and reselling opportunities.
Marketing. Our marketing group is responsible for building brand awareness
through public relations and marketing communications, identifying key market
and customer segments and creating marketing programs to target those segments.
The marketing organization focuses on supporting the direct sales as well as
developing and enhancing channel partner relationships. The primary mechanisms
include:
. Comprehensive lead generation through telemarketing, direct marketing,
direct mail programs, select 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 Internet application developers
and consultants; and
. Lead generation, referrals, mutual Web site links or co-marketing
activities, leveraging close strategic relationships with technology
partners such as Cisco Systems, Dell Corporation, Compaq Computer
Corporation, BMC, Inc. and EMC Corporation.
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, 2001, we had approximately 288
customers, down from 362 as of July 31, 2000.
A representative list of our hosting customers as of July 31, 2001 includes:
Biogen, Inc., Levi Strauss, Inc., Stop and Shop Supermarket Company, Optika,
Inc., Fuel Spot, Inc., Wolters Kluwer nv, Blue Cross Blue Shield of Central New
York, Sun Mircrosystems, Inc., SLI, Inc., The Premier Insurance Company of
Massachusetts and Restoration Hardware.
A representative list of our streaming customers as of July 31, 2001
includes: St. Jude Hospital, MSN, Anheuser-Busch, NFL Films, TWI Interactive
and Northeast Utilities.
Product Management and Product Development
Our product management and development organizations work together in
developing a broad range of "horizontal" managed infrastructure, network and
application services. Our teams identify and evaluate new Internet applications
and technologies; we develop monitoring and management services specifically
for these applications, and then incorporate 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
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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.
Customer Service and Support
We believe high levels of customer service and support are critical to our
continued success and future 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 offers a 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
to eight 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,
and 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 sophisticated and experience-tested infrastructure established to support
CMGI and a number of its affiliates, which were deploying some of the most
demanding, high-traffic Web applications. We have differentiated our
infrastructure from competing application service providers and co-location
hosting providers through our superior operational metrics that directly impact
customer performance and reliability, our experience with high-performance
Internet applications and our comprehensive managed service offerings. We
designed our infrastructure specifically to provide superior performance for
our Internet application and Web site 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. NaviSite has built a select number of high performance managed
application 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 serve customers from two primary data centers, located
in Andover, Massachusetts and in San Jose 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 utilize 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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Private Transit Internet Connectivity. Our use of direct private transit
Internet connections to three major Internet backbone providers differentiates
our network infrastructure from those of our competitors. We have redundant
high-capacity Internet connections to UUNet, InterNap, and Cable and Wireless
on the East Coast and UUNet and InterNap 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, one of our offerings is a 99.99% full site high
availability SLA that covers their entire application stack.
Network Security. Our network incorporates host-based security with
CheckPoint back-end firewalls and Cisco router access control lists, as well as
SecureID 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;
.ability to consistently measure, track and report on operational metrics;
.Web site and Internet application hosting and management expertise;
.fast, redundant, and reliable Internet connectivity;
.a state-of-the-art infrastructure providing availability, speed,
scalability and security;
.comprehensive 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.
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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, and a large number of local and regional hosting
providers;
. companies that focus on customized Internet application services and
application hosting, including CORIO, Inc., IBM Global Services and
LoudCloud;
. 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., Quest and
Sprint Corporation, and regional and local telecommunications companies,
including AT&T Broadband.
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 proprietary assets. In
addition, we offer 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, or other claims or assertions, 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.
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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 offer services over the Internet in many states in
the United States and internationally 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, 2001, we had 386 employees. Of these employees, 215 were
principally engaged in operations, 65 were principally engaged in sales and
marketing, 54 were principally engaged in product development and 52 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.
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, 2001, we had an accumulated deficit of $215.7
million. We anticipate increased expenses as we continue to improve our
infrastructure, introduce new services, enhance our application management
expertise, expand our sales and marketing efforts and pursue additional
industry relationships. As a result, we expect to incur operating losses for at
least the next fiscal year.
Fluctuations in our quarterly operating results may negatively impact our
stock price. Our quarterly operating results may fluctuate significantly in the
future as a result of a variety of factors, many of which are outside our
control. These factors include: reduction of market demand and or acceptance
for our Web site and Internet application hosting and management services;
oversupply of data center space in the industry; our ability to develop, market
and introduce new services on a timely basis; downward price adjustments by our
competitors; changes in the mix of services provided by our competitors;
technical difficulties or system downtime affecting the Internet generally or
our hosting operations specifically; our ability to meet any increased
technological demands of our customers; the amount and timing of costs related
to our marketing efforts and service introductions; and economic conditions
specific to the Internet application service provider industry. Our operating
results for any particular quarter may fall short of our expectations or those
of investors or securities analysts. In this event, the market price of our
common stock would be likely to fall.
11
CMGI is currently a majority stockholder and CFS is a potential majority
stockholder, and both may have interests that conflict with the interests of
our other stockholders. As of July 31, 2001, CMGI beneficially owned
approximately 76.74% 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.
As of October 29, 2001, in conjunction with the restructuring of certain of
our lease obligations, we have agreed to issue CFS convertible notes which,
upon conversion, would give CFS a controlling interest in NaviSite.
Accordingly, CFS would have the power, acting alone, to elect a majority of our
board of directors. If CFS becomes a majority stockholder, it may have
interests that conflict with the interests of our other stockholders, as
described above for CMGI.
A significant portion of our revenue currently is generated by services
provided to CMGI and companies affiliated with CMGI, and the loss of this
revenue would substantially impair the growth of our business. We anticipate
that we will continue to receive a significant portion of our revenue in the
future from CMGI and CMGI affiliates. CMGI and CMGI affiliates accounted for
approximately 35% of our revenue in the fiscal year ended July 31, 2001,
approximately 50% of our revenue in the fiscal year ended July 31, 2000, and
approximately 68% of our revenue in the fiscal year ended July 31, 1999. We
cannot assure you that revenues generated by CMGI and CMGI affiliates will
continue or that we will be able to secure business from unaffiliated customers
to replace this revenue in the future. The loss of revenue from CMGI and CMGI
affiliates, or our inability to replace this operating revenue, would
substantially impair the growth of our business.
