UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended October 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
NAVISITE, INC.
(Exact name of registrant as specified in its charter)
Delaware 52-2137343
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation)
400 Minuteman Road
Andover, Massachusetts 01810
(Address of principal executive (Zip Code)
offices)
(978) 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 December 12, 2001 there were 86,989,380 shares outstanding of the
registrant's common stock, par value $.01 per share.
NAVISITE, INC.
Form 10-Q for the Quarter ended October 31, 2001
INDEX
Page
Number
------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of October 31, 2001 (unaudited)
and July 31, 2001................................................ 3
Consolidated Statements of Operations for the three months
ended October 31, 2001 and 2000 (unaudited)...................... 4
Consolidated Statements of Cash Flows for the three months
ended October 31, 2001 and 2000 (unaudited)...................... 5
Notes to Interim Consolidated Financial Statements............... 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.............................. 10
Item 3. Quantitative and Qualitative Disclosures About
Market Risk...................................................... 27
PART II. OTHER INFORMATION
Item 1. Legal Proceedings........................................ 28
Item 2. Changes in Securities and Use of Proceeds................ 28
Item 3. Defaults Upon Senior Securities.......................... 28
Item 4. Submission of Matters to a Vote of Security Holders...... 28
Item 5. Other Information........................................ 29
Item 6. Exhibits and Reports on Form 8-K......................... 29
SIGNATURE........................................................ 30
EXHIBIT INDEX.................................................... 31
-2-
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
NAVISITE, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except par value and share value)
October 31, July 31,
-------------------------------
2001 2001
--------------- ---------------
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 12,221 $ 22,214
Accounts receivable, less allowance for doubtful accounts
of $4,637 and $6,859 at October 31, 2001 and July 31, 2001,
respectively 9,600 10,933
Due from CMGI and affiliates 5,341 4,362
Prepaid expenses and other current assets 2,212 2,184
------------ -----------
Total current assets 29,374 39,693
Property and equipment, net 68,645 63,410
Other assets 4,163 3,718
Restricted cash 4,449 5,051
Goodwill, net of accumulated amortization of $682 and $631
at October 31, 2001 and July 31, 2001, respectively 343 394
------------ -----------
Total assets $ 106,974 $ 112,266
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Capital lease obligations, current portion $ - $ 42
Due to CMGI 17,211 14,821
Accounts payable 6,442 10,341
Accrued expenses 24,566 19,299
Deferred revenue 3,236 3,818
Software vendor payable, current portion 695 837
Customer deposits 256 218
------------ -----------
Total current liabilities 52,406 49,376
Software vendor payable, less current portion - 79
Convertible notes payable to CMGI, net 70,849 69,773
Due to Compaq 35,000 -
------------ -----------
Total liabilities 158,255 119,228
Commitments and contingencies
Stockholders' equity (deficit):
Preferred Stock, $.01 par value, 5,000 shares authorized; 0 and 0 shares issued
and outstanding at October 31, 2001 and July 31, 2001, respectively - -
Common Stock, $.01 par value, 150,000 shares authorized: 62,337 and 61,868
shares issued and outstanding at October 31, 2001 and July 31, 2001,
respectively 623 619
Additional paid-in capital 208,081 208,064
Accumulated deficit (259,985) (215,645)
------------ -----------
Total stockholders' equity (deficit) (51,281) (6,962)
------------ -----------
Total liabilities and stockholders' equity (deficit) $ 106,974 $ 112,266
============ ===========
See accompanying notes to interim consolidated financial statements.
-3-
NAVISITE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
(in thousands, except share and per share data)
Three months ended
October 31,
----------------------------------
2001 2000
-------------- -----------------
Revenue:
Revenue $ 13,483 $ 15,017
Revenue, related parties 5,796 11,038
-------------- -----------------
Total revenue 19,279 26,055
Cost of revenue 21,377 32,057
Impairment of long-lived assets 27,359 -
-------------- -----------------
Total cost of revenue 48,736 32,057
Gross margin (29,457) (6,002)
Operating expenses:
Product development 1,977 2,896
Selling and marketing 2,636 8,129
General and administrative 6,835 5,963
-------------- -----------------
Total operating expenses 11,448 16,988
-------------- -----------------
Loss from operations (40,905) (22,990)
Other income (expense):
Interest income 164 874
Interest expense (3,609) (949)
Other income, net 10 -
-------------- -----------------
Loss before cumulative effect of change
in accounting principle (44,340) (23,065)
Cumulative effect of change in
accounting principle - (4,295)
-------------- -----------------
Net loss $ (44,340) $ (27,360)
============== =================
Basic and diluted net loss per
common share:
Before cumulative effect of change
in accounting principle $ (0.71) $ (0.39)
Cumulative effect of change in
accounting principle - (0.07)
-------------- -----------------
Basic and diluted net loss per
common share $ (0.71) $ (0.47)
============== =================
Basic and diluted weighted
average number of common
shares outstanding 62,073 58,535
============== =================
See accompanying notes to interim consolidated financial statements.
-4-
NAVISITE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands)
Three months ended
October 31,
-------------------------------
2001 2000
-------------- ---------------
Cash flows from operating activities:
Net loss $ (44,340) $ (27,360)
Adjustments to reconcile net loss to net cash
used for operating activities:
Depreciation and amortization 5,363 3,816
Provision for bad debts 1,750 1,289
Amortization of deferred compensation - 692
Interest on debt from CMGI 1,500 -
Loss on impairment of long-lived assets 27,359 -
Amortization of interest related to stock warrants
issued with the notes to CMGI 1,076 -
Changes in operating assets and liabilities:
Accounts receivable (999) (3,824)
Due from CMGI and affiliates (979) (1,841)
Due to CMGI 2,390 886
Prepaid expenses and other current assets (28) (535)
Other assets (504) (69)
Accounts payable (3,899) 6,664
Accrued expenses and deferred revenue 1,762 (179)
Customer deposits 38 -
-------------- --------------
Net cash used for operating activities (9,511) (20,461)
Cash flows from investing activities:
Purchases of property and equipment (842) (13,401)
Restricted cash 602 -
-------------- --------------
Net cash used for investing activities (240) (13,401)
Cash flows from financing activities:
Proceeds from exercise of stock options and
employee stock purchase plan 21 540
Payments of capital lease obligations (42) (1,362)
Payments of software vendor obligations (221) (203)
-------------- --------------
Net cash used for financing activities (242) (1,025)
-------------- --------------
Net decrease in cash (9,993) (34,887)
Cash, beginning of period 22,214 77,947
-------------- --------------
Cash, end of period $ 12,221 $ 43,060
============== ==============
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest $ 19 $ 954
============== ==============
See accompanying notes to interim consolidated financial statements.
