UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
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(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934.
For the quarterly period ended April 30, 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
__________________
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)
(Address of principal executive offices)
(978) 682-8300
(Registrant's telephone number, including area code)
__________________
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period than the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
As of June 11, 2001 there were 60,016,050 shares outstanding of the Registrant's
common stock, par value $.01 per share.
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NAVISITE, INC.
Form 10-Q for the Quarter ended April 30, 2001
INDEX
Page
Number
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements (Unaudited)
Consolidated Condensed Balance Sheets as of April 30, 2001 and July 31, 2000................. 3
Consolidated Statements of Operations for the three and nine months ended
April 30, 2001 and 2000...................................................................... 4
Consolidated Statements of Cash Flows for the nine months ended
April 30, 2001 and 2000...................................................................... 5
Notes to Interim Consolidated Financial Statements........................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations.................................................................................. 9
Item 3. Quantitative and Qualitative Disclosures About
Market Risk................................................................................. 21
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.................................................................... 21
Item 2. Changes in Securities and Use of Proceeds............................................ 21
Item 3. Defaults Upon Senior Securities...................................................... 21
Item 4. Submission of Matters to a Vote of Security Holders.................................. 21
Item 5. Other Information.................................................................... 21
Item 6. Exhibits and Reports on Form 8-K..................................................... 22
SIGNATURE.................................................................................... 23
EXHIBIT INDEX
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PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements.
NAVISITE, INC.
CONSOLIDATED CONDENSED BALANCE SHEETS
(unaudited)
(in thousands, except par value)
April 30, July 31,
2001 2000
--------- ---------
ASSETS
Current assets:
Cash and cash equivalents................................................ $ 44,055 $ 77,947
Accounts receivable, net................................................. 14,078 14,025
Due from CMGI and affiliates............................................. 3,637 5,985
Prepaid expenses and other current assets................................ 2,746 3,201
--------- ---------
Total current assets.................................................. 64,516 101,158
--------- ---------
Property and equipment, net.............................................. 72,985 70,651
Other assets............................................................. 3,637 3,051
Restricted cash.......................................................... 4,955 --
Goodwill, net............................................................ 446 601
--------- ---------
Total assets.......................................................... $ 146,539 $ 175,461
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Capital lease obligations, current portion............................... $ 62 $ 5,689
Due to CMGI.............................................................. 13,097 5,310
Accounts payable......................................................... 14,481 13,457
Accrued expenses and deferred revenue.................................... 20,973 27,776
Software vendor payable, current portion................................. 819 767
--------- ---------
Total current liabilities............................................. 49,432 52,999
--------- ---------
Capital lease obligations, less current portion.......................... -- 23,999
Software vendor payable, less current portion............................ 315 989
Convertible notes payable to CMGI, net................................... 68,696 --
--------- ---------
Total liabilities..................................................... 118,443 77,987
========= =========
Commitments and contingencies
Stockholders' equity:
Preferred stock, $.01 par value, 5,000 shares authorized; no shares
issued and outstanding................................................ -- --
Common stock, $.01 par value, 150,000 shares authorized; 59,020 and
58,364 shares issued and outstanding at April 30, 2001 and July
31, 2000, respectively................................................ 590 584
Deferred compensation.................................................... -- (762)
Additional paid-in capital............................................... 204,474 190,301
Accumulated deficit...................................................... (176,968) (92,649)
--------- ---------
Total stockholders' equity............................................... 28,096 97,474
--------- ---------
Total liabilities and stockholders' equity............................... $ 146,539 $ 175,461
========= =========
See accompanying notes to interim unaudited consolidated financial
statements.
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NAVISITE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
(in thousands, except per share data)
Three months Nine months
ended ended
April 30, April 30,
-------------------- --------------------
2001 2000 2001 2000
-------- -------- -------- --------
Revenue:
Revenue............................................. $ 17,313 $ 6,757 $ 49,315 $ 13,224
Revenue, related parties............................ 8,850 7,438 30,582 16,007
-------- -------- -------- --------
Total revenue..................................... 26,163 14,195 79,897 29,231
Cost of revenue..................................... 32,945 20,161 98,772 41,552
-------- -------- -------- --------
Gross margin........................................ (6,782) (5,966) (18,875) (12,321)
-------- -------- -------- --------
Operating expenses:
Selling and marketing............................... 7,954 6,310 27,246 15,380
General and administrative.......................... 8,516 3,131 24,303 8,395
Product development................................. 4,143 1,357 10,836 3,304
-------- -------- -------- --------
Total operating expenses.......................... 20,613 10,798 62,385 27,079
-------- -------- -------- --------
Loss from operations................................ (27,395) (16,764) (81,260) (39,400)
Other income (expense):
Interest income..................................... 679 382 2,372 1,221
Interest expense.................................... (2,603) (48) (5,305) (244)
Other............................................... (6) -- (126) --
-------- -------- -------- --------
Net loss............................................ $(29,325) $(16,430) $(84,319) $(38,423)
======== ======== ======== ========
Basic and diluted net loss per common share......... $ (.50) $ (.29) $ (1.44) $ (.98)
======== ======== ======== ========
Basic and diluted weighted average number of common
shares outstanding.................................. 58,914 56,304 58,717 39,202
======== ======== ======== ========
Pro forma basic and diluted net loss per share...... $ (.73)
Pro forma basic and diluted weighted average number ========
of shares outstanding............................... 52,371
========
See accompanying notes to interim unaudited consolidated
financial statements.
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NAVISITE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands)
Nine months
ended April 30,
--------------------
2001 2000
-------- --------
Cash flows from operating activities:
Net loss............................................................................. $(84,319) $(38,423)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization........................................................ 11,435 5,899
Amortization of interest related to stock warrants issued with notes payable to
CMGI............................................................................... 1,614 --
Amortization of deferred compensation................................................ 1,051 663
Loss on disposal of assets........................................................... 120 --
Provision for bad debts.............................................................. 8,127 481
Changes in operating assets and liabilities:
Accounts receivable................................................................ (8,180) (6,628)
Due from CMGI and affiliates....................................................... 2,348 (5,660)
Prepaid expenses and other current assets.......................................... 455 (960)
Accounts payable................................................................... 1,848 8,462
Due to CMGI........................................................................ 7,787 12,898
Accrued expenses and deferred revenue.............................................. (9,803) 5,799
-------- --------
Net cash used in operating activities............................................ (67,517) (17,469)
-------- --------
Cash flows from investing activities:
Net cash acquired in acquisition..................................................... -- 6
Purchases of property and equipment.................................................. (24,618) (44,804)
Restricted cash...................................................................... (4,955) --
Proceeds from sale of property and equipment......................................... 13,884 --
Increase in other assets............................................................. (586) (2,610)
-------- --------
Net cash used in investing activities............................................ (16,275) (47,408)
Cash flows from financing activities:
Proceeds from issuance of common stock, net of issuance costs........................ -- 80,382
Issuance of convertible notes payable to CMGI........................................ 80,000 --
Repayment of note payable............................................................ -- (1,000)
Proceeds from exercise of stock options and Employee Stock Purchase Plan ............ 972 356
Payments of capital lease obligations................................................ (29,626) (176)
Payments of software vendor obligations.............................................. (1,446) (510)
-------- --------
Net cash provided by financing activities........................................ 49,900 79,052
-------- --------
Net (decrease) increase in cash...................................................... (33,892) 14,175
Cash and cash equivalents, beginning of period....................................... 77,947 3,352
-------- --------
Cash and cash equivalents, end of period............................................. $ 44,055 $ 17,527
======== ========
Supplemental disclosure of cash flow information:
Cash paid during the period for interest......................................... $ 30 $ 274
======== ========
Supplemental disclosure of noncash financing and investing activities:
Amount ascribed to the issuance of stock warrants and related to the convertible
notes payable to CMGI $ 12,918 $ --
======== ========
Software vendor obligations $ 3,000 $ --
======== ========
See accompanying notes to interim unaudited consolidated
financial statements.