Our ability to grow our business would be substantially impaired if we were
unable to obtain, on commercially reasonable terms, certain equipment that is
currently provided under leases. Certain of the equipment that we use or
provide to our customers for their use in connection with our services is
provided under leases. We or our customers will have to obtain this equipment
for new leases and renewal of existing leases directly, on a stand alone basis.
Our business would be substantially impaired if we were unable to obtain or
continue these leases on commercially reasonable terms.
We are attempting to renogotiate certain lease obligations. During the
renegotiations of our equipment lease obligations, we have not paid certain
scheduled lease payments to certain vendors. Our total remaining lease
obligation to these vendors is approximately $57 million. Of this amount,
approximately $27 million will be restructured in the CFS agreement, which
provides for our purchase of equipment under operating lease. During these
renegotiations, we have been notified by certain lessors that we are in default
of our lease agreements. Remedies under these leases, if the event of default
is not cured, include the demand of all remaining lease payments under the
original lease terms, payment of stipulated loss amounts or return of the
underlying equipment. We plan to cure these defaults within 60 days of closing
the CFS agreement. In the event we do not cure these defaults, these lessors
may enforce their rights.
If the market for Internet commerce and communication does not continue, or
it continues to decrease, there may be insufficient demand for our services,
and as a result, our business strategy may not be successful. The increased use
of the Internet for retrieving, sharing and transferring information among
businesses and consumers has developed only recently, and the market for the
purchase of products and
12
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 business could be substantially impaired if the market for
Internet application services fails to continue to develop or if we cannot
continue to achieve broad market acceptance. The market for Internet
application services has recently developed and is evolving.
Our ability to successfully market our services could be substantially
impaired if we are unable to deploy new Internet applications or if new
Internet applications deployed by us prove to be unreliable, defective or
incompatible. We cannot assure you that we will not experience difficulties
that could delay or prevent the successful development, introduction or
marketing of Internet application services in the future. If any newly
introduced Internet applications suffer from reliability, quality or
compatibility problems, market acceptance of our services could be greatly
hindered and our ability to attract new customers could be adversely affected.
We cannot assure you that new applications deployed by us will be free from any
reliability, quality, or compatibility problems. If we incur increased costs or
are unable, for technical or other reasons, to host and manage new Internet
applications or enhancements of existing applications, our ability to
successfully market our services could be substantially impaired.
The market we serve is highly competitive, and we may lack the financial and
other resources, expertise or capability needed to capture increased market
share or maintain market share. We compete in the Internet application service
market. This market is rapidly evolving, highly competitive and likely to be
characterized by over capacity and industry consolidation. We believe that
participants in this market must grow rapidly and achieve a significant
presence to compete effectively. Our business is not as developed as that of
many of our competitors. Many of our competitors have substantially greater
financial, technical and marketing resources, greater name recognition and more
established relationships in the industry. We may lack the financial and other
resources, expertise or capability needed to capture increased or maintain
market share in this environment in the future.
Any interruptions in, or degradation of, our private transit Internet
connections could result in the loss of customers or hinder our ability to
attract new customers. Our customers rely on our ability to move their digital
content as efficiently as possible to the people accessing their Web sites and
Internet applications. We utilize our direct private transit Internet
connections to major backbone providers as a means of avoiding congestion and
resulting performance degradation at public Internet exchange points. We rely
on these telecommunications network suppliers to maintain the operational
integrity of their backbones so that our private transit Internet connections
operate effectively.
Increased costs associated with our private transit Internet connections
could result in the loss of customers or significant increases in operating
costs. Our private transit Internet connections are already more costly than
alternative arrangements commonly utilized to move Internet traffic. If
providers increase the pricing associated with utilizing their bandwidth, we
may be required to identify alternative methods to distribute our customers'
digital content. We cannot assure you that our customers will continue to be
willing to pay the higher costs associated with direct private transit or that
we could effectively move to another network approach. If we 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 and utilize any of these applications could materially impair our
ability to provide services to our customers or require us to obtain
13
substitute software applications of lower quality or performance standards or
at greater cost. In addition, because we generally license applications on a
non-exclusive basis, our competitors may license and utilize the same software
applications. In fact, many of the companies with which we have strategic
relationships currently have, or could enter into, similar license agreements
with our competitors or prospective competitors. We cannot assure you that
software applications will continue to be available to us from Internet
application software vendors on commercially reasonable terms. If we are unable
to identify and license software applications which meet our targeted criteria
for new application introductions, we may have to discontinue or delay
introduction of services relating to these applications.
We purchase from a limited number of suppliers key components of our
infrastructure, including networking equipment. We cannot assure you that we
will have the necessary hardware or parts on hand or that our suppliers will be
able to provide them in a timely manner in the event of equipment failure. Our
dependency to obtain and continue to maintain the necessary hardware or parts
on a timely basis could result in sustained equipment failure and a loss of
revenue due to customer loss or claims for service credits under our service
level guarantees.
Our inability to scale our infrastructure or manage customer growth and the
related expansion of our operations could result in decreased revenue and
continued operating losses. In order to service our customer base, we will need
to continue to improve our network infrastructure. Our ability to continue to
meet the needs of a substantial number of customers while maintaining superior
performance is largely unproven. If our network infrastructure is not scalable,
we may not be able to provide our services to additional customers, which would
result in decreased revenue.
Our customer base includes a significant number of dot.com businesses that
face increased risk of loss of funding depending upon the availability of 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. We have
experienced and may continue to experience a loss of revenue associated with
these customers and will then have to increase sales to other businesses using
the Internet in order to preserve and grow our revenue.