-5-
NAVISITE, INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
October 31, 2001
1. Basis of Presentation
The accompanying interim consolidated financial statements have been
prepared by NaviSite, Inc. (NaviSite or the Company) in accordance with
accounting principles generally accepted in the United States of America and
pursuant to the rules and regulations of the Securities and Exchange Commission.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with accounting principles generally accepted
in the United States of America have been condensed or omitted pursuant to such
rules and regulations. It is suggested that the financial statements be read in
conjunction with the audited financial statements and the accompanying notes
included in the Company's Form 10-K which was filed with the Securities and
Exchange Commission on October 30, 2001.
The information furnished reflects all adjustments, which, in the
opinion of management, are of a normal recurring nature and are considered
necessary for a fair presentation of results for the interim periods. Such
adjustments consist only of normal recurring items. It should also be noted that
results for the interim periods are not necessarily indicative of the results
expected for the full year or any future period.
The preparation of these interim consolidated financial statements in
conformity with accounting principles generally accepted in the United States of
America requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosures of contingent assets
and liabilities at the date of the financial statements and the reported amounts
of revenues and expenses during the reporting period. Actual results could
differ from those estimates.
2. Principles of Consolidation
The accompanying financial statements include the accounts of the
Company and its wholly owned subsidiary, ClickHear, Inc. (ClickHear), after
elimination of all significant intercompany balances and transactions.
3. Cash and Cash Equivalents
Cash equivalents consist of a money market fund that invests in high
quality short-term debt obligations, including commercial paper, asset-backed
commercial paper, corporate bonds, U.S. government agency obligations, taxable
municipal securities and repurchase agreements.
During the fiscal 2002 first quarter, the letter of credit related to
the LaJolla, California facility was not renewed and the landlord drew down the
related $555,000 of restricted cash.
During the fiscal 2002 first quarter, non-cash financing activities
included a $35 million obligation to Compaq Financial Services Corporation (CFS)
incurred for the purchase of equipment previously held under operating lease
agreements with a fair value, based on an appraisal, of $9.6 million. Since the
fair market value of the equipment purchased was less than the associated
obligation, the Company has recorded an impairment charge in the first quarter
of fiscal 2002 in the amount of $25.4 million. See Note 9.
-6-
4. Property and Equipment
October 31, July 31,
-----------------------------
2001 2001
------------- ---------------
Office furniture and equipment $ 5,905 $ 5,318
Computer equipment 28,565 18,178
Software licenses 16,736 16,657
Leasehold improvements 44,887 45,452
------------- ---------------
96,093 85,605
Less: Accumulated depreciation
and amortization (27,448) (22,195)
------------- ---------------
$ 68,645 $ 63,410
============= ===============
5. Accrued Expenses
October 31, July 31,
-----------------------------
2001 2001
------------ ----------------
Accrued payroll, benefits and commissions $ 2,629 $ 2,772
Accrued accounts payable 4,985 3,078
Accrued lease payments 5,681 6,030
Accrued restructuring 3,831 5,236
Accrued interest 2,518 5
Other 4,922 2,178
------------ ----------------
24,566 19,299
============ ================
In July 2001, the Company announced a plan, approved by the Board of
Directors, to restructure its operations and consolidate data centers, which
resulted in a charge of approximately $8.0 million of which approximately $5.2
million was accrued for as of July 31, 2001. Of the total restructuring charge,
approximately $1,810,000 is related to employee termination benefits. The
Company terminated 126 employees on July 31, 2001.
The restructuring charge also included approximately $6,201,000 of
costs related to the closing of the Company's two original data centers. The
components of the facility closing costs included $3,829,000 of lease costs and
other contractual obligations, to be paid over the term of the respective
agreements through 2002, and $2,372,000 of write-offs of leasehold improvements,
which were recorded as of July 31, 2001. Details of activity in the
restructuring accrual for the three-month period ended October 31, 2001 follows:
Balance at Balance at
July 31, 2001 Activity October 31, 2001
------------- -------- ----------------
Severance /
Employee Costs $ 1,408,209 $(1,064,775) $ 343,434
Facility Closing
Costs 3,828,299 (340,352) 3,487,947
----------- ------------ ------------
Total $ 5,236,508 $(1,405,127) $ 3,831,381
=========== ============ ============
-7-
6. Net Loss Per Common Share
Basic earnings (loss) per share is computed using the weighted average
number of common shares outstanding during the period. Diluted earnings (loss)
per share is computed using the weighted average number of common and dilutive
common equivalent shares outstanding during the period using the as-if-converted
method for convertible notes payable or the treasury stock method for options,
unless such amounts are anti-dilutive.
For the three months ended October 31, 2001 and 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 three months ended October 31, 2001, 274,977 of dilutive shares
related to employee stock options were excluded as they have an anti-dilutive
effect due to the loss. Subsequent to October 31, 2001, CMGI converted the
convertible notes payable and certain other amounts due from the Company into
the Company's Common Stock. For the three months ended October 31, 2001, a pro
forma basic and diluted loss per share calculation, assuming the conversion of
the $80.0 million notes to CMGI and intercompany payable to CMGI into Common
Stock using the "if-converted" method as of the beginning of the period is
presented. The following table provides a reconciliation of the numerator and
denominator used in calculating the pro forma basic and diluted earnings (loss)
per share for the three months ended October 31, 2001.
Three months ended
October 31,
-----------------------
2001
-----------------------
Numerator:
Net loss $ (44,340)
Reversal of interest recognized on $80 million CMGI notes payable 1,500
-----------------------
$ (42,840)
=======================
Denominator:
Common shares outstanding 62,073
Assumed conversion of $80 million CMGI notes payable 14,453
Assumed conversion of $16.2 million due to CMGI 9,905
-----------------------
Weighted average number of pro forma basic
and diluted share outstanding 86,431
=======================
Pro forma basic and diluted net loss per share $ (0.50)
=======================
7. New Accounting Pronouncements
In June 2001, the FASB issued SFAS No. 141, "Business Combinations,"
and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141 will
apply to all business combinations that the Company enters into after June 30,
2001, and eliminates the pooling-of-interest method of accounting. SFAS No. 142
is effective for fiscal years beginning after December 15, 2001. Under SFAS Nos.
141 and 142, goodwill and intangible assets deemed to have indefinite lives will
no longer be amortized but will be subject to annual impairment tests in
accordance with the Statements. Other intangible assets will continue to be
amortized over their useful lives.
-8-
The Company is required to adopt these Statements for accounting for
goodwill and other intangible assets beginning the first quarter of fiscal year
2003. Application of the non-amortization provisions of the Statement is
indeterminable at October 31, 2001. The Company intends to continue to perform
an impairment analysis of the remaining goodwill through the end of fiscal year
2002. Upon adoption on August 1, 2002, the Company will perform the required
impairment test of goodwill and does not expect the implementation of these
standards to have a material impact on its financial condition or results of
operations.