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NAVISITE, INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
April 30, 2001
1. Basis of Presentation
The accompanying unaudited consolidated financial statements have been
prepared by NaviSite, Inc. ("NaviSite" or the "Company") in accordance with
accounting principles generally accepted in the United States of America ("U.S.
GAAP") and pursuant to the rules and regulations of the Securities and Exchange
Commission ("SEC"). Certain information and footnote disclosures normally
included in financial statements prepared in accordance with U.S. GAAP have been
condensed or omitted pursuant to such rules and regulations. It is suggested
that the financial statements be read in conjunction with the audited financial
statements and the accompanying notes included in the Company's Annual Report on
Form 10-K for the year ended July 31, 2000, which was filed with the SEC on
October 30, 2000.
The information furnished reflects all adjustments, which in the
opinion of management, are of a normal reoccurring nature and are considered
necessary for a fair presentation of results for the interim periods. Such
adjustments consist only of normal recurring items. It should also be noted that
results for the interim periods are not necessarily indicative of the results
expected for the full year or any future period.
The preparation of these consolidated financial statements in
conformity with U.S. GAAP requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosures of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
2. Principles of Consolidation
The accompanying financial statements include the accounts of the
Company and its wholly owned subsidiary, ClickHear, Inc. ("ClickHear"), after
elimination of all significant intercompany balances and transactions.
3. Cash and Cash Equivalents
Cash equivalents consist of a money market fund, which invests in high
quality short-term debt obligations, including commercial paper, asset-backed
commercial paper, corporate bonds, U.S. government agency obligations, taxable
municipal securities and repurchase agreements.
On February 3, 2001, the Company renewed two letters of credit related
to certain of its leased facilities. Under the terms of the letters of credit,
the Company was required to pledge approximately $5.0 million in cash, which is
reflected as restricted cash on the accompanying balance sheet at April 30,
2001.
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4. Property and Equipment
April 30, July 31,
2001 2000
--------- --------
(In thousands)
Office furniture and equipment.................................. $ 5,780 $ 4,335
Computer equipment.............................................. 19,064 21,558
Software licenses............................................... 19,916 11,941
Leasehold improvements.......................................... 33,655 42,101
Leasehold improvements in progress.............................. 14,179 --
------------ ----------
92,594 79,935
Less: Accumulated depreciation and amortization (19,609) (9,284)
------------ ----------
$ 72,985 $ 70,651
============ ==========
5. Net Loss Per Common Share
Basic loss per share is computed using the weighted average number of
common shares outstanding during the period. Diluted loss per share is computed
using the weighted average number of common and dilutive common equivalent
shares outstanding during the period, using either the "as-if-converted" method
for convertible preferred stock and convertible notes payable due to CMGI, Inc.
("CMGI") or the treasury stock method for options and warrants, unless such
amounts are anti-dilutive.
For the three and nine months ended April 30, 2001 and three months
ended April 30, 2000, net loss per basic and diluted share is based on weighted
average common shares and excludes any common stock equivalents, as they would
be anti-dilutive due to the reported loss. For the nine months ended April 30,
2000, a pro forma basic and diluted loss per share calculation, assuming the
conversion of all amounts due to CMGI and all outstanding shares of preferred
stock into common stock using the "as-if-converted" method from the later of the
date of issuance or beginning of the period, is presented. All amounts due to
CMGI were converted to preferred stock, and all outstanding preferred stock was
converted into 43,244,630 shares of common stock in connection with the closing
of the Company's initial public offering. The following table provides a
reconciliation of the denominators used in calculating the pro forma basic and
diluted loss per share for the nine months ended April 30, 2000:
Numerator:
Net loss.................................................................... $ (38,423)
==============
Denominator:
Basic weighted average number of common shares outstanding.................. 39,202
Assumed conversion of amounts due to CMGI and preferred stock............... 13,169
--------------
Weighted average number of pro forma basic and diluted shares outstanding... $ 52,371
==============
Pro forma basic and diluted net loss per share.............................. $ (.73)
==============
6. Leases
In June 2000, the Company sold certain equipment and leasehold
improvements in its two new data centers in a sale-leaseback transaction to a
bank for approximately $30.0 million. The Company entered into a capital lease
(the "Capital Lease") for the leaseback of those assets. In January 2001, the
Company paid-off the Capital Lease obligation for approximately $27.0 million.
During the second quarter of fiscal year 2001, the Company sold certain
equipment in sale-leaseback transactions for a total of approximately $13.9
million. Simultaneously with the sales, the Company entered into operating
leases for the equipment. The leases are payable in monthly installments of
principal and interest totaling approximately $607,000 through December 31,
2002.
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7. Convertible Notes
On December 12, 2000, the Company entered into a Note and Warrant
Purchase Agreement (the "Agreement") with CMGI. The Agreement provides for the
sale of a subordinated, unsecured, convertible note in the principal amount of
$50,000,000 and a subordinated, unsecured, convertible note in the principal
amount of $30,000,000 (collectively, the "Notes"). The Notes are convertible at
CMGI's option, and by NaviSite under defined circumstances, into NaviSite common
stock, $.01 par value per share ("Common Stock"), at a conversion price of
$5.535 per share. In connection with the Agreement, the Company granted to CMGI,
effective December 15, 2000, two warrants to purchase 2,601,525 shares of Common
Stock, for an total of 5,203,050 shares of Common Stock. The exercise price for
each warrant is $5.77 and $6.92 per share, respectively. These warrants are
exercisable upon issuance and expire on December 15, 2005. The Company ascribed
a fair value, using the Black-Scholes method, to the warrants of approximately
$12.9 million and is amortizing this value over the life of the Notes as an
additional component of interest expense.
During the quarter ended January 31, 2001, the Company received gross
proceeds of $80.0 million from the issuance of the Notes. The annual interest
rate of the Notes is 7.5% payable quarterly in, at the Company's discretion,
either cash or Common Stock. During the fourth quarter of fiscal 2001, the
Company paid CMGI interest accrued on the Notes through the date of payment in
the amount of $2,104,530. The Company elected to make this payment in the form
of 960,631 shares of Common Stock. The principal amount of the Notes is due in
full by December 12, 2003.
8. Stockholders' Equity
During the nine months ended April 30, 2001, the Company granted
options to purchase 7,217,635 shares of Common Stock at exercise prices ranging
from $1.03 to $49.81 per share. During the nine months ended April 30, 2001,
468,736 options were exercised at prices ranging from $.01 to $7.00 per share.
During the nine months ended April 30, 2001, 1,917,474 options were cancelled at
prices ranging from $.03 to $153.75 per share.
9. New Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 133, Accounting for
Derivative Instruments and Hedging Activities. SFAS 133 was amended by SFAS 138
in June 2000. SFAS 133 and SFAS 138 will require the Company to record all
derivatives on the balance sheet at fair value. The Company adopted these
statements on August 1, 2000. Since the Company does not have any derivative
financial instruments and does not engage in hedging activities, the adoption of
SFAS 133 and SFAS 138 had no impact on the consolidated financial statements.
In December 1999, the SEC released Staff Accounting Bulletin ("SAB")
No. 101, Revenue Recognition in Financial Statements, as amended by SAB No. 101A
and SAB 101B, which expresses the views of the SEC staff in applying generally
accepted accounting principles to certain revenue recognition issues. SAB 101
will be adopted by the Company in its fourth quarter of fiscal 2001. Although we
do not expect the adoption of SAB 101 to have a material effect on our
consolidated financial position or results of operations, the SEC has released
implementation guidance and we are in the process of analyzing the effect.