You may experience dilution because of our recent financing arrangements
with CFS and CMGI. The financing arrangement, as of October 29, 2001, with CFS
and CMGI includes terms which allow CFS and CMGI at their discretion, to
convert the debt obligation of $65 million into our common stock at a
conversion price of $0.26 per share, subject to our stockholder approval. This
conversion will increase the number of our common stock shares issued by
approximately 250 million shares. In addition, we may pay a portion of interest
due to CFS and all interest due to CMGI with our common shares. Moreover, if
additional funds are raised through the issuance of additional equity or
convertible debt securities, your percentage of ownership in us will be reduced
and you may experience additional dilution. In certain circumstances, if we
issue equity or convertible debt securities at values below those provided to
CFS, we must issue CFS additional shares of our common stock which will further
dilute existing stockholders.
Funding may not be available to us on favorable terms, if at all. We may
need to raise additional funds from time to time, and we cannot assure you that
additional financing will be available on terms favorable to us, if at all. In
addition, pursuant to our financing arrangements with CFS as of October 29,
2001, we may need to obtain approval from CFS for incremental funding, and we
may not obtain this approval from CFS.
Our 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
14
telecommunications failures, sabotage or other intentional acts of vandalism.
Even if we take precautions, the occurrence of a natural disaster, equipment
failure or other unanticipated problem at one or more of our data centers could
result in interruptions in the services we provide to our customers. We cannot
assure you that our disaster recovery plan will address all, or even most, of
the problems we may encounter in the event of such a disaster.
We have experienced service interruptions in the past, and any future
service interruptions could: require us to spend substantial amounts of money
to replace equipment or facilities; entitle customers to claim service credits
under our service level guarantees; cause customers to seek damages for losses
incurred; or make it more difficult for us to attract new customers, retain
current customers or enter into additional strategic relationships. Any of
these occurrences could result in significant operating losses.
The misappropriation of our proprietary rights could result in the loss of
our competitive advantage in the market. We rely on a combination of trademark,
service mark, copyright and trade secret laws and contractual restrictions to
establish and protect our proprietary rights. We do not own any patents that
would prevent or inhibit competitors from using our technology or entering our
market. We cannot assure you that the contractual arrangements or other steps
taken by us to protect our proprietary rights will prove sufficient to prevent
misappropriation of our proprietary rights or to deter independent, third-party
development of similar proprietary assets. In addition, we provide our services
in other countries where the laws may not afford adequate protection for our
proprietary rights.
Third-party infringement claims against our technology suppliers, customers
or us could result in disruptions in service, the loss of customers or costly
and time-consuming litigation. We license or lease most technologies used in
the Internet application services that we offer. Our technology suppliers may
become subject to third-party infringement claims or other claims and
assertions, which could result in their inability or unwillingness to continue
to license their technology to us. We expect that we and our customers
increasingly will be subject to third-party infringement claims as the number
of Web sites and third-party service providers for Web-based businesses grows.
In addition, we have received notices alleging that our service marks infringe
the trademark rights of third parties. We cannot assure you that third parties
will not assert claims against us in the future or that these claims will not
be successful. Any infringement claim as to our technologies or services,
regardless of its merit, could result in delays in service, installation or
upgrades, the loss of customers or costly and time-consuming litigation, or
require us to enter into royalty or licensing agreements.
The loss of key officers, key management, and other personnel could impair
our ability to successfully execute our business strategy, because we
substantially rely on their experience and management skills, or could
jeopardize our ability to continue to provide service to our customers. We
believe that the continued service of key personnel, including Tricia Gilligan,
our President and Chief Executive Officer, is a key component of the future
success of our business. None of our key officers or personnel is currently a
party to an employment agreement with us. This means that any officer or
employee can terminate his or her relationship with us at any time. In
addition, we do not carry life insurance for any of our key personnel to insure
our business in the event of their death. In addition, the loss of key members
of our sales and marketing teams or key technical service personnel could
jeopardize our positive relations with our customers. Any loss of key technical
personnel would jeopardize the stability of our infrastructure and our ability
to provide the guaranteed service levels our customers expect. On July 31,
2001, we initiated a reduction in force eliminating 126 full- and part-time
employees, representing approximately 25 percent of our total staff. We also
announced the departure of 7 of 13 vice presidents, in the areas of sales,
human resources, international, strategic planning, managed services, marketing
and technology planning, as well as our general counsel. In addition, since
July 31, 2001, both Joel B. Rosen, our then Chief Executive Officer, and
Kenneth W. Hale, our then Chief Financial Officer, have left our company.
Although further reductions are not presently anticipated, we cannot assure you
that such reductions will not be necessary in the future.
If we fail to attract or retain skilled personnel, our ability to provide
Web site and Internet application management and technical support may be
limited, and as a result, we may be unable to attract customers. Our business
requires individuals with significant levels of Internet application expertise,
in particular, to win
15
consumer confidence in outsourcing the hosting and management of mission-
critical applications. Qualified technical personnel are likely to remain a
limited resource for the foreseeable future. We may not be able to retain or
hire the necessary personnel to implement our business strategy or may need to
provide higher compensation to such personnel than we currently anticipate.
Any future acquisitions we make of companies or technologies may result in
disruptions to our business or distractions of our management due to
difficulties in assimilating acquired personnel and operations. Our business
strategy contemplates future acquisitions of complementary technologies. If we
do pursue additional acquisitions, our risks may increase because our ongoing
business may be disrupted and management's attention and resources may be
diverted from other business concerns. In addition, through acquisitions, we
may enter into markets or market segments in which we have limited prior
experience.