Statement of Financial Accounting Standards No. 143, "Accounting For
Asset Retirement Obligations," ("SFAS 143"), issued in August 2001, addresses
financial accounting and reporting for obligations associated with the
retirement of tangible long-lived assets and for the associated retirement
costs. SFAS 143, which applies to all entities that have a legal obligation
associated with the retirement of a tangible long-lived asset, is effective for
fiscal years beginning after June 15, 2001. The Company does not expect the
implementation of SFAS 143 to have a material impact on its financial condition
or results of operations.
Statement of Financial Accounting Standards No. 144, "Accounting for
the Impairment or Disposal of Long-Lived Assets," ("SFAS 144"), issued in
October 2001, addresses financial accounting and reporting for the impairment or
disposal of long-lived assets. SFAS 144, which applies to all entities, is
effective for fiscal years beginning after December 15, 2001. The Company does
not expect the implementation of SFAS 144 to have a material impact on its
financial condition or results of operations.
8. Revenue Recognition
Effective August 1, 2000, the Company adopted SEC Staff Accounting
Bulletin No. 101 - Revenue Recognition in Financial Statements (SAB "101").
Under SAB 101, installation fees are recognized over the life of the related
customer contract. Prior to fiscal year 2001, the Company recognized
installation fees at the time that the installation occurred. The cumulative
effect of the change in accounting for installation services on all prior
periods resulted in a $4.3 million increase in net loss for the quarter ended
October 31, 2000 and is reflected as a cumulative effect of change in accounting
principle. For the quarter ended October 31, 2000, revenue has been restated to
include $19,000 related to the three months ended October 31, 2000 that was
previously recognized in the fourth quarter of 2001 in connection with the
implementation of SAB 101.
9. Agreements with CMGI and Compaq Financial Services
In connection with an agreement dated October 29, 2001 among the Company,
CMGI, Inc. (CMGI) and Compaq Financial Services Corporation (CFS), a wholly-
owned subsidiary of Compaq Computer Corporation, the Company purchased certain
equipment with a fair market value of $9.6 million, previously leased by the
Company from CFS under operating lease agreements expiring through 2003, in
exchange for a note payable in the face amount of approximately $35 million. As
the fair market value of the equipment, based on an appraisal, was less than the
associated debt obligation, the Company has recorded a preliminary asset
impairment charge in the first quarter of fiscal 2002 of $25.4 million. The
Company recorded the assets purchased and associated impairment charge effective
August 1, 2001 with a corresponding obligation to CFS. Based on the terms of the
$35 million obligation, interest accrues commencing on November 8, 2001. The
Company imputed and recognized $1.1 million of interest for the first quarter of
fiscal 2002.
On November 8, 2001, in connection with the October 29, 2001 agreement, the
Company received $20 million and $10 million in cash from CFS and CMGI,
respectively, in exchange for six-year convertible notes payable in the face
amounts of $20 million and $10 million to CFS and CMGI, respectively, making the
total notes payable issued by the Company to CFS and CMGI approximately $55
million and $10 million, respectively. The notes require payment of interest
only, at 12% per annum, for the first three years from the date of issuance and
then repayment of principal and interest, on a straight-line basis, over the
next three years until maturity on the sixth anniversary of the date of
issuance. At the Company's option, the Company may make interest payments (i)
100% in shares of the Company's common stock, in the case of amounts owed to
CMGI, through December 2007 and (ii) approximately 16.67% in shares of the
Company's common stock, in the case of amounts owed to CFS, through December
2003. The convertible notes payable are secured by substantially all of the
assets of the Company and cannot be prepaid.
-9-
Subject to approval by the Company's stockholders, the principal balances
may be converted into the Company's common stock at the option of the holders at
any time prior to or at maturity at a conversion rate of $0.26 per share. The
conversion rate of $0.26 results in beneficial conversion rights for both CMGI
and CFS. The beneficial conversion rights have been fair valued at $6.5 million
and $36.0 million for CMGI and CFS, respectively. The value of the beneficial
conversions rights will be amortized over the life of the convertible notes
payable. CMGI also converted its $80 million in aggregate principal outstanding
under its existing notes payable, plus the accrued interest thereon, into
approximately 14.7 million shares of the Company's common stock. CMGI also
converted approximately $16.2 million in other amounts due by the Company to
CMGI into approximately 9.9 million shares of the Company's common stock.
Holders of the convertible notes payable are entitled to both demand and
"piggyback" registration rights, and CFS is entitled to anti-dilution protection
under certain circumstances. The agreement with CFS also contains certain
restrictive covenants, including but not limited to limitations on the issuance
of additional debt, the sale of equity securities to affiliates and certain
acquisitions and dispositions of assets.
Subsequent to October 31, 2001, the Company finalized an agreement with
an equipment lessor whereby the Company purchased all equipment previously held
under operating lease with the equipment lessor for $4.3 million. The fair
market value of the equipment at the time of purchase was $2.3 million. The $2.0
million difference between the fair market value of the equipment, based on a
preliminary appraisal, and the purchase price has been accrued as an asset
impairment charge within cost of revenue for the three months ended October 31,
2001.
During the renegotiations of the equipment lease obligations, the Company
did not make certain scheduled lease payments to certain vendors. The Company's
total remaining lease obligation to these vendors as of October 31, 2001 was
approximately $57 million. Of this amount, approximately $27 million was
restructured in the CFS agreement, approximately $10 million in the lease buyout
from an equipment vendor and approximately $4.3 million was either restructured
or bought out from three other equipment vendors. The Company has been notified
by certain other lessors that it is in default of the respective lease
agreements. The Company is currently negotiating with these vendors. 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.
10. Legal Matters
On or about June 13, 2001, Stuart Werman and Lynn McFarlane filed a lawsuit
against the Company, BancBoston Robertson Stephens, Inc., an underwriter of the
Company's initial public offering in October 1999, Joel B. Rosen, the Company's
then Chief Executive Officer, and Kenneth W. Hale, the Company's then Chief
Financial Officer. The suit was filed in the United States District Court for
the Southern District of New York. The suit generally alleges that the
defendants violated federal securities laws by not disclosing certain actions
allegedly taken by Robertson Stephens in connection with the Company's initial
public offering. The suit alleges specifically that Robertson Stephens, in
exchange for the allocation to its customers of shares of the Company's common
stock sold in the Company's initial public offering, solicited and received from
its customers undisclosed commissions on transactions in other securities and
required its customers to purchase additional shares of the Company's common
stock in the aftermarket at pre-determined prices. The suit seeks unspecified
monetary damages and certification of a plaintiff class consisting of all
persons who acquired shares of the Company's common stock between October 22,
1999 and December 6, 2000.