10. Subsequent Event
On June 11, 2001, CMGI provided the Company with a $30 million funding
commitment through the end of fiscal 2002 in the event that the Company requires
additional funding. CMGI's funding commitment is subject to certain conditions,
such as the negotiation of a mutually acceptable funding vehicle, the Company's
financial condition and prospects (including the Company's prospects of
achieving profitability or being sold), the financial condition of CMGI and its
affiliates, the then prevailing market conditions and the approval of the
respective boards of directors of the Company and CMGI.
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Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
This Quarterly Report on Form 10-Q contains forward-looking statements
within the meaning of Section 21E of the Securities Exchange Act of 1934, as
amended, that involve risks and uncertainties. All statements other than
statements of historical information provided herein are forward-looking
statements and may contain information about financial results, economic
conditions, trends and known uncertainties. Our actual results could differ
materially from those discussed in the forward-looking statements as a result of
a number of factors, including those discussed in this section and elsewhere in
this report and the risks discussed in our other filings with the Securities and
Exchange Commission. Readers are cautioned not to place undue reliance on these
forward-looking statements, which reflect management's analysis, judgment,
belief or expectation only as of the date hereof. We undertake no obligation to
publicly reissue these forward-looking statements to reflect events or
circumstances that arise after the date hereof.
Overview
We provide outsourced Web hosting and managed application services for
companies conducting business on the Internet, including enterprises and other
businesses deploying Internet applications. Our goal is to help customers focus
on their core competencies by outsourcing the management and hosting of their
Web operations and applications, allowing customers to fundamentally improve the
efficiency of their Web operations. We also provide related professional and
consulting services. Our focus on enhanced management services, beyond basic co-
location services, allows us to meet the expanding needs of businesses as their
Web sites and Internet applications become more complex. We believe that we are
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.
Since January 31, 2000, our corporate headquarters has been located at
400 Minuteman Road, Andover, Massachusetts. Before this date, our corporate
headquarters were shared with CMGI and several other CMGI affiliates. CMGI
allocated rent, facility maintenance and service costs among these affiliates
based upon headcount within each affiliate and within each department of each
affiliate. Other services provided by CMGI to us included support for enterprise
services, human resources and benefits and Internet marketing and business
development. Management believes that costs approximate the fair value of the
services received. Actual expenses could have varied had we been operating on a
stand-alone basis. Costs are allocated to us on the basis of the fair market
value for the facilities used and the services provided. We operate two data
centers in California and two data centers in Andover, Massachusetts.
On March 14, 2001, we announced that we had been approached by
companies interested in strategic investments or acquisitions and that we
engaged the investment banking firm of Goldman, Sachs & Co. to assist us in
exploring acquisition and other strategic alternatives. While this process and
relationship is ongoing and productive, no assurances can be given that any such
transaction will occur.
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
and installation fees are recognized in the period of installation. Our
contracts generally are a one to three year commitment.
Our revenue from sales to related parties principally consists of sales
of services to CMGI and other customers that are CMGI affiliates. In general, in
pricing the services provided to CMGI and its affiliates, we have: negotiated
the services and levels of service to be provided; calculated the price of the
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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%.
THREE-MONTH PERIOD ENDED APRIL 30, 2001 COMPARED TO THE THREE-MONTH PERIOD ENDED
APRIL 30, 2000
Revenue
Total revenue increased 84% to approximately $26.2 million for the
three-month period ended April 30, 2001, from approximately $14.2 million for
the same period in 2000. The increase in revenue is due primarily to an increase
of approximately $12.7 million of revenue related to the 28 new unaffiliated
customers in the quarter and additional business with both existing unaffiliated
customers, affiliated customers of CMGI and termination fees totaling $841,000,
offset by a reduction of approximately $1.5 million of revenue related to lost
customers. Revenue from unaffiliated customers increased to approximately $17.3
million or 66% of total revenue for the three-month period ended April 30, 2001,
from approximately $6.8 million or 48% of total revenue for the same period in
2000. The number of unaffiliated customers increased 27% to 327 at April 30,
2001 from 258 as of April 30, 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.
Cost of Revenue
Cost of revenue principally includes labor and headcount expenses,
equipment and maintenance costs, bandwidth and connectivity charges, and
depreciation and lease expense from our data centers. Cost of revenue increased
63% to approximately $32.9 million for the three-month period ended April 30,
2001, from approximately $20.2 million for the same period in 2000. As a
percentage of revenue, cost of revenue decreased to 126% for the three-month
period ended April 30, 2001, from 142% for the same period in 2000. The
dollar-value increase in the three-month period ended April 30, 2001 as compared
to the same period in 2000 is due primarily to the costs associated with the
increased investment in our existing data centers and an increase in labor
expense. Management anticipates, barring unforeseen circumstances, that our cost
of revenue as a percentage of revenue will continue to decrease beginning in our
fourth quarter of fiscal 2001 as we continue to focus on our efforts to improve
operational efficiencies and economies of scale and expand our revenue base.
However, there can be no assurances that we will be successful.
Gross Margin
Gross margin improved to approximately a negative (26%) of total
revenue for the three-month period ended April 30, 2001, from approximately a
negative (42%) of total revenue for the same period in 2000. The improvement in
the gross margin for the three-months ended April 30, 2001, as compared to the
same period in 2000 is a direct result of scaling the fixed infrastructure and
labor costs across a larger customer base. Our business model requires that we
make "up-front" fixed investments in both equipment and personnel. These costs
are leveraged across our data centers. We anticipate that our gross margins
should continue to improve, 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
Selling and Marketing. Selling and marketing expenses primarily
include salaries and commissions and expenses for marketing programs, including
advertising, events, sponsorships, direct marketing, website development and
support, market research, product literature, alliance program development,
alliance co-marketing and agency fees. Selling and marketing expenses increased
26% to approximately $8.0 million for the three-month period ended April 30,
2001, from approximately $6.3 million for the same period in 2000. On a
percentage of revenue basis, selling and marketing expenses decreased to 30% of
total revenue for the three-months ended April 30, 2001 from 44% of total
revenue for the same period in 2000. The increase in absolute dollars is due
primarily to the continued development of our sales and marketing capability, in
the form of increased headcount and marketing programs, and the increase of
commission expense resulting from increased revenue levels. The reduction of
sales and marketing expense as a percentage of revenue is a result of the
scaling of the sales and marketing infrastructure over a larger customer base
with low incremental customer costs. We plan to decrease our
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selling and marketing expenses in the aggregate dollar amount in the near
future. We also expect that this amount will decrease as a percentage of revenue
with an expanded revenue base.
General and Administrative. General and administrative expenses
primarily include the costs of financial, leasing, human resources, information
technology, business development, administrative personnel, professional
services, and corporate overhead and bad debt expense. General and
administrative expenses increased 172% to approximately $8.5 million for the
three-month period ended April 30, 2001, from approximately $3.1 million for the
same period in 2000. On a percentage of revenue basis, general and
administrative expenses increased to 33% of total revenue for the three-months
ended April 30, 2001 from 22% of total revenue for the same period in 2000. The
increase in absolute dollars is due to an increase in the provision for doubtful
accounts of $2.6 million and the costs of $2.8 million resulting from the hiring
and increased infrastructure costs related to additional administrative and
finance personnel to support our growing operations.
Our increased bad debt expense is related to our continuing evaluation
of our customer base and the inability of our "Dot Com" customer base to secure
additional financing. Excluding $3.0 million recorded in our provision for bad
debt expense for the three months ended April 30, 2001, general and
administrative expense for this period would have decreased from 33% to 21% as a
percentage of revenue as compared to 22% for the same three-month period in
2000. We intend, barring unforeseen circumstances, to decrease general and
administrative costs as a percentage of revenue as we plan to continue to expand
our customer base.
Product Development. Product development expenses consist mainly of
salaries and related development costs. Product development expenses increased
205% to approximately $4.1 million for the three-month period ended April 30,
2001, from approximately $1.4 million for the same period in 2000. This increase
is due primarily to the costs associated with an increase in product development
personnel from 34 to 73 as of April 30, 2000 and April 30, 2001, respectively,
and the use of consultants in this quarter. This growth in product development
personnel reflects our efforts to increase service offerings and our emphasis on
application services. We anticipate, barring unforeseen circumstances, that our
product development cost will remain constant as an aggregate dollar amount as
we continue to invest in the expansion of our product offerings and services.