Once we complete an acquisition, we will face additional risks. These risks
include: difficulty assimilating acquired operations, technologies and
personnel; inability to retain management and other key personnel of the
acquired business; and changes in management or other key personnel that may
harm relationships with the acquired business's customers and employees. We
cannot assure you that any acquisitions will be successfully identified and
completed or that, if one or more acquisitions are completed, the acquired
business, assets or technologies will generate sufficient revenue to offset the
associated costs or other adverse effects.
The emergence and growth of a market for our Internet application services
will be impaired if third parties do not continue to develop and improve the
Internet infrastructure. The recent growth in the use of the Internet has
caused frequent periods of performance degradation, requiring the upgrade of
routers and switches, telecommunications links and other components forming the
infrastructure of the Internet-by-Internet service providers and other
organizations with links to the Internet. Any perceived degradation in the
performance of the Internet as a means to transact business and communicate
could undermine the benefits and market acceptance of our Web site and Internet
application hosting and management services. Our services are ultimately
limited by, and dependent upon, the speed and reliability of hardware,
communications services and networks operated by third parties. Consequently,
the market for our Internet application services may be impaired if
improvements are not made to the entire Internet infrastructure to alleviate
overloading and congestion.
We could be subject to increased operating costs, as well as claims,
litigation or other potential liability, in connection with risks associated
with Internet security and the security of our systems. A significant barrier
to the growth of e-commerce and communications over the Internet has been the
need for secure transmission of confidential information. Several of our
Internet application services utilize encryption and authentication technology
licensed from third parties to provide the protections necessary to ensure
secure transmission of confidential information. We also rely on security
systems designed by third parties and the personnel in our network operations
centers to secure those data centers. Any unauthorized access, computer
viruses, accidental or intentional actions and other disruptions could result
in increased operating costs. For example, we may incur additional significant
costs to protect against these interruptions and the threat of security
breaches or to alleviate problems caused by such interruptions or breaches, and
we may expend additional financial resources in the future to equip our data
centers with enhanced security measures. If a third party were able to
misappropriate a consumer's personal or proprietary information, including
credit card information, during the use of an application solution provided by
us, we could be subject to claims, litigation or other potential liability.
We may become subject to burdensome government regulation and legal
uncertainties that could substantially impair our business or expose us to
unanticipated liabilities. It is likely that laws and regulations directly
applicable to the Internet or to Internet application service providers may be
adopted. These laws may cover a variety of issues, including user privacy and
the pricing, characteristics and quality of products and services. The adoption
or modification of laws or regulations relating to commerce over the Internet
could substantially impair 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
16
expose us to substantial liability if they are found to be applicable to our
business. For example, we provide services over the Internet in many states in
the United States and elsewhere and facilitate the activities of our customers
in such jurisdictions. As a result, we may be required to qualify to do
business, be subject to taxation or be subject to other laws and regulations in
these jurisdictions, even if we do not have a physical presence, employees or
property there.
We may be subject to legal claims in connection with the information
disseminated through our network, which could have the effect of diverting
management's attention and require us to expend significant financial
resources. We may face potential direct and indirect liability for claims of
defamation, negligence, copyright, patent or trademark infringement, violation
of securities laws and other claims based on the nature and content of the
materials disseminated through our network. For example, lawsuits may be
brought against us claiming that content distributed by some of our current or
future customers may be regulated or banned. In these and other instances, we
may be required to engage in protracted and expensive litigation that could
have the effect of diverting management's attention and require us to expend
significant financial resources. Our general liability insurance may not
necessarily cover any of these claims or may not be adequate to protect us
against all liability that may be imposed.
In addition, on a limited number of occasions in the past, businesses,
organizations and individuals have sent unsolicited commercial e-mails from
servers hosted at our facilities to a number of people, typically to advertise
products or services. This practice, known as "spamming," can lead to
complaints against service providers that enable such activities, particularly
where recipients view the materials received as offensive. We have in the past
received, and may in the future receive, letters from recipients of information
transmitted by our customers and service providers 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.
Our common stock may be delisted from Nasdaq. On September 5, 2001, we
received a deficiency notice from Nasdaq indicating that our common stock had
failed to maintain a minimum bid price of $1.00 over the previous 30
consecutive trading days and that we had until December 4, 2001 to regain
compliance with Nasdaq's listing requirements. Nasdaq informed us that if we
failed to demonstrate compliance with Nasdaq's listing requirements on or
before December 4, 2001, Nasdaq would provide us with written notification that
it had determined that we do not meet the standards for continued listing, and
our securities would be delisted from Nasdaq. However, on September 27, 2001,
Nasdaq announced that it had suspended its minimum bid and market value of
public float requirements for continued listing until January 2, 2002. Nasdaq
adopted this measure to help companies remain listed in view of the
extraordinary market conditions following the tragedy of September 11, 2001.
Under the temporary relief provided by the new rules, companies will not be
cited for bid price or market value of public float deficiencies and companies,
such as NaviSite, currently under review for deficiencies or in the hearings
process will be taken out of the process with respect to the bid price or market
value of public float requirements and no deficiencies will accrue during the
proposed suspension process.
17
Nevertheless, if the minimum bid price requirement for continued listing on
Nasdaq is reinstated on January 2, 2002, new delisting proceedings may be
initiated against our common stock. If we are unable to regain compliance with
this requirement, our common stock may be delisted from trading on Nasdaq. If
our common stock were delisted from Nasdaq, among other things, this could
result in a number of negative implications, including reduced liquidity in our
common stock as a result of the loss of market efficiencies associated with
Nasdaq and the loss of federal preemption of state securities laws as well as
the potential loss of confidence by suppliers, customers and employees, the
loss of analyst coverage and institutional investor interest, fewer business
development opportunities and greater difficulty in obtaining financing.
Item 2. Properties
Facilities
Our executive offices are located at 400 Minuteman Road, Andover,
Massachusetts, in an approximately 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 two domestic data center locations, with a total of
approximately 74,000 square feet of raised floor. In addition to the 400
Minuteman Road data center, we also occupy a 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.