On or about June 21, 2001, David Federico filed in the United States
District Court for the Southern District of New York a lawsuit against the
Company, Mr. Rosen, Mr. Hale, FleetBoston Robertson Stephens, Inc. and other
underwriter defendants including J.P. Morgan Chase, First Albany Companies,
Inc., Bank of America Securities, LLC, Bear Stearns & Co., Inc., B.T.
Alex.Brown, Inc., Chase Securities, Inc., CIBC World Markets, Credit Suisse
First Boston Corp., Dain Rauscher, Inc., Deutsche Bank Securities, Inc., The
Goldman Sachs Group, Inc., J.P. Morgan & Co., J.P. Morgan Securities, Lehman
Brothers, Inc., Merrill Lynch, Pierce, Fenner & Smith, Inc., Morgan Stanley Dean
Witter & Co., Robert Fleming, Inc. and Salomon Smith Barney, Inc. The suit
generally alleges that the defendants violated the anti-trust laws and the
federal securities laws by conspiring and agreeing to raise and increase the
compensation received by the underwriter defendants by requiring those who
received allocation of initial public offering stock to agree to purchase shares
of manipulated securities in the after-market of the initial public offering at
escalating price levels designed to inflate the price of the manipulated stock,
thus artificially creating an appearance of demand and high prices for that
stock, and initial public offering stock in general, leading to further stock
offerings. The suit also alleges that the defendants arranged for the
underwriter defendants to receive undisclosed and excessive brokerage
commissions and that, as a consequence, the underwriter defendants successfully
increased investor interest in the manipulated initial public offering
securities and increased the underwriter defendants' individual and collective
underwritings, compensation and revenues. The suit further alleges that the
defendants violated the federal securities laws by issuing and selling
securities pursuant to the initial public offering without disclosing to
investors that the underwriter defendants in the offering, including the lead
underwriters, had solicited and received excessive and undisclosed commissions
from certain investors. The suit seeks unspecified monetary damages and
certification of a plaintiff class consisting of all persons who acquired shares
of the Company's common stock between October 22, 1999 and June 12, 2001.
The Company believes that the allegations are without merit and it intends
to vigorously defend against the plantiffs' claims. As the litigation is in an
initial stage, the Company is not able to predict the possible outcome of the
suits and their ultimate effect, if any, on its financial condition.
The Company is also subject to other legal proceedings and claims which
arise in the ordinary course of its business. In the opinion of management, the
amount of ultimate liability with respect to these actions will not materially
affect the consolidated financial position or results from operations of the
Company.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
This Form 10-Q contains forward-looking statements within the meaning
of Section 21E of the Securities Exchange Act of 1934, as amended, that involve
risks and uncertainties. All statements other than statements of historical
information provided herein are forward-looking statements and may contain
information about financial results, economic conditions, trends and known
uncertainties. Our actual results could differ materially from those discussed
in the forward-looking statements as a result of a number of factors, which
include those discussed in this section and elsewhere in this report and the
risks discussed in our other filings with the Securities and Exchange
Commission. Readers are cautioned not to place undue reliance on these forward-
looking statements, which reflect management's analysis, judgment, belief or
expectation only as of the date hereof. We undertake no obligation to publicly
reissue these forward-looking statements to reflect events or circumstances that
arise after the date hereof.
-10-
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 and are a 68.83% owned subsidiary
of CMGI.
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 were shared with CMGI and several other CMGI affiliates. CMGI
allocated rent, facility maintenance and service costs among these affiliates
based upon headcount within each affiliate and within each department of each
affiliate. Other services provided by CMGI to us included support for enterprise
services, human resources and benefits and Internet marketing and business
development. Actual expenses could have varied had we been operating on a stand-
alone basis. Costs are allocated to us on the basis of the fair market value for
the facilities used and the services provided. Through July 31, 2001, we
operated two data centers in California and two data centers in Andover,
Massachusetts. On July 31, 2001, we announced the closure of our two original
data centers, one in Andover, Massachusetts and one in Scotts Valley,
California.
We derive our revenue primarily from managed hosting services, but
within that framework, from a variety of services, including: Web site and
Internet application hosting, which includes access to our state-of-the-art data
centers, a range of bandwidth services, Content Distribution Network services,
advance back-up options, managed storage and monitoring services; enhanced
server management, which includes custom reporting, hardware options, network
and application load balancing, system security, and the services of our
technical account managers; specialized application management, which includes
management of e-commerce and other sophisticated applications support services,
including scalability testing, 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 ratably over the period of the customer
contract. Previous to fiscal year 2001, installation revenue was recognized at
the time installation services were provided. Our customer contracts generally
are a one to three year commitment.
-11-
We have incurred significant net losses and negative cash flows from
operations since our inception and, as of October 31, 2001 had an accumulated
deficit of approximately $260 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
In connection with an agreement dated October 29, 2001 among NaviSite,
CMGI, Inc. (CMGI) and Compaq Financial Services Corporation (CFS), a wholly-
owned subsidiary of Compaq Computer Corporation, we purchased certain equipment
with a fair market value of $9.6 million, previously leased by us from CFS under
operating lease agreements expiring through 2003, in exchange for a note payable
in the face amount of approximately $35 million. As the fair market value of the
equipment, based on a preliminary appraisal, was less than the associated debt
obligation, we have recorded an asset impairment charge in the first quarter of
fiscal 2002 of $25.4 million. We recorded the assets purchased and associated
impairment charge effective August 1, 2001 with a corresponding obligation to
CFS. Based on the terms of the $35 million obligation, interest accrues
commencing on November 8, 2001. We imputed and recognized $1.1 million of
interest for the first quarter of fiscal 2002.
On November 8, 2001, in connection with the October 29, 2001 agreement,
we received $20 million and $10 million in cash from CFS and CMGI, respectively,
in exchange for six-year convertible notes payable in the face amounts of $20
million and $10 million to CFS and CMGI, respectively; making the total notes
payable issued by us to CFS and CMGI approximately $55 million and $10 million,
respectively. The notes require payment of interest only, at 12% per annum, for
the first three years from the date of issuance and then repayment of principal
and interest, on a straight-line basis, over the next three years until maturity
on the sixth anniversary of the date of issuance. At our option, we may make
interest payments (i) 100% in shares of NaviSite common stock, in the case of
amounts owed to CMGI, through December 2007 and (ii) approximately 16.67% in
shares of NaviSite common stock, in the case of amounts owed to CFS, through
December 2003. The convertible notes payable are secured by substantially all of
the assets of NaviSite and cannot be prepaid.