However, we plan that this amount will decrease as a percentage of revenue
beginning in our fourth quarter of fiscal 2001.
Interest Income
Interest income increased to approximately $679,000 for the three-month
period ended April 30, 2001, from approximately $382,000 for the same period in
2000. The increase is due primarily to the amount of funds available for
investment resulting from our various fiscal year 2001 financing activities,
mostly from the sale of common stock, issuance of convertible notes and
sale-leaseback transactions. We anticipate that this amount will decrease in the
future as cash invested decreases in order to fund operations.
Interest Expense
Interest expense increased to approximately $2.6 million for the
three-month period ended April 30, 2001, from approximately $48,000 from the
same period in 2000. This increase is due primarily to interest incurred on
capital lease obligations, convertible notes payable to CMGI and the related
amortization of warrants as a component of interest expense. We anticipate
interest expense will remain constant in the near term related to the Company's
outstanding $80 million convertible notes.
NINE-MONTH PERIOD ENDED APRIL 30, 2001 COMPARED TO THE NINE-MONTH PERIOD ENDED
APRIL 30, 2000
Revenue
Total revenue increased 173% to approximately $79.9 million for the
nine-month period ended April 30, 2001, from approximately $29.2 million for the
same period in 2000. The increase in revenue is due to an increase of
approximately $51.9 million revenue related to the 109 new unaffiliated
customers and additional business with both existing unaffiliated customers and
affiliated customers plus termination fees totaling $2.2 million, offset by a
reduction of approximately $3.4 million in revenue related to
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customer terminations. Related party revenue increased 91% while the
unaffiliated revenue increased 273% over the same nine-month period ended April
30, 2000. We will continue to focus our efforts to expand our business revenue
with new unaffiliated enterprise customers in 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.
Cost of Revenue
Cost of revenue principally includes labor and headcount expenses,
additional equipment, maintenance and facilities costs, increased bandwidth,
connectivity charges, and depreciation and lease expense from terminated
customers. Cost of revenue increased 138% to approximately $98.8 million for the
nine-month period ended April 30, 2001, from approximately $41.6 million for the
same period in 2000. As a percentage of revenue, cost of revenue decreased to
124% for the nine-month period ended April 30, 2001, from 142% for the same
period in 2000. The dollar increase for the nine-months ended April 30, 2001 is
due primarily to the costs associated with increased investment in our existing
and our new data centers in San Jose, California and Andover, Massachusetts and
an increase in our labor expense. Management anticipates, barring unforeseen
circumstances, that our cost of revenue as a percentage of revenue will continue
to decrease while we continue to focus on our efforts to improve operational
efficiencies and economies of scale and expand our revenue base. However, there
can be no assurances that this will be successful.
Gross Margin
Gross margin improved to approximately a negative (24%) of total
revenue for the nine-month period ended April 30, 2001, up from approximately a
negative (42%) of total revenue for the same period in 2000. The improvement in
the gross margin for the nine-months ended April 30, 2001, as compared to the
same period in 2000, is a direct result of scaling the fixed infrastructure and
labor costs across a larger customer base. Our business model requires that we
make "up-front" fixed investments in both equipment and personnel. We anticipate
that our gross margins should continue to improve, barring unforeseen
circumstances, based on current estimates and expectations, as our occupancy
rate increases and we achieve increased operational efficiencies and economies
of scale.
Operating Expenses
Selling and Marketing. Selling and marketing expenses primarily include
salaries, commissions and expenses for marketing programs, including
advertising, events, sponsorships, direct marketing, website development and
support, market research, product literature, alliance program development,
alliance co-marketing and agency fees. Selling and marketing expenses increased
77% to approximately $27.2 million for the nine-month period ended April 30,
2001, from approximately $15.4 million for the same period in 2000. On a
percentage of revenue basis, selling and marketing expenses decreased to 34% of
total revenue for the nine-months ended April 30, 2001 from 53% of total revenue
for the same period in 2000. The increase in absolute dollars is due primarily
to the continued development of our sales and marketing capability, in the form
of increased headcount and marketing programs, and the increase of commission
expense resulting from increased revenue levels. The reduction of sales and
marketing expense as a percentage of revenue is a result of the scaling of the
sales and marketing infrastructure over a larger customer base with low
incremental customer costs. We plan to decrease selling and marketing expenses
in the aggregate in the future. We also expect that this amount, barring
unforeseen circumstances, will decrease as a percentage of revenue with an
expanded revenue base.
General and Administrative. General and administrative expenses
primarily include the costs of financial, leasing, human resource, information
technology, business development and administrative personnel, professional
services, and corporate overhead and bad debt expense. General and
administration expenses increased 189% to approximately $24.3 million for the
nine-month period ended April 30, 2001, from approximately $8.4 million for the
same period 2000. On a percentage of revenue basis, general and administrative
expenses increased to 30% of total revenue for the nine-months ended April 30,
2001 from 29% of total revenue for the same period in 2000. The increase in
absolute dollars is due to an increase in the provision for doubtful accounts of
$7.6 million and the cost of $9.6 million resulting from the hiring and
increased infrastructure costs related to additional administrative and finance
personnel to support our growing operations, offset by a reduction of $1.3
million in Y2K related expenses incurred during the same period last year.
-12-
Our increased bad debt expense is related to our continuing evaluation
of our customer base and the inability of our "Dot Com" customer base to secure
additional financing. Excluding $8.1 million recorded in our provision for bad
debt expense for the nine months ending April 30, 2001, general and
administrative expense for this period would have decreased from 30% to 20% as a
percentage of revenue, as compared to 29% for the same nine-month period in
2000. We intend, barring unforeseen circumstances, to decrease general and
administrative costs as a percentage of revenue as we continue to expand our
revenue base.
Product Development. Product development expenses consist primarily of
salaries and related development costs. Product development expenses increased
228% to approximately $10.8 million for the nine-month period ended April 30,
2001, from approximately $3.3 million for the same period in 2000. This increase
is due primarily to the costs associated with an increase in product development
personnel from 34 to 73 as of April 30, 2000 and April 30, 2001, respectively,
and the use of consultants in the third quarter of fiscal 2001. This growth in
product development personnel reflects our efforts to increase service offerings
and our emphasis on application services. We anticipate, barring unforeseen
circumstances, that our product development cost will remain constant as an
aggregate dollar amount as we continue to invest to expand our product offerings
and services. However, we expect that this amount will decrease as a percentage
of revenue beginning in our fourth quarter of fiscal 2001 as we continue to
expand our revenue base.
Interest Income
Interest income increased to approximately $2.4 million for the
nine-month period ended April 30, 2001, from approximately $1.2 million for the
same period in 2000. The increase is due primarily to the amount of funds
available for investment resulting from our various fiscal year 2001 financing
activities, mostly from the sale of common stock, issuance of convertible notes
due to CMGI and sale-leaseback transactions. We anticipate that our average cash
and cash equivalent balances will decrease in the future as cash invested
decreases in order to fund future operations.
Interest Expense
Interest expense increased to approximately $5.3 million for the
nine-month period ended April 30, 2001, from approximately $244,000 from the
same period in 2000. This increase is due primarily to interest incurred on
capital lease obligations, convertible notes due to CMGI and the related
amortization of warrants as a component of interest expense. We anticipate that
interest expense will remain constant in the near term due to our outstanding
$80 million convertible notes due in December 2003.
Liquidity and Capital Resources
Since our inception, our operations have been funded primarily by CMGI
through the issuance of common stock, preferred stock and convertible debt,
preferred stock to strategic investors, and our initial public offering and
related underwriters' over-allotment in November 1999.