On July 31, 2001, we closed a 22,000 square foot facility located at 300
Federal Street, Andover, Massachusetts (10,000 square feet of raised floor). In
addition, we also closed our 14,100 square foot facility at 1700 Green Hill
Road, Scotts Valley, California (4,000 square feet of raised floor). The
closing of these original data centers will allow us to operate our data
centers more efficiently. In addition to our existing data centers, we
presently utilize approximately 10,000 square feet of space in Sunnyvale,
California and approximately 2,000 square feet of space in New York through an
arrangement with Level 3.
Sales and Marketing Space:
In connection with our sales and marketing efforts, we occupy offices at
11601 Wilshire Boulevard, Suite 500, Los Angeles, California; 680 Third Avenue
10th Floor, New York, New York; 2720 Zanker Road, San Jose, California; 8300
Boone Boulevard, Suite 540, Vienna, Virginia; 3340 Peachtree Road, Atlanta, GA;
575 Market Street, San Francisco, 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
On or about June 13, 2001, Stuart Werman and Lynn McFarlane filed a lawsuit
against us, BancBoston Robertson Stephens, Inc., an underwriter of our initial
public offering in October 1999, Joel B. Rosen, our then Chief Executive
Officer, and Kenneth W. Hale, our then Chief Financial Officer. The suit was
filed in the United States District Court for the Southern District of New
York. The suit generally alleges that the defendants violated federal
securities laws by not disclosing certain actions allegedly taken by Robertson
18
Stephens in connection with our initial public offering. The suit alleges
specifically that Robertson Stephens, in exchange for the allocation to its
customers of shares of our common stock sold in our initial public offering,
solicited and received from its customers undisclosed commissions on
transactions in other securities and required its customers to purchase
additional shares of our common stock in the aftermarket at pre-determined
prices. The suit seeks unspecified monetary damages and certification of a
plaintiff class consisting of all persons who acquired shares of our common
stock between October 22, 1999 and December 6, 2000.
On or about June 21, 2001, David Federico filed in the United States
District Court for the Southern District of New York a lawsuit against us, Mr.
Rosen, Mr. Hale, FleetBoston Robertson Stephens, Inc. and other underwriter
defendants including J.P. Morgan Chase, First Albany Companies, Inc., Bank of
America Securities, LLC, Bear Stearns & Co., Inc., B.T. Alex.Brown, Inc., Chase
Securities, Inc., CIBC World Markets, Credit Suisse First Boston Corp., Dain
Rauscher, Inc., Deutsche Bank Securities, Inc., The Goldman Sachs Group, Inc.,
J.P. Morgan & Co., J.P. Morgan Securities, Lehman Brothers, Inc., Merrill
Lynch, Pierce, Fenner & Smith, Inc., Morgan Stanley Dean Witter & Co., Robert
Fleming, Inc. and Salomon Smith Barney, Inc. The suit generally alleges that
the defendants violated the anti-trust laws and the federal securities laws by
conspiring and agreeing to raise and increase the compensation received by the
underwriter defendants by requiring those who received allocation of initial
public offering stock to agree to purchase shares of manipulated securities in
the after-market of the initial public offering at escalating price levels
designed to inflate the price of the manipulated stock, thus artificially
creating an appearance of demand and high prices for that stock, and initial
public offering stock in general, leading to further stock offerings. The suit
also alleges that the defendants arranged for the underwriter defendants to
receive undisclosed and excessive brokerage commissions and that, as a
consequence, the underwriter defendants successfully increased investor
interest in the manipulated initial public offering securities and increased
the underwriter defendants' individual and collective underwritings,
compensation and revenues. The suit further alleges that the defendants
violated the federal securities laws by issuing and selling securities pursuant
to the initial public offering without disclosing to investors that the
underwriter defendants in the offering, including the lead underwriters, had
solicited and received excessive and undisclosed commissions from certain
investors. The suit seeks unspecified monetary damages and certification of a
plaintiff class consisting of all persons who acquired shares of our common
stock between October 22, 1999 and June 12, 2001.
We believe that the allegations are without merit and we intend to
vigorously defend against the plantiffs' claims. As the litigation is in an
initial stage, we are not able to predict the possible outcome of the suits and
their ultimate effect, if any, on our financial condition.
We are also subject to other 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, 2001.
Executive Officers of NaviSite
Patricia Gilligan, age 50, has served as NaviSite's President and Chief
Executive Officer since July 2001. From June 2000 to July 2001, Ms. Gilligan
served as Navisite's Chief Operating Officer . 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.
19
Anthony Amato, age 36, has served as NaviSite's Vice President of Finance
since September 2001. From August 2000 to August 2001, Mr. Amato served as
Director of Finance at CMGI, Inc. From July 1999 to August 2000, Mr. Amato
served as Director of Finance and Administration at Raging Bull, Inc., a
financial messaging board provider and subsidiary of CMGI. From April 1998 to
July 1999, Mr. Amato served as Controller for Software Emancipation Technology,
Inc., a software developer of information systems. From December 1996 to April
1998, Mr. Amato was Controller at MyWay.com Corporation, formerly known as
Planet Direct Corporation, a personal on-line content service and subsidiary of
CMGI.
Kevin Lo, age 28, has served as NaviSite's Vice President of Products,
Services and Business Development since July, 2001 and has served as Chief
Technology Officer since January 2001. From October 2000 to January 2001, Mr.
Lo served NaviSite as the Director of Utility Infrastructure Services. From
August 1997 to October 2000, Mr. Lo served as Chairman and Chief Executive
Officer at X-Collaboration Software Corporation, an application infrastructure
provider of collaborative Web services. From September 1995 to August 1997, Mr.
Lo was a Strategy Consultant at Bain & Company.