Subject to NaviSite stockholder approval, the principal balances may be
converted into NaviSite common stock at the option of the holders at any time
prior to or at maturity at a conversion rate of $0.26 per share. The conversion
rate of $0.26 results in beneficial conversion rights for both CMGI and CFS. The
beneficial conversion rights have been fair valued at $6.5 million and $36.0
million for CMGI and CFS, respectively. The value of the beneficial conversions
rights will be amortized over the life of the convertible notes payable. CMGI
also converted its $80 million in aggregate principal outstanding under its
existing notes payable, plus the accrued interest thereon, into approximately
14.7 million shares of NaviSite common stock. CMGI also converted approximately
$16.2 million in other amounts due by NaviSite to CMGI into approximately 9.9
million shares of NaviSite common stock.
-12-
Holders of the convertible notes payable are entitled to both demand
and "piggyback" registration rights, and CFS is entitled to anti-dilution
protection under certain circumstances. The agreement with CFS also contains
certain restrictive covenants, including but not limited to limitations on the
issuance of additional debt, the sale of equity securities to affiliates and
certain acquisitions and dispositions of assets.
Subsequent to October 31, 2001, we finalized an agreement with an
equipment lessor whereby we purchased all equipment previously held under
operating lease for $4.3 million. The fair market value of the equipment at the
time of purchase was $2.3 million; the difference between the fair market value
of the equipment, based on a preliminary appraisal, and the purchase price has
been recorded as an asset impairment charge for the three months ended October
31, 2001.
THREE-MONTH PERIOD ENDED OCTOBER 31, 2001 COMPARED TO THE THREE-MONTH PERIOD
ENDED OCTOBER 31, 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 the three months ended October 31, 2001, we sold services to
CMGI and CMGI affiliates totaling approximately $5.8 million, or 30.1% of
revenue. Four of these customers accounted for approximately 33%, 25%, 14% and
13% of revenue, respectively. As of October 31, 2001, CMGI owned approximately
68.83% of our outstanding common stock, with the balance of our common stock
owned by the public.
Total revenue decreased 26.0% to approximately $19.3 million for the
three months ended October 31, 2001, from approximately $26.0 million for the
same period in 2000. The decrease is due primarily to a decrease in revenue from
CMGI and CMGI affiliates of approximately $5.2 million, or 47%, combined with a
decrease of approximately $1.5 million of revenue from unaffiliated customers.
Revenue from unaffiliated customers decreased to approximately $13.5 million or
70% of total revenue for the three months ended October 31, 2001, from
approximately $15.0 million or 58% of total revenue for the same period in 2000.
The number of unaffiliated customers decreased 44% to 206 at October 31, 2001
from 366 as of October 31, 2000. During the three months ended October 31, 2001,
we lost 77 customers, accounting for approximately $1.1 million or 6% of
revenue for that period. The number of CMGI and CMGI affiliated customers
decreased 62% to 10 at October 31, 2001 from 26 as of October 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 continue in the future.
Cost of Revenue
Cost of revenue consists primarily of salaries and benefits for
operations personnel, bandwidth fees and related Internet connectivity charges,
equipment costs and related depreciation and costs to run our two data centers,
such as rent and utilities. Included in the cost of revenue for the three months
ended October 31, 2001 are asset impairment charges of approximately $27.4
million related to the purchase of assets previously held under operating lease
with Compaq Financial Services and another equipment lessor. With the growth of
our business, we expect the costs of revenue, excluding asset impairment
charges, 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
increased volume over fixed assets, increasing productivity and using new
technological tools. For fiscal year 2002, we are anticipating that the cost of
revenue, excluding asset impairment charges, will decrease in absolute dollars
from fiscal year 2001 levels. The anticipated decrease is a result of our fiscal
year 2001 restructuring efforts, which are expected to result in decreased labor
costs and reduced equipment and infrastructure expenses going forward. We are
currently negotiating with several leasing vendors to either purchase equipment
under operating lease or terminate the leasing arrangement before the lease
termination date. We cannot assure you that we will be successful in these
efforts, but if we are, we expect to incur reduced equipment expenses in fiscal
year 2002 as compared to fiscal year 2001.
-13-
Cost of revenue increased 52% to approximately $48.7 million for the
three months ended October 31, 2001, from approximately $32.1 million for the
same period in 2000. Excluding the $27.4 million asset impairment charge, cost
of revenue for the three months ended October 31, 2001 would have been
approximately $21.4 million, a decrease of approximately $10.7 million or 33% as
compared to the same period in 2000. As a percentage of revenue, cost of
revenue, excluding the asset impairment charge, decreased to 111% for the three
months ended October 31, 2001, from 123% for the same period in 2000. The dollar
value increase in cost of revenue is primarily due to the $27.4 million asset
impairment charge related to the buy-out of certain operating leases. This is
offset by a decrease in head count, salaries and related costs, to approximately
$4.7 million, or 24% of revenue, for the three months ended October 31, 2001,
from approximately $10.5 million, or 40% of revenue, for the same period in
2000, resulting from the realization of labor efficiencies and headcount
reductions; and a decrease in equipment costs to approximately $10.6 million for
the three months ended October 31, 2001, from approximately $13.1 million for
the same period in 2000, resulting from the buyout of certain operating leases.
We currently have certain equipment which is not in service due to the decrease
in our customer base. We are currently evaluating this equipment in order to
determine if it is impaired. We anticipate this process to be completed in the
second fiscal quarter of 2002 and, as such, any resulting asset impairment
charge would be recognized in the second fiscal quarter of 2002.
Gross Margin
The gross margin decreased to approximately (153%) of total revenue for
the three months ended October 31, 2001, from approximately (23%) of total
revenue for the same period in 2000. Excluding the $27.4 million asset
impairment charge, the gross margin improved to (11%). This improvement in the
gross margin, for the three months ended October 31, 2001, as compared to the
same period in 2000, is a direct result of our restructuring efforts. These
restructuring efforts have resulted in lower labor costs through increased
efficiencies and headcount reductions and reduced equipment expenses resulting
from the buyout of certain operating leases. We typically make "up-front" fixed
investments in both equipment and personnel and the costs are leveraged across
our data centers. We anticipate that our gross margins will 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 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. 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 product development expenses to decline on
a percentage of revenue basis. Product development expenses decreased 32% to
approximately $2.0 million for the three months ended October 31, 2001, from
approximately $2.9 million for the same period in 2000. As a percentage of
revenue, product development expenses decreased slightly to 10% in the three
months ended October 31, 2001, from 11% for the same period in 2000. The
dollar value decrease in product development expenses is primarily related to a
reduction in usage of outside consultants combined with a reduction in headcount
costs resulting from the decrease in product development personnel as of October
31, 2001 to 20, from 64 employees for the same period in 2000, offset by an
increase in equipment and software costs.