Net cash used in operating activities for the nine-month period ended
April 30, 2001 amounted to $67.5 million, resulting primarily from net operating
losses, increases in accounts receivable and decreases in accrued expenses and
deferred revenue, which are partially offset by increases in accounts payable,
decreases in amounts due from CMGI and CMGI affiliates, non-cash depreciation,
amortization and provision for bad debts charges and an increase in amounts due
to CMGI. Our bad debt expense totaled $8.1 million for the nine-months ended
April 30, 2001.
Net cash used in investing activities for the nine-month period ended
April 30, 2001 amounted to $16.3 million. The net cash used in investing
activities is the result of sale proceeds from the sale-leaseback of $13.9
million less $24.6 million utilized to acquire property and equipment required
to support the growth of the business and to expand data center infrastructure,
and approximately $5.0 million of restricted cash pursuant to letters of credit
on certain leased facilities and an increase in other assets of approximately
$600,000. We also acquired a software license for $3.0 million that we are
required to pay for over 11 monthly installments beginning February 2001. We
also purchased approximately $1.5 million of equipment during the three-months
ended April 30, 2001 that we intend to sell under a sale-leaseback transaction
in the future.
Net cash provided by financing activities for the nine-month period
ended April 30, 2001 amounted to $49.9 million, consisting primarily of $80.0
million in proceeds from the sale of convertible
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notes payable to CMGI and $1.0 million in proceeds from the exercise of stock
options and amounts received from payments relating to purchases under our
Employee Stock Purchase Plan, offset by the prepayment of the $27.0 million
capital lease obligation (as defined below) and scheduled payments on other
obligations totaling approximately $4.1 million.
In June 2000, we sold certain of our equipment and leasehold
improvements in our two new data centers in a sale-leaseback transaction
(referred to as the capital lease) to a bank for approximately $30.0 million.
As discussed above, we repaid the remaining balance of the capital lease
obligation totaling approximately $27.0 million. The pay-off of this capital
lease will result in a net reduction in cash outflows for principal and interest
payments of approximately $2.0 million per fiscal quarter, starting in the third
quarter of fiscal year 2001.
During the quarter ended January 31, 2001, we entered into a Note and
Warrant Purchase Agreement (referred to as the Agreement) with CMGI. The
Agreement provided for the sale of a subordinated, unsecured, convertible note
in the principal amount of $50 million and a subordinated, unsecured,
convertible note in the principal amount of $30 million (collectively referred
to as the Notes). The Notes are convertible at CMGI's option, and by NaviSite
under defined circumstances, into our common stock at a conversion price equal
to $5.535 per share. We received gross proceeds of $80 million from the
issuance of the Notes. The annual interest rate on the notes is 7.5% payable
quarterly in, at our discretion, either cash or our common stock. The principal
amount is due in full by December 12, 2003. In connection with the Agreement, we
granted CMGI, effective December 15, 2000, a warrant to purchase 2,601,626
shares of our common stock at $5.77 per share, and a warrant to purchase
2,601,626 shares of our common stock at $6.92 per share. The warrants are
exercisable upon issuance and expire on December 15, 2005. We ascribed a fair
value of $12.9 million to the warrants using the Black-Scholes model and are
amortizing this fair value over the life of the Notes as an additional component
of interest expense.
On December 12, 2000, we sold certain equipment in a sale-leaseback
transaction to an equipment vendor for approximately $13.9 million. We
simultaneously entered into an operating lease of the equipment with the vendor.
The lease is payable in monthly installments through December 2002.
On February 3, 2001, we renewed a letter of credit for the lease of our
Andover, Massachusetts facility. The terms of the letter of credit require a
pledge of approximately $4.4 million, which is reflected on the balance sheet
as restricted cash at April 30, 2001.
On February 3, 2001, we entered into a letter of credit for the lease
of our San Diego, California facility. The terms of the letter of credit require
a pledge of approximately $555,000, which is also reflected on the balance
sheet as restricted cash at April 30, 2001.
We have experienced a substantial increase in our expenditures since
inception consistent with our growth in operations and staffing. We anticipate
that expenditures will continue to increase as we grow our business.
Additionally, we will continue to evaluate investment opportunities in
businesses that management believes will complement our technologies and market
strategies.
We currently anticipate that, barring unforeseen circumstances, our
available cash resources at April 30, 2001, combined with our ability to obtain
additional lease financing credit lines and other strategic financings as well
as our ability to implement and achieve necessary cost reductions and
operational efficiencies will be sufficient to meet our currently anticipated
needs for working capital and capital expenditures over the next 12 months based
on current estimates and expectations. We may need to raise additional funds in
order to fund our operating losses and expansion, to fund our domestic and
international expansion, to develop new or enhance existing services or
products, to respond to competitive pressures or to acquire complementary
businesses, products or technologies. On June 11, 2001, CMGI provided us with a
$30 million funding commitment through the end of fiscal 2002 in the event that
we require additional funding. CMGI's funding commitment is subject to certain
conditions, such as the negotiation of a mutually acceptable funding vehicle,
our financial condition and prospects (including our prospects of achieving
profitability or being sold), the financial condition of CMGI and its
affiliates, the then prevailing market conditions and the approval of our
respective boards of directors. In addition, on a long-term basis, we may
require additional external financing for working capital and capital
expenditures through credit facilities, sales of additional equity, debt or
other financing vehicles. If additional funds are raised through the issuance of
equity or convertible debt securities, the percentage ownership of our
stockholders will be reduced and our stockholders may experience additional
dilution. We cannot assure you that additional financing will be available on
terms favorable to us, if at all. If adequate funds are not available or are not
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available on acceptable terms, our ability to fund our expansion, take advantage
of unanticipated opportunities, develop or enhance services or products or
otherwise respond to competitive pressures would be significantly limited.
Inflation
We believe that our revenue and results from operations have not been
significantly impacted by inflation.
Additional Risk Factors That May Affect Future Results
The risks and uncertainties described below are not the only risks we
face. Additional risks and uncertainties not presently known to us or that are
currently deemed immaterial may also impair our business operations. If any of
the following risks actually occur, our financial condition and operating
results could be materially adversely affected.
We have a history of operating losses and expect future losses. There
can be no assurance that we will ever achieve profitability on a quarterly or
annual basis or, if we achieve profitability, that it will be sustainable. We
were organized in 1996 by CMGI to support the networks and host the Web sites of
CMGI and a number of CMGI affiliates. It was not until the fall of 1997 that we
began providing Web site hosting and Internet application management services to
companies unaffiliated with CMGI. Since our inception in 1996, we have
experienced operating losses and negative cash flows for each quarterly and
annual period. As of April 30, 2001, we had an accumulated deficit of $177.0
million. While we are focused on decreasing expenses, we continue to incur
additional expenses to expand and improve our infrastructure, introduce new
services, enhance our application management expertise, expand internationally
and pursue additional industry relationships. As a result, we expect to incur
operating losses for at least the next four fiscal quarters.
Fluctuations in our quarterly operating results may negatively impact
our stock price. Our quarterly operating results may fluctuate significantly in
the future as a result of a variety of factors, many of which are outside our
control. These factors include: continued market demand and acceptance for our
Web site and Internet application hosting and management services; our ability
to develop, market and introduce new services on a timely basis; downward price
adjustments by our competitors; changes in the mix of services provided by our
competitors; technical difficulties or system downtime affecting the Internet
generally or our hosting operations specifically; our ability to meet any
increased technological demands of our customers; the amount and timing of costs
related to our marketing efforts and service introductions; and economic
conditions specific to the Internet application service provider industry. Our
operating results for any particular quarter may fall short of our expectations
or those of investors or securities analysts. In this event, the market price of
our common stock would likely fall.
CMGI is a majority stockholder, and CMGI may have interests that
conflict with the interests of our other stockholders. As of April 30, 2001,
CMGI beneficially owned approximately 76.21% of our outstanding common stock.