Martin Sinozich, age 39, has served as NaviSite's Vice President of
Operations since March 2001. Mr. Sinozich served as Chief Operating Officer of
Epesi, a web services firm, from November 2000 to March 2001. From June 1999 to
November 2000, Mr. Sinozich served as Vice President of Operations for Engage,
Inc., a subsidiary of CMGI. From November 1996 to June 1999, Mr. Sinozich
served as Vice President at Fidelity Investments. From April 1995 to November
1996, Mr. Sinozich served as Vice President of Desktop Computing for MBNA
America Bank.
Wayne Whitcomb, age 42, has served as NaviSite's Vice President of
Engineering since October 2001. From February 2001 to September 2001, Mr.
Whitcomb served as Chief Infrastructure Architect for NaviSite. From August
2000 to February 2001, Mr. Whitcomb was Vice President of Engineering for
Mirror Image, a content delivery network. From August 1998 to August 2000, Mr.
Whitcomb was Vice President of Engineering at MyWay.com Corporation, formerly
known as Planet Direct Corporation, a subsidiary of CMGI. From May 1997 to
August 1998, Mr. Whitcomb was Director of Information Services at MyWay.com.
From February 1997 to May 1997, Mr. Whitcomb was a consultant for OceanOne
Technologies LLC, a technology consulting firm. From April 1995 to February
1997, Mr. Whitcomb was a Manager and Team Leader of Integrated Business Systems
at Borden Global Packaging.
20
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 September 30, 2001, there
were 118 holders of record of our common stock. Because brokers and other
institutions on behalf of stockholders hold many of such shares, 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.
Closing Price
--------------
High Low
------- ------
Fiscal Year Ending July 31, 2001:
May 1, 2001 through July 31, 2001.......................... $ 2.85 $ 0.75
February 1, 2001 through April 30, 2001.................... 3.59 1.03
November 1, 2000 through January 31, 2001.................. 12.75 2.03
August 1, 2000 through October 31, 2000.................... 53.00 7.78
Fiscal Year Ending July 31, 2000:
May 1, 2000 through July 31, 2000.......................... $ 58.88 $34.00
February 1, 2000 through April 30, 2000.................... 164.94 26.50
November 1, 1999 through January 31, 2000.................. 63.25 21.50
October 22, 1999 through October 31, 1999.................. 25.50 14.06
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 11, 2001, we issued 158,956 shares of our common stock to CMGI for
payment of interest in an amount of $586,155 related to the $80 million
convertible notes payable to CMGI. These shares were issued on June 11, 2001,
representing the number of shares of common stock equal to $586,155 divided by
the average of the closing prices per share of common stock as reported on the
Nasdaq National Market on January 24, 25, 26, 29 and 30, 2001, rounded up to
the nearest whole share. On June 11, 2001, we issued 801,675 shares of our
common stock to CMGI for payment of interest in an amount of $1,518,375 related
to the notes. These shares were issued on June 11, 2001, representing the
number of shares of common stock equal to $1,518,375 divided by the average of
the closing prices per share of common stock as reported on the Nasdaq National
Market on April 23, 24, 25, 26 and 27, 2001, rounded up to the nearest whole
share. On July 31, 2001, we issued 1,829,075 shares of our common stock to CMGI
for payment of interest in an amount of $1,503,500 related to the notes. These
shares were issued on July 31, 2001, representing the number of shares of
common stock equal to $1,503,500 divided by the average of the closing prices
per share of common stock as reported on the Nasdaq National Market on July 24,
25, 26, 27 and 30, 2001, 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.
21
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. Historical results are not
necessarily indicative of results of any future period.
(Amounts in 000's except per Year Ended July 31,
share data) ------------------------------------------------
2001 2000 1999 1998 1997
--------- -------- -------- -------- -------
STATEMENT OF OPERATIONS DATA:
Revenue:
Revenue....................... $ 66,358 $ 24,870 $ 3,461 $ 158 $ --
Revenue, related parties...... 36,368 24,893 7,058 3,871 3,361
--------- -------- -------- -------- -------
Total revenue................... 102,726 49,763 10,519 4,029 3,361
Cost of revenue................. 129,085 68,496 20,338 8,876 3,494
--------- -------- -------- -------- -------
Gross margin................ (26,359) (18,733) (9,819) (4,847) (133)
Operating expenses:
Product development........... 14,072 5,197 2,620 287 --
Selling and marketing......... 32,251 22,805 6,888 2,530 347
General and administrative.... 33,011 12,270 4,823 1,412 467
Restructuring................. 8,011 -- -- -- --
--------- -------- -------- -------- -------
Total operating expenses.... 87,345 40,272 14,331 4,229 814
Loss from operations............ (113,704) (59,005) (24,150) (9,076) (947)
Other income (expense):
Interest income............... 2,753 2,027 4 -- --
Interest expense.............. (8,042) (1,001) (347) (85) (1)
Other income (expense), net... 292 9 (39) (11) --
--------- -------- -------- -------- -------
Loss before cumulative effect of
change in accounting
principle...................... (118,701) (57,970) (24,532) (9,172) (948)
Cumulative effect of change in
accounting principle........... (4,295) -- -- -- --
--------- -------- -------- -------- -------
Net loss........................ (122,996) (57,970) (24,532) (9,172) (948)
Accretion of dividends on Series
C and D convertible redeemable
preferred stock................ -- -- (172) -- --
--------- -------- -------- -------- -------
Net loss applicable to common
shareholders................... $(122,996) $(57,970) $(24,704) $ (9,172) $ (948)
========= ======== ======== ======== =======
Basic and diluted net loss per
common share:
Before cumulative effect of
change in accounting
principle.................... $ (2.01) $ (1.37) $ (3.71) $ (0.57) $ (0.12)
Cumulative effect of change in
accounting principle......... (0.07) -- -- -- --
--------- -------- -------- -------- -------
Basic and diluted net loss per
common share................... $ (2.08) $ (1.37) $ (3.71) $ (0.57) $ (0.12)
========= ======== ======== ======== =======
Basic and diluted weighted
average number of common shares
outstanding.................... 58,993 42,270 6,663 16,034 8,000
========= ======== ======== ======== =======
BALANCE SHEET DATA:
Working capital (deficit)....... $ (9,683) $ 48,159 $ (1,355) $(13,552) $(2,566)
========= ======== ======== ======== =======
Total assets.................... $ 112,266 $175,461 $ 21,111 $ 5,479 $ 2,010
========= ======== ======== ======== =======
Long-term obligations........... $ 69,852 $ 24,988 $ 1,935 $ 1,090 $ --
========= ======== ======== ======== =======
Shareholder's equity (deficit).. $ (6,962) $ 97,474 $ (4,369) $(10,066) $ (895)
========= ======== ======== ======== =======
22
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, affected 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 outsourced Web hosting and managed application services for
companies conducting business on the Internet, including enterprises and other
businesses deploying Internet applications. Our goal is to help customers focus
on their core competencies by outsourcing the management and hosting of their
Web operations and applications, allowing customers to fundamentally improve
the efficiency of their Web operations. We also provide related professional
and consulting services. Our focus on enhanced management services, beyond
basic co-location services, allows us to meet the expanding needs of businesses
as their Web sites and Internet applications become more complex. We believe
that we are one of only a relatively small number of companies that combine a
highly scalable and developed infrastructure with experience, intellectual
property, skill sets, processes and procedures for delivering managed hosting
services. The cost for our services varies from customer to customer based on
the number of managed servers and the nature, extent and level of services
provided.