-14-
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 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 this by adding capabilities in our direct sales and marketing
organizations, building leveraged distribution channels with selected technology
partners and increasing spending in targeted PR and marketing programs.
Selling and marketing expenses decreased 68% to approximately $2.6 million
for the three months ended October 31, 2001, from approximately $8.1 million for
the same period in 2000. As a percentage of revenue, selling and marketing
expenses decreased to 14% of total revenue for the three months ended October
31, 2001 from 31% of total revenue for the same period in 2000. The dollar value
decrease is due primarily to reduced headcount, related salaries and
commissions, and decreased expenses for marketing programs, advertising and
product literature.
General and Administrative. General and administrative expenses include the
costs of financial, leasing, human resources, IT and administrative personnel,
professional services, bad debt, and corporate overhead. Also included are
intercompany charges from CMGI for human resource support and business
development. With the growth of our business, we expect the dollar value of
these expenses to increase, but decline on a percentage of revenue basis, as we
hire additional personnel and incur additional costs related to the growth of
our business.
General and administrative expenses increased 15% to approximately $6.8
million for the three months ended October 31, 2001, from approximately $6.0
million for the same period in 2000. As a percentage of revenue, general and
administrative expenses increased to 35% of total revenue for the three months
ended October 31, 2001 from 23% of total revenue for the same period in 2000.
The dollar value increase in general and administrative expenses is primarily
due to an increase in intercompany charges in the amount of $1.1 million and
legal, professional fees in the amount of $1.2 million, offset by a decrease in
headcount related expenses and salaries in the amount of $1.5 million. For
fiscal year 2002, we are anticipating a decrease in general and administrative
expense resulting from the fiscal year 2001 restructuring, lower labor levels
and decreased bad debt expense.
Interest Income
Interest income decreased to approximately $164,000 for three months ended
October 31, 2001, from approximately $874,000 for the same period in 2000. The
decrease is due primarily to the lower average cash on hand due to operating
requirements during the fiscal year.
Interest Expense
Interest expense increased to approximately $3.6 million for the three
months ended October 31, 2001, from approximately $949,000 from the same period
in 2000. This increase is due primarily to interest on the $80.0 million CMGI
Notes and related warrant amortization and other long-term obligations.
-15-
Liquidity and Capital Resources
Since our inception, our operations have been funded primarily by CMGI
through the issuance of common stock, preferred stock and convertible debt, our
initial public offering, the issuance of preferred stock to strategic investors,
and related underwriters' over-allotment in October 1999 and November 1999,
respectively.
Our cash and cash equivalents decreased to $12.2 million at October 31,
2001 from $22.2 million at July 31, 2001 and we had a working capital deficit of
$23.0 million for at October 31, 2001. Net cash used for operating activities
for the three months ended October 31, 2001 amounted to $9.5 million, resulting
primarily from net operating losses, increases in accounts receivable, and
decreases in accounts payable and deferred revenue, partially offset by
increases in accrued expenses, amounts due to CMGI, bad debt expense, and
depreciation and amortization and the asset impairment charge.
Net cash used in investing activities was $240,000 for the three months
ended October 31, 2001, which was primarily associated with the acquisition of
property and equipment and the reduction of restricted cash. Net cash used by
financing activities was $242,000 for the three months ended October 31, 2001,
which was primarily associated with the repayment of capital lease and financed
software obligations.
In connection with an agreement dated October 29, 2001 among NaviSite,
CMGI, Inc. (CMGI) and Compaq Financial Services Corporation (CFS), a wholly-
owned subsidiary of Compaq Computer Corporation, we purchased certain equipment
with a fair market value of $9.6 million, previously leased by us from CFS under
operating lease agreements expiring through 2003, in exchange for a note payable
in the face amount of approximately $35 million. As the fair market value of the
equipment, based on a preliminary appraisal, was less than the associated debt
obligation, we have recorded an asset impairment charge in the first quarter of
fiscal 2002 of $25.4 million. We recorded the assets purchased and associated
impairment charge effective August 1, 2001 with a corresponding obligation to
CFS. Based on the terms of the $35 million obligation, interest accrues
commencing on November 8, 2001. We imputed and recognized $1.1 million of
interest for the first quarter of fiscal 2002.
On November 8, 2001, in connection with the October 29, 2001 agreement, we
received $20 million and $10 million in cash from CFS and CMGI, respectively, in
exchange for six-year convertible notes payable in the face amounts of $20
million and $10 million to CFS and CMGI, respectively making the total notes
payable issued by us to CFS and CMGI approximately $55 million and $10 million,
respectively. The notes require payment of interest only, at 12% per annum, for
the first three years from the date of issuance and then repayment of principal
and interest, on a straight-line basis, over the next three years until maturity
on the sixth anniversary of the date of issuance. At our option, we may make
interest payments (i) 100% in shares of NaviSite common stock, in the case of
amounts owed to CMGI, through December 2007 and (ii) approximately 16.67% in
shares of NaviSite common stock, in the case of amounts owed to CFS, through
December 2003. The convertible notes payable are secured by substantially all of
the assets of NaviSite and cannot be prepaid.
Subject to NaviSite stockholder approval, the principal balances may be
converted into NaviSite common stock at the option of the holders at any time
prior to or at maturity at a conversion rate of $0.26 per share. The conversion
rate of $0.26 results in beneficial conversion rights for both CMGI and CFS. The
beneficial conversion rights have been fair valued at $6.5 million and $36.0
million for CMGI and CFS, respectively. The value of the beneficial conversions
rights will be amortized over the life of the convertible notes payable. CMGI
also converted its $80 million in aggregate principal outstanding under its
existing notes payable, plus the accrued interest thereon, into approximately
14.7 million shares of NaviSite common stock. CMGI also converted approximately
$16.2 million in other amounts due by NaviSite to CMGI into approximately 9.9
million shares of NaviSite common stock.
Holders of the convertible notes payable are entitled to both demand and
"piggyback" registration rights, and CFS is entitled to anti-dilution protection
under certain circumstances. The agreement with CFS also contains certain
restrictive covenants, including but not limited to limitations on the issuance
of additional debt, the sale of equity securities to affiliates and certain
acquisitions and dispositions of assets.
-16-
During the renegotiations of the equipment lease obligations, we did
not make certain scheduled lease payments to certain vendors. Our total
remaining lease obligation to these vendors as of October 31, 2001 was
approximately $57 million. Of this amount, approximately $27 million was
restructured in the CFS agreement, approximately $10 million in the lease buyout
from an equipment vendor and approximately $4.3 million was either restructured
or bought out from three other equipment vendors. We have been notified by
certain other lessors that we are in default of the respective lease agreements.