Accordingly, CMGI has the power, acting alone, to elect a majority of our board
of directors and has the ability to determine the outcome of any corporate
actions requiring stockholder approval, regardless of how our other stockholders
may vote. Under Delaware law, CMGI may exercise its voting power by written
consent, without convening a meeting of the stockholders, meaning that CMGI
could affect a sale or merger of our company without prior notice to, or the
consent of, our other stockholders. CMGI's interests could conflict with the
interests of our other stockholders. The possible need of CMGI to maintain
control of us in order to avoid becoming a registered investment company could
influence future decisions by CMGI as to the disposition of any or all of its
ownership position in our company. CMGI would be subject to numerous regulatory
requirements with which it would have difficulty complying if it were required
to register as an investment company. As a result, CMGI may be motivated to
maintain at least a majority ownership position in us, even if our other
stockholders might consider a sale of control of our company to be in their best
interests. As long as it is a majority stockholder, CMGI has contractual rights
to purchase shares in any of our future financing sufficient to maintain its
majority ownership position. CMGI's ownership may have the effect of delaying,
deferring or preventing a change in control of our company or discouraging a
potential acquirer from attempting to obtain control of us, which in turn could
adversely affect the market price of our common stock.
-15-
A significant portion of our revenue currently is generated by
services provided to CMGI and companies affiliated with CMGI, and the loss of
this revenue would substantially impair the growth of our business. We
anticipate that we will continue to receive a significant portion of our revenue
in the future from CMGI and CMGI's affiliates. CMGI and CMGI's affiliates
accounted for approximately 33.8% of our total revenue in the quarter ended
April 30, 2001 and approximately 50% of our revenue for the fiscal year ended
July 31, 2000. We cannot assure you that revenues generated by CMGI and CMGI's
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's affiliates, or our inability to replace this
operating revenue, would substantially impair the growth of our business.
Our ability to grow our business would be substantially impaired if we
were unable to obtain, on commercially reasonable terms, certain equipment that
is currently provided under leases executed or guaranteed by CMGI. Certain of
the equipment that we use or provide to our customers for their use in
connection with our services is provided under leases executed or guaranteed by
CMGI prior to our October 1999 initial public offering. CMGI has not continued
this practice, and accordingly, we or our customers will have to obtain this
equipment with new leases and renew existing leases directly, on a stand alone
basis. Our ability to grow our business would be substantially impaired if we
were unable to obtain, on commercially reasonable terms, leases for this
equipment. We cannot assure you that equipment leases will continue to be
available on commercially reasonable terms, if at all.
If the growth of the market for outsourced hosting services, and
Internet commerce does not continue, or it decreases, there may be insufficient
demand for our services, and as a result, our business strategy may not be
successful. The increased use of the Internet for retrieving, sharing and
transferring information among businesses and consumers has developed only
recently, and the market for the purchase of products and services over the
Internet is new and emerging. If acceptance and growth of the Internet as a
medium for commerce and communication does not continue, our business strategy
may not be successful because there may not be a continuing market demand for
our Web site and Internet application hosting and management services. Our
growth could be substantially limited if the market for Internet application
services fails to continue to develop or if we cannot continue to achieve broad
market acceptance.
Our ability to successfully market our services could be substantially
impaired if we are unable to deploy new outsourced services that address
customer requirements, or if new products and services deployed by us prove to
be unreliable, defective or incompatible with our then existing applications or
systems of our customers. We cannot assure you that we will not experience
difficulties that could delay or prevent the successful development,
introduction or marketing of managed hosting or other services in the future. If
any newly introduced managed hosting or other services 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 managed hosting or other
services 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 other products
and services or enhancements of existing applications, our ability to
successfully market our services could be substantially impaired.
The market we serve is highly competitive, and as a rapidly growing
company, we may lack financial and other resources, the expertise or
capabilities needed to capture increased market share. We compete in the managed
hosting services market. This market is rapidly evolving, highly competitive and
likely to be characterized by an increasing number of specialized market
entrants as well as by industry consolidation that may result in the creation of
larger and more heavily resourced competitors. We believe that participants in
this market must maintain growth and achieve a significant presence to compete
effectively. Insufficient growth capacity in our facilities or the lack of the
availability of non-owned facilities could impair our ability to achieve rapid
growth through an increase in our customer base. Moreover, many of our
competitors have substantially greater financial, technical and marketing
resources, greater name recognition and more established relationships in the
industry than we have. We may lack the financial and other resources, expertise
or capabilities needed to capture increased market share in this environment in
the future.
Any interruptions in, or degradation of, our infrastructure, or any
significant components of our infrastructure, including network components, data
center facilities, or private transit Internet connections could result in the
loss of customers or hinder our ability to attract new customers. Our customers
rely on
-16-
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 may be 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 software vendors, the sale, marketing and provision
of our Internet products and services may be adversely affected. We believe that
to penetrate the market for managed hosting and other services we must maintain
existing and develop additional relationships with industry-leading Internet
software vendors and other third parties. We license or rent select software
applications from Internet application software vendors. The loss of our ability
to continually obtain any of these applications could materially impair our
ability to provide services to our customers or require us to obtain substitute
software applications of lower quality or performance standards or at greater
cost. In addition, because we generally license applications on a non-exclusive
basis, our competitors may license and use the same software applications. In
fact, many of the companies with which we have strategic relationships currently
have, or could enter into, similar license agreements with our competitors or
prospective competitors. We cannot assure you that software applications will
continue to be available to us from Internet application software vendors on
commercially reasonable terms. If we are unable to identify and license software
applications which meet our targeted criteria for new application introductions,
we may have to discontinue or delay introduction of services relating to these
applications.
We purchase from a limited number of suppliers key components of our
infrastructure, including networking equipment, that are available only from
limited sources in the quantities and with the quality that we demand. For
example, we purchase most of the routers and switches used in our infrastructure
from Cisco Systems Inc. We cannot assure you that we will have the necessary
hardware or parts on hand or that our suppliers will be able to provide them in
a timely manner in the event of equipment failure. Our inability or failure to
obtain the necessary hardware or parts on a timely basis could result in
sustained equipment failure and a loss of revenue due to customer loss or claims
for service credits under our service level guarantees.
Our inability to scale our infrastructure or otherwise manage our
anticipated growth and the related expansion of our operations could result in
decreased revenue and continued negative margins and operating losses. We have
experienced rapid growth in our service offerings and our customer base. We were
a Web site hosting provider with approximately 283 customers as of April 30,
2000. As of April 30, 2001, we are currently providing Web site and Internet
application hosting and management services to 348 customers. In order to
service our growing customer base, we will need to continue to improve and
expand our network infrastructure. Our ability to continue to meet the needs of
a substantial and growing number of customers while maintaining superior
performance is largely unproven. If our network infrastructure is not scalable,
we may not be able to provide our services to additional customers, which would
result in decreased revenue.
In addition, between April 30, 2000 and April 30, 2001, we increased
the number of our employees from 425 to 562. This growth has placed, and likely
will continue to place, a significant strain on our financial, management,
operational and other resources. To effectively manage our anticipated growth,
we will be required to continue to enhance our operating and financial
procedures and controls, to upgrade or replace our operational, financial and
management information systems and to attract, train, motivate, manage and
retain key employees. If we are unable to effectively manage our rapid growth,
we could experience continued negative margins and operating losses. Our
customer base includes a significant number of businesses that face increased
risk of losing funding depending upon the availability
-17-
of private and/or public funding. Many of our customers are small start-up
Internet based businesses that have traditionally been initially funded by
venture capital firms and then through public securities offerings. If the
market for technology and Internet based businesses is not supported by the
private investors who have funded these customers, we face the risk that these
customers may cease, curtail or limit Web site operations hosted by us. If this
occurs, we could experience a loss of revenue associated with these customers
and will then have to increase sales to other businesses using the Internet in
order to preserve and grow our revenue.