We were incorporated in Delaware in December 1998 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.
Since January 31, 2000, our corporate headquarters has been located at 400
Minuteman Road, Andover, Massachusetts. Before this date, our corporate
headquarters was shared with CMGI and several other CMGI
23
affiliates. CMGI allocated rent, facility maintenance and service costs among
these affiliates based upon headcount within each affiliate and within each
department of each affiliate. Other services provided by CMGI to us included
support for enterprise services, human resources and benefits and Internet
marketing and business development. Management believes that costs approximate
the fair value of the services received. Actual expenses could have varied had
we been operating on a stand-alone basis. Costs are allocated to us on the
basis of the fair market value for the facilities used and the services
provided. Through July 31, 2001, we operated two data centers in California and
two data centers in Andover, Massachusetts. On July 31, 2001, we announced the
closure of our two original data centers, one in Andover, Massachusetts and one
in Scotts Valley, California.
We derive our revenue primarily from managed hosting services, but within
that framework, from a variety of services, including: Web site and Internet
application hosting, which includes access to our state-of-the-art data
centers, a range of bandwidth services, Content Distribution Network services,
advanced back-up options, managed storage and monitoring services; enhanced
server management, which includes custom reporting, hardware options, network
and application load balancing, system security, and the services of our
technical account managers; specialized application management, which includes
management of e-commerce and other sophisticated applications support services,
including scalability testing, streaming services for managed hosting
customers, databases and transaction processing services. We also derive
revenue from related consulting and other professional services, and from
providing a full suite of streaming services for the production, management,
reporting, and tracking of live and on-demand web events. Revenue also includes
income from the rental of equipment to customers, termination fees and one-time
installation fees. Revenue is recognized in the period in which the services
are performed. Installation fees are recognized over the period of the customer
contract. Previous to fiscal year 2001, installation revenue was recognized at
the time installation services were provided. Our customer contracts generally
are a one to three year commitment.
We have incurred significant net losses and negative cash flows from
operations since our inception and, as of July 31, 2001, had an accumulated
deficit of approximately $215.7 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 in sales,
marketing, promotion, technology and infrastructure development as we grow. We
believe that we will continue to incur operating losses and negative cash flows
from operations for at least the next fiscal year.
Recent Developments
On October 29, 2001, we entered into an agreement under which we will
receive a total of $65 million in financing from CFS and CMGI. Under the terms
of the agreement, CFS and CMGI will provide us with cash investments of $20
million and $10 million respectively in exchange for convertible notes.
Additionally, CFS has agreed to restructure certain outstanding NaviSite lease
obligations. We have agreed to purchase equipment from CFS leased under
operating leases in exchange for a six-year, $35 million convertible note. As a
result, we expect to substantially reduce cash expenditures on operating leases
over the next two fiscal years. This note also allows us to finance past due
lease payments, the sales tax on the equipment purchase and the outright
purchase of the equipment.
The notes bear interest at 12% and will require payment of interest only for
the first three years from the date of issuance and then repayment of interest
and principal, on a straight-line basis, over the next three years until
maturity on the sixth anniversary of the date of issuance. The principal amount
may be convertible into our common stock at the option of the noteholders at
any time prior to or at maturity. Should CFS convert its notes into NaviSite
common stock, they would own a controlling stake in NaviSite. Additionally, the
agreement includes a provision for non-voting participation rights by CFS on
our board of directors.
As a part of this agreement, CMGI has also agreed to convert its existing
$80 million in outstanding notes into approximately 14.5 million shares of our
common stock and an additional $16.2 million of other amounts
24
due CMGI into approximately 9.9 million shares of our common stock. The result
of this agreement is that $7 million in remaining interest payments due to
CMGI, $9.2 million in unamortized debt issuance costs and the repayment of the
$80 million principal amount due in December 2003 will be converted to equity.
This agreement has been approved by the boards of directors of each of
NaviSite, CMGI and CFS. Certain NaviSite terms relating to the authorization
and issuance of shares of our common stock upon conversion of the senior
secured convertible notes issued under the agreements will be subject to
approval by our stockholders.