We are currently negotiating with these vendors. 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 currently anticipate that our available cash resources at October 31,
2001 combined with the cash to be received from CMGI and CFS, as described above
will be sufficient to meet our anticipated needs, barring unforeseen
circumstances, for working capital and capital expenditures over the next nine
months. However, we may need to raise additional funds in order to develop new,
or enhance existing, services or products, to respond to competitive pressures,
to acquire complementary businesses, products or technologies or to continue
as a going concern. In addition, on a long-term basis, we may require additional
external financing for working capital and capital expenditures through credit
facilities, sales of additional equity or other financing vehicles. Under our
arrangement with CFS, we must obtain their consent in order to issue debt
securities or sell shares of our common stock to affiliates. We may not receive
their consent. If additional funds are raised through the issuance of equity or
convertible debt securities,
-17-
the percentage ownership of our stockholders will be reduced and our
stockholders may experience additional dilution. We cannot assure you that
additional financing will be available on terms favorable to us, if at all. If
adequate funds are not available or are not available on acceptable terms, our
ability to fund our expansion, take advantage of unanticipated opportunities,
develop or enhance services or products or otherwise respond to competitive
pressures would be significantly limited.
INFLATION
We believe that our revenue and results from operations have not been
significantly impacted by inflation.
Additional Risk Factors That May Affect Future Results:
The risks and uncertainties described below are not the only risks we face.
Additional risks and uncertainties not presently known to us or that are
currently deemed immaterial may also impair our business operations. If any of
the following risks actually occur, our financial condition and operating
results could be materially adversely affected.
WE HAVE A HISTORY OF OPERATING LOSSES AND EXPECT FUTURE LOSSES. We cannot
assure you that we will ever achieve profitability on a quarterly or annual
basis or, if we achieve profitability, that it will be sustainable. We were
organized in 1996 by CMGI to support the networks and host the Web sites of CMGI
and a number of CMGI affiliates. It was not until the fall of 1997 that we began
providing Web site hosting and Internet application management services to
companies unaffiliated with CMGI. Since our inception in 1996, we have
experienced operating losses and negative cash flows for each quarterly and
annual period. As of October 31, 2001, we had an accumulated deficit of $260
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.
-18-
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 October 31, 2001, CMGI beneficially owned
approximately 76.3% of our outstanding common stock. Accordingly, CMGI has the
power, acting alone, to elect a majority of our board of directors and has the
ability to determine the outcome of any corporate actions requiring stockholder
approval, regardless of how our other stockholders may vote. Under Delaware law,
CMGI may exercise its voting power by written consent, without convening a
meeting of the stockholders, meaning that CMGI could affect a sale or merger of
our company without prior notice to, or the consent of, our other stockholders.
CMGI's interests could conflict with the interests of our other stockholders.
The possible need of CMGI to maintain control of us in order to avoid becoming a
registered investment company could influence future decisions by CMGI as to the
disposition of any or all of its ownership position in our company. CMGI would
be subject to numerous regulatory requirements with which it would have
difficulty complying if it were required to register as an investment company.
As a result, CMGI may be motivated to maintain at least a majority ownership
position in us, even if our other stockholders might consider a sale of control
of our company to be in their best interests. As long as it is a majority
stockholder, CMGI has contractual rights to purchase shares in any of our future
financing sufficient to maintain its majority ownership position. CMGI's
ownership may have the effect of delaying, deferring or preventing a change in
control of our company or discouraging a potential acquirer from attempting to
obtain control of us, which in turn could adversely affect the market price of
our common stock.
On November 8, 2001, in conjunction with the restructuring of certain of
our lease obligations, we issued convertible notes which, upon conversion, would
give CFS a controlling interest in NaviSite. Should CFS elect to convert its $55
million in convertible notes into our common stock and CMGI elect not to
convert, CFS would own approximately 211,897,436 shares of our common stock,
which, based on our capitalization as of November 8, 2001, would be
approximately 71% of our then outstanding shares of common stock. In the event
both CFS and CMGI elect to convert their notes into our common stock, CFS would
own approximately 63% of our common stock and CMGI would own approximately 28%
of our common stock. Accordingly, if CFS converts these notes to shares of our
common stock, CFS would have the power, acting alone, to elect a majority of our
board of directors and would have the ability to determine the outcome of any
corporate actions requiring stockholder approval regardless of how our other
stockholders may vote. If CFS becomes a majority stockholder, it may have
interests that conflict with the interests of our other stockholders, as
described above for CMGI.
A SIGNIFICANT PORTION OF OUR REVENUE CURRENTLY IS GENERATED BY SERVICES
PROVIDED TO CMGI AND COMPANIES AFFILIATED WITH CMGI, AND THE LOSS OF THIS
REVENUE WOULD SUBSTANTIALLY IMPAIR THE GROWTH OF OUR BUSINESS. We anticipate
that we will continue to receive a significant portion of our revenue in the
future from CMGI and CMGI affiliates. CMGI and CMGI affiliates accounted for
approximately 30% of our revenue in the quarter ended October 31, 2001 and
approximately 35% of our revenue for the fiscal year ended July 31, 2001. We
cannot assure you that revenues generated by CMGI and CMGI affiliates will
continue or that we will be able to secure business from unaffiliated customers
to replace this revenue in the future. The loss of revenue from CMGI and CMGI
affiliates, or our inability to replace this operating revenue, would
substantially impair the growth of our business. During the three months
ended October 31, 2001, we lost 77 customers, accounting for approximately $1.1
million or 6% of revenue for that period.
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
-19-
to our customers for their use in connection with our services is provided under
lease. We or our customers will have to obtain this equipment for new leases and
renewal of existing leases directly, on a stand alone basis. Our business would
be substantially impaired if we were unable to obtain or continue these leases
on commercially reasonable terms.
WE ARE ATTEMPTING TO RENEGOTIATE CERTAIN LEASE OBLIGATIONS AND WE MAY NOT
BE SUCCESSFUL. During the renegotiations of the equipment lease obligations, we
did not make certain scheduled lease payments to certain vendors. Our total
remaining lease obligation to these vendors as of October 31, 2001 was
approximately $57 million. Of this amount, approximately $27 million was
restructured in the CFS agreement and approximately $10 million in the lease
buyout from another equipment vendor. We have been notified by certain other
lessors that we are in default of the respective lease agreements. We are
currently negotiating with these vendors. 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.