You may experience dilution because our historical source of funding
is expected to change, and other funding may not be available to us on favorable
terms, if at all. Until the completion of our initial public offering, CMGI
funded our operations as needed, increasing our obligations to CMGI and allowing
us to maintain a zero-balance cash account. Upon completion of our initial
public offering, our net obligations to CMGI, together with all convertible
preferred stock held by CMGI, were converted into common stock. We may need to
raise additional funds from time to time. In June 2000, we completed a $30
million sale-leaseback transaction with a bank and a $50 million private
placement sale of common stock to CMGI. In December 2000 and January 2001,
we entered into an agreement to sell CMGI convertible notes and warrants for an
aggregate of $80.0 million and completed a $13.9 million sale-leaseback
transaction with an equipment vendor. In January 2001, we prepaid the balance
owed on the lease obligation with the proceeds received from the Notes. There is
no assurance that we will be able to obtain additional financing on terms
favorable to us, if at all. If adequate funds were not available or were not
available on acceptable terms, our ability to respond to competitive pressures
would be significantly limited. Moreover, if additional funds are raised through
the issuance of equity or convertible debt securities, your percentage ownership
in us will be reduced, and you may experience additional dilution.
Our network infrastructure could fail, which would impair our ability
to provide guaranteed levels of service and could result in significant
operating losses. To provide our customers with guaranteed levels of service, we
must operate our network infrastructure 24 hours a day, seven days a week
without interruption. In order to operate in this manner, we must protect our
network infrastructure, equipment and customer files against damage from human
error, natural disasters, unexpected equipment failure, power loss or
telecommunications failures, sabotage or other intentional acts of vandalism.
Even if we take precautions, the occurrence of a natural disaster, equipment
failure or other unanticipated problem at one or more of our data centers could
result in interruptions in the services we provide to our customers. We cannot
assure you that our disaster recovery plan will address all, or even most, of
the problems we may encounter in the event of such a disaster. We have
experienced service interruptions in the past, and any future service
interruptions could require us to spend substantial amounts of money to replace
equipment or facilities, entitle customers to claim service credits under our
service level guarantees, cause customers to seek damages for losses incurred,
or make it more difficult for us to attract new customers or enter into
additional strategic relationships. Any of these occurrences could result in
significant operating losses.
The misappropriation of our proprietary rights could result in the
loss of our competitive advantage in the market. We rely on a combination of
trademark, service mark, copyright and trade secret laws and contractual
restrictions to establish and protect our proprietary rights. We do not own any
patents that would prevent or inhibit competitors from using our technology or
entering our market. We cannot assure you that the contractual arrangements or
other steps taken by us to protect our proprietary rights will prove sufficient
to prevent misappropriation of our proprietary rights or to deter independent,
third-party development of similar proprietary assets. In addition, we provide
our services in other countries where the laws may not afford adequate
protection for our proprietary rights.
Third-party infringement claims against our technology suppliers,
customers or us could result in disruptions in service, the loss of customers or
costly and time consuming litigation. We license or lease most technologies used
in the Internet application services that we offer. Our technology suppliers may
become subject to third-party infringement claims, which could result in their
inability or unwillingness to continue to license their technology to us. We
expect that we and our customers increasingly will be subject to third-party
infringement claims as the number of Web sites and third-party service providers
for Web-based businesses grows. In addition, we have received notices alleging
that our service marks infringe the trademark rights of third parties. We cannot
assure you that third parties will not assert claims against us in the future or
that these claims will not be successful. Any infringement claim as to our
technologies or services, regardless of its merit, could result in delays in
service, installation or upgrades, the loss of customers or costly and
time-consuming litigation, or require us to enter into royalty or licensing
agreements.
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The loss of key officers and personnel could impair our ability to
successfully execute our business strategy, because we substantially rely on
their experience and management skills, or could jeopardize our ability to
continue to provide service to our customers. We believe that the continued
service of key personnel, including Joel B. Rosen, our Chief Executive Officer,
is a key component of the future success of our business. None of our key
officers or personnel is currently a party to an employment agreement with us.
This means that any officer or employee can terminate his or her relationship
with us at any time. In addition, we do not carry life insurance for any of our
key personnel to insure our business in the event of their death. In addition,
the loss of key members of our sales and marketing teams or key technical
service personnel could jeopardize our positive relations with our customers.
Any loss of key technical personnel would jeopardize the stability of our
infrastructure and our ability to provide the guaranteed service levels our
customers expect.
If we fail to attract and retain additional skilled personnel, our
ability to provide Web site and Internet application management and technical
support may be limited, and as a result, we may be unable to attract customers.
Our business requires individuals with significant levels of Internet
application expertise, in particular, to win consumer confidence in outsourcing
the hosting and management of mission-critical applications. Competition for
such personnel is intense, and qualified technical personnel are likely to
remain a limited resource for the foreseeable future. Locating candidates with
the appropriate qualifications, particularly in the desired geographic location,
can be costly and difficult. We may not be able to hire the necessary personnel
to implement our business strategy, or may need to provide higher compensation
to such personnel than we currently anticipate.
Any future acquisitions we make of companies or technologies may
result in disruptions to our business or distractions of our management due to
difficulties in assimilating acquired personnel and operations. Our business
strategy contemplates future acquisitions of complementary businesses or
technologies. If we pursue additional acquisitions, our risks may increase
because our ongoing business may be disrupted and management's attention and
resources may be diverted from other business concerns. In addition, through
acquisitions, we may enter into markets or market segments in which we have
limited prior experience.
Once we complete an acquisition, we will face additional risks. These
risks include difficulty assimilating acquired operations, technologies and
personnel; inability to retain management and other key personnel of the
acquired business; and changes in management or other key personnel that may
harm relationships with the acquired business's customers and employees. We
cannot assure you that any acquisitions will be successfully identified and
completed or that, if one or more acquisitions are completed, the acquired
business, assets or technologies will generate sufficient revenue to offset the
associated costs or other adverse effects.
The market for our services in international territories is unproven,
and as a result, the revenue generated by any future international operations
may not be adequate to offset the expense of establishing and maintaining those
operations. One component of our strategy is to expand into international
markets. We cannot assure you that we will be able to market, sell and provide
our services successfully outside the United States. We could suffer significant
operating losses if the revenue generated by any current or future international
data center or other operations adequate to offset the expense of establishing
and maintaining those international operations. Our present international
strategy is based upon the creation of alliances with foreign telecommunications
companies that own or operate data centers into which we intend to place our
infrastructure and to service our current customers as well as the customers of
those telecommunications companies desiring our services. In the event that we
are unable to negotiate favorable agreements with or successfully market our
services together with such telecommunications companies, our international
strategy will be significantly impaired, curtailed or eliminated.
We face risks inherent in doing business in international markets that
could adversely affect the success of our international operations. There are
risks inherent in doing business in international markets, including different
regulatory requirements, trade barriers, challenges in staffing and managing
foreign operations, currency risk, different technology standards, different tax
structures which may adversely impact earnings, different privacy, censorship
and service provider liability standards and regulations and foreign political
and economic instability, any of which could adversely affect the success of our
international operations.
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The emergence and growth of a market for our managed hosting services
could be impaired if third parties do not continue to develop and improve the
Internet infrastructure. The recent growth in the use of the Internet has caused
frequent periods of performance degradation, requiring the upgrade of routers
and switches, telecommunications links and other components forming the
infrastructure of the Internet, by Internet service providers and other
organizations with links to the Internet. Any perceived degradation in the
performance of the Internet as a means to transact business and communicate
could undermine the benefits and market acceptance of our Web site and Internet
application hosting and management services. Our services are ultimately limited
by, and dependent upon, the speed and reliability of hardware, communications
services and networks operated by third parties. Consequently, the emergence and
growth of the market for our Internet application services will be impaired if
improvements are not made to the entire Internet infrastructure to alleviate
overloading and congestion.