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
------------------------
2001 2000 1999
------ ------ ------
Revenue:
Revenue....................................... 64.6% 50.0% 32.9%
Revenue, related parties...................... 35.4% 50.0% 67.1%
------ ------ ------
Total revenue............................... 100.0% 100.0% 100.0%
Cost of revenue................................. 125.7% 137.6% 193.3%
------ ------ ------
Gross margin................................ (25.7)% (37.6)% (93.3)%
Operating expenses:
Product development........................... 13.7% 10.4% 24.9%
Selling and marketing......................... 31.4% 45.8% 65.5%
General and administrative.................... 32.1% 24.7% 45.9%
Restructuring................................. 7.8% 0.0% 0.0%
------ ------ ------
Total operating expenses.................... 85.0% 80.9% 136.3%
------ ------ ------
Loss from operation............................. (110.7)% (118.5)% (229.6)%
Other income (expense):
Interest income............................... 2.7% 4.1% 0.1%
Interest expense.............................. (7.8)% (2.0)% (3.3)%
Other income (expense), net................... 0.3% 0.0% (0.4)%
------ ------ ------
Total other income (expense)................ (4.8)% 2.1% (3.6)%
------ ------ ------
Loss before cumulative effect of change in
accounting principle........................... (115.5)% (116.4)% (233.2)%
Cumulative effect of change in accounting
principle...................................... (4.2)% 0.0% 0.0%
------ ------ ------
Net loss........................................ (119.7)% (116.4)% (233.2)%
====== ====== ======
Comparison of Fiscal Years Ended July 31, 2001 and 2000
Revenue
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 2001, we sold services to CMGI and CMGI
affiliates totaling approximately $36.4 million, or 35% of revenue. Four of
these customers accounted for approximately 24.64%, 17.14%, 15.07% and 13.57%
of revenue, respectively. As of July 31, 2001, CMGI owned approximately 69.35%
of our outstanding common stock, the balance of the common stock owned by the
public.
25
Total revenue increased 106% to approximately $102.7 million in fiscal 2001,
from approximately $49.8 million in fiscal 2000. The increase in revenue is due
primarily to an increase of approximately $13.8 million of revenue related to
the 114 new unaffiliated customers in the fiscal year and additional business
with both existing unaffiliated customers, and affiliated customers of CMGI.
Revenue from unaffiliated customers increased to approximately $66.4 million or
65% of total revenue, from approximately $24.8 million or 50% of total revenue
for fiscal year 2000. The number of unaffiliated customers decreased 19% to 273
at July 31, 2001 from 338 as of July 31, 2000. We will continue to focus our
efforts to expand our revenues with new unaffiliated enterprise customers over
the near term. However, there can be no assurance that we will be successful or
that the industry trend towards outsourcing IT functions and Web hosting
applications will increase in the future. For fiscal year 2002, we are
anticipating a 10 to 15% decrease in revenue from the fiscal year 2001 levels.
During fiscal year 2001, we adopted SEC Staff Accounting Bulletin No. 101--
Revenue Recognition in Financial Statements ("SAB 101"). Under SAB 101,
installation fees are recognized over the life of the related customer
contracts. Prior to fiscal year 2001, we recognized installation fees at the
time the installation occurred. The cumulative effect of the change in
accounting principle on all prior years resulted in a $4.3 million increase in
net loss for the year ended July 31, 2001 and is reflected as a cumulative
effect of change in accounting principle. Revenue for the year ended July 31,
2001 includes $1.5 million that was included in the cumulative effect
adjustment. The $1.5 million of 2001 revenue was primarily attributable to the
recognition of previously deferred revenue on customers lost during 2001.
Cost of Revenue
Cost of revenue consists primarily of salaries and benefits for operations
personnel, bandwidth fees and related Internet connectivity charges, equipment
costs and related depreciation and costs to run our four data centers, such as
rent and utilities. With the growth of our business, we expect these costs to
increase in dollar terms, but decline on a percentage of revenue basis. 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. For
fiscal year 2002, we are anticipating that the cost of sales will decrease from
the fiscal year 2001 levels. The anticipated decrease is a result of our fiscal
year 2001 restructuring efforts. The restructuring efforts are expected to
result in decreased labor costs and reduced equipment and infrastructure
expenses going forward.
Cost of revenue in dollars increased 88% to approximately $129.1 million in
fiscal 2001, from approximately $68.5 million in fiscal 2000. As a percentage
of revenue, cost of revenue decreased to 126% in fiscal 2001, from 138% in
fiscal 2000. The dollar-value increase 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. Included in the fiscal year 2001 cost of revenue is a
charge of approximately $1.9 million related to certain equipment under
operating leases, which has been deemed not to have a future economic benefit
us.
Gross Margin
Gross margin improved to approximately a negative (25.7%) of total revenue
for fiscal year 2001, from approximately a negative (37.6%) of total revenue
for fiscal year 2000. The improvement in the gross margin is a direct result of
scaling the fixed infrastructure and labor costs across a larger customer base.
Our business model requires that we make "up-front" fixed investments in both
equipment and personnel. These costs are leveraged across our data centers. We
anticipate that our gross margins will continue to improve, based on current
estimates and expectations and barring unforeseen circumstances, as our
occupancy rate increases and we achieve higher operational efficiencies and
economies of scale.
Operating Expenses
Product Development. 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
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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 implements the various
technologies, including network storage and back-up, that provide the
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. For fiscal year 2002, we expect the dollar
value of product development expenses to decline on a percentage of revenue
basis. Product development expenses increased to $14.1 million in fiscal 2001,
from approximately $5.2 million in fiscal 2000. As a percentage of revenue,
product development expenses increased to 14% in fiscal 2001, from 10% in
fiscal 2000. 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 54 at July 31, 2001 from 31 at
July 31, 2000. This growth in product development personnel reflects our
increased service offerings and emphasis on application services.
Selling and Marketing. 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. For fiscal year 2002, we expect selling and marketing expenses to
decline in dollar terms. We continue to make targeted investments in areas that
promote brand recognition and increase new customer acquisitions. We intend to
accomplish t