We could be subject to increased operating costs, as well as claims,
litigation or other potential liability, in connection with risks associated
with Internet security and the security of our systems. A significant barrier to
the growth of e-commerce and communications over the Internet has been the need
for secure transmission of confidential information. Several of our Internet
application services use encryption and authentication technology licensed from
third parties to provide the protections necessary to ensure secure transmission
of confidential information. We also rely on security systems designed by third
parties and the personnel in our network operations centers to secure those data
centers. Any unauthorized access, computer viruses, accidental or intentional
actions and other disruptions could result in increased operating costs. For
example, we may incur significant costs to protect against these interruptions
and the threat of security breaches or to alleviate problems caused by such
interruptions or breaches, and we expect to expend significant financial
resources in the future to equip our new and existing data centers with
state-of-the-art security measures. If a third party were able to misappropriate
a consumer's personal or proprietary information, including credit card
information, during the use of an application solution provided by us, we could
be subject to claims, litigation or other potential liability.
We may become subject to burdensome government regulation and legal
uncertainties that could substantially impair the growth of our business or
expose us to unanticipated liabilities. It is likely that laws and regulations
directly applicable to the Internet or to Internet application service providers
may be adopted. These laws may cover a variety of issues, including user privacy
and the pricing, characteristics and quality of products and services. The
adoption or modification of laws or regulations relating to commerce over the
Internet could substantially impair the growth of our business or expose us to
unanticipated liabilities. Moreover, the applicability of existing laws to the
Internet and Internet application service providers is uncertain. These existing
laws could expose us to substantial liability if they are found to be applicable
to our business. For example, we provide services over the Internet in many
states in the United States and in the United Kingdom and facilitate the
activities of our customers in these jurisdictions. As a result, we may be
required to qualify to do business, be subject to taxation or be subject to
other laws and regulations in these jurisdictions, even if we do not have a
physical presence, employees or property there.
We may be subject to legal claims in connection with the information
disseminated through our network, which could have the effect of diverting
management's attention and require us to expend significant financial resources.
We may face potential direct and indirect liability for claims of defamation,
negligence, copyright, patent or trademark infringement, violation of securities
laws and other claims based on the nature and content of the materials
disseminated through our network. For example, lawsuits may be brought against
us claiming that content distributed by some of our current or future customers
may be regulated or banned. In these and other instances, we may be required to
engage in protracted and expensive litigation which could have the effect of
diverting management's attention and require us to expend significant financial
resources. Our general liability insurance may not necessarily cover any of
these claims or may not be adequate to protect us against all liability that may
be imposed.
In addition, on a limited number of occasions in the past, businesses,
organizations and individuals have sent unsolicited, commercial e-mails from
servers hosted at our facilities to massive numbers of people, typically to
advertise products or services. This practice, known as "spamming," can lead to
complaints against service providers that enable such activities, particularly
where recipients view the materials received as offensive. We have in the past
received, and may in the future receive, letters from recipients of information
transmitted by our customers objecting to such transmission. Although we
prohibit our customers by contract from spamming, we cannot assure you that our
customers will not engage in this practice, which could subject us to claims for
damages.
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The market price of our common stock may experience extreme price and
volume fluctuations. The market price of our common stock may fluctuate
substantially due to a variety of factors, including any actual or anticipated
fluctuations in our financial condition and operating results; public
announcements concerning us or our competitors, or the Internet industry; the
introduction or market acceptance of new service offerings by us or our
competitors; changes in industry research analysts' earnings estimates, changes
in accounting principles, sales of our common stock by existing stockholders,
and the loss of any of our key personnel.
In addition, the stock market has experienced extreme price and volume
fluctuations. The market prices of the securities of technology and
Internet-related companies have been especially volatile. This volatility often
has been unrelated to the operating performance of particular companies. In the
past, securities class action litigation often has been brought against
companies that experience volatility in the market price of their securities.
Whether or not meritorious, litigation brought against us could result in
substantial costs and a diversion of management's attention and resources.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
Our exposure to market rate risk for changes in interest rates relates
primarily to our cash equivalents. We invest our cash primarily in money market
funds. An increase or decrease in interest rates would not significantly
increase or decrease interest expense on capital lease obligations and our
outstanding debt due to CMGI resulting from the fixed nature of such
obligations. We do not currently have any significant foreign operations and
thus are not exposed to foreign currency fluctuations.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
We are subject to legal proceedings and claims which arise in the
ordinary course of our business. In the opinion of management, the amount of
ultimate liability with respect to these actions should not materially affect
the consolidated financial position or results from operations of our company.
Item 2. Changes in Securities and Use of Proceeds.
None.
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Submission of Matters to a Vote of Security Holders.
None.
Item 5. Other Information.
None.
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Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
Exhibit
Number Exhibit
10.1 Amended and Restated Director Indemnification Agreement, dated
February 23, 2001, by and between the Registrant and James F.
Moore, Ph.D.
10.2 Amended and Restated Director Indemnification Agreement, dated
February 23, 2001, by and between the Registrant and Stephen D.R.
Moore.
10.3 Non-Statutory Stock Option Agreement, dated February 23, 2001, by
and between the Registrant and James F. Moore, Ph.D.
10.4 Non-Statutory Stock Option Agreement, dated February 23, 2001, by
and between the Registrant and Stephen D.R. Moore.
10.5 Form of Executive Retention Agreement by and between the
Registrant and each of Patricia Gilligan, Kenneth Hale, Kevin Lo,
Jill Maunder, John Muleta, Scott Semel, James Sherman and Joel
Rosen.
10.6 Form of Indemnification Agreement by and between the Registrant
and each of Patricia Gilligan, Kenneth Hale, Kevin Lo, John
Muleta and Scott Semel.
10.7 Form of Amended and Restated Director Indemnification Agreement
by and between the Registrant and each of Craig Goldman, Andrew
Hajducky, Joel Rosen and David Wetherell.
10.8 Form of Executive Non-Statutory Stock Option Agreement by and
between the Registrant and each of Patricia Gilligan, Kenneth
Hale, Kevin Lo, Jill Maunder, John Muleta, Scott Semel, James
Sherman and Joel Rosen.
(b) Reports on Form 8-K
None.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
NAVISITE, INC.
Date: June 14, 2001
By /s/ Kenneth W. Hale
Kenneth W. Hale
Chief Financial Officer (Principal
Financial and Accounting Officer)
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EXHIBIT INDEX
Exhibit
Number Exhibit
10.1 Amended and Restated Director Indemnification Agreement, dated
February 23, 2001, by and between the Registrant and James F.
Moore, Ph.D.
10.2 Amended and Restated Director Indemnification Agreement, dated
February 23, 2001, by and between the Registrant and Stephen D.R.
Moore.
10.3 Non-Statutory Stock Option Agreement, dated February 23, 2001, by
and between the Registrant and James F. Moore, Ph.D.
10.4 Non-Statutory Stock Option Agreement, dated February 23, 2001, by
and between the Registrant and Stephen D.R. Moore.
10.5 Form of Executive Retention Agreement by and between the
Registrant and each of Patricia Gilligan, Kenneth Hale, Kevin Lo,
Jill Maunder, John Muleta, Scott Semel, James Sherman and Joel
Rosen.
10.6 Form of Indemnification Agreement by and between the Registrant
and each of Patricia Gilligan, Kenneth Hale, Kevin Lo, John
Muleta and Scott Semel.
10.7 Form of Amended and Restated Director Indemnification Agreement
by and between the Registrant and each of Craig Goldman, Andrew
Hajducky, Joel Rosen and David Wetherell.
10.8 Form of Executive Non-Statutory Stock Option Agreement by and
between the Registrant and each of Patricia Gilligan, Kenneth
Hale, Kevin Lo, Jill Maunder, John Muleta, Scott Semel, James
Sherman and Joel Rosen.
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