IF THE MARKET FOR INTERNET COMMERCE AND COMMUNICATION DOES NOT CONTINUE, OR
IT CONTINUES TO DECREASE, THERE MAY BE INSUFFICIENT DEMAND FOR OUR SERVICES, AND
AS A RESULT, OUR BUSINESS STRATEGY MAY NOT BE SUCCESSFUL. The increased use of
the Internet for retrieving, sharing and transferring information among
businesses and consumers has developed only recently, and the market for the
purchase of products and services over the Internet is new and emerging. If
acceptance and growth of the Internet as a medium for commerce and communication
does not continue, our business strategy may not be successful because there may
not be a continuing market demand for our Web site and Internet application
hosting and management services. Our growth could be substantially impaired if
the market for Internet application services fails to continue to develop or if
we cannot continue to achieve broad market acceptance. The market for Internet
application services has recently developed and is evolving.
OUR ABILITY TO SUCCESSFULLY MARKET OUR SERVICES COULD BE SUBSTANTIALLY
IMPAIRED IF WE ARE UNABLE TO DEPLOY NEW INTERNET APPLICATIONS OR IF NEW INTERNET
APPLICATIONS DEPLOYED BY US PROVE TO BE UNRELIABLE, DEFECTIVE OR INCOMPATIBLE.
We cannot assure you that we will not experience difficulties that could delay
or prevent the successful development, introduction or marketing of Internet
application services in the future. If any newly introduced Internet
applications suffer from reliability, quality or compatibility problems, market
acceptance of our services could be greatly hindered and our ability to attract
new customers could be adversely affected. We cannot assure you that new
applications deployed by us will be free from any reliability, quality or
compatibility problems. If we incur increased costs or are unable, for technical
or other reasons, to host and manage new Internet applications or enhancements
of existing applications, our ability to successfully market our services could
be substantially impaired.
-20-
THE MARKET WE SERVE IS HIGHLY COMPETITIVE, WE MAY LACK THE FINANCIAL AND
OTHER RESOURCES, EXPERTISE OR CAPABILITY NEEDED TO CAPTURE INCREASED MARKET
SHARE OR MAINTAIN MARKET SHARE. We compete in the Internet application service
market. This market is rapidly evolving, highly competitive and likely to be
characterized by over capacity and industry consolidation. We believe that
participants in this market must grow rapidly and achieve a significant presence
to compete effectively. Our business is not as developed as that of many of our
competitors. Many of our competitors have substantially greater financial,
technical and market resources, greater name recognition and more established
relationships in the industry. We may lack the financial and other resources,
expertise or capability needed to capture increased market share in this
environment in the future.
ANY INTERRUPTIONS IN, OR DEGRADATION OF, OUR PRIVATE TRANSIT INTERNET
CONNECTIONS COULD RESULT IN THE LOSS OF CUSTOMERS OR HINDER OUR ABILITY TO
ATTRACT NEW CUSTOMERS. Our customers rely on our ability to move their digital
content as efficiently as possible to the people accessing their Web sites and
Internet applications. We utilize our direct private transit Internet
connections to major backbone providers as a means of avoiding congestion and
resulting performance degradation at public Internet exchange points. We rely on
these telecommunications network suppliers to maintain the operational integrity
of their backbones so that our private transit Internet connections operate
effectively.
INCREASED COSTS ASSOCIATED WITH OUR PRIVATE TRANSIT INTERNET CONNECTIONS
COULD RESULT IN THE LOSS OF CUSTOMERS OR SIGNIFICANT INCREASES IN OPERATING
COSTS. Our private transit Internet connections are already more costly than
alternative arrangements commonly utilized to move Internet traffic. If
providers increase the pricing associated with utilizing their bandwidth, we may
be required to identify alternative methods to distribute our customers' digital
content. We cannot assure you that our customers will continue to be willing to
pay the higher costs associated with direct private transit or that we could
effectively move to another network approach. If we were unable to access
alternative networks to distribute our customers' digital content on a cost-
effective basis or to pass any additional costs on to our customers, our
operating costs would increase significantly.
IF WE ARE UNABLE TO MAINTAIN EXISTING AND DEVELOP ADDITIONAL RELATIONSHIPS
WITH INTERNET APPLICATION SOFTWARE VENDORS, THE SALE, MARKETING AND PROVISION OF
OUR INTERNET APPLICATION SERVICES MAY BE UNSUCCESSFUL. We believe that to
penetrate the market for Web site and Internet application hosting and
management services we must maintain existing and develop additional
relationships with industry-leading Internet application software vendors and
other third parties. We license or lease select software applications from
Internet application software vendors. The loss of our ability to continually
obtain and utilize any of these applications could materially impair our ability
to provide services to our customers or require us to obtain substitute software
applications of lower quality or performance standards or at greater cost. In
addition, because we generally license applications on a non-exclusive basis,
our competitors may license and utilize the same software applications. In fact,
many of the companies with which we have strategic relationships currently have,
or could enter into, similar license agreements with our competitors or
prospective competitors. We cannot assure you that software applications will
continue to be available to us from Internet application software vendors on
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commercially reasonable terms. If we are unable to identify and license software
applications which meet our targeted criteria for new application introductions,
we may have to discontinue or delay introduction of services relating to these
applications.
WE PURCHASE FROM A LIMITED NUMBER OF SUPPLIERS KEY COMPONENTS OF OUR
INFRASTRUCTURE, INCLUDING NETWORKING EQUIPMENT. We cannot assure you that we
will have the necessary hardware or parts on hand or that our suppliers will be
able to provide them in a timely manner in the event of equipment failure. Our
dependency to obtain and continue to maintain the necessary hardware or parts on
a timely basis could result in sustained equipment failure and a loss of revenue
due to customer loss or claims for service credits under our service level
guarantees.
Our inability to scale our infrastructure or manage our customer growth and
the related expansion of our operations could result in decreased revenue and
continued operating losses. In order to service our customer base, we will need
to continue to improve and expand our network infrastructure. Our ability to
continue to meet the needs of a substantial number of customers while
maintaining superior performance is largely unproven. If our network
infrastructure is not scalable, we may not be able to provide our services to
additional customers, which would result in decreased revenue.
OUR CUSTOMER BASE INCLUDES A SIGNIFICANT NUMBER OF DOT.COM BUSINESSES THAT
FACE INCREASED RISK OF LOSS OF FUNDING DEPENDING UPON THE AVAILABILITY OF
PRIVATE AND/OR PUBLIC FUNDING. Many of our customers are small start-up Internet
based businesses that have traditionally been initially funded by venture
capital firms and then through public securities offerings. If the market for
technology and Internet based businesses is not supported by the private
investors who have funded these customers, we face the risk that these customers
may cease, curtail or limit Web site operations hosted by us. We have
experienced and may continue to experience a loss of revenue associated with
these customers and will then have to increase sales to other businesses using
the Internet in order to preserve and grow our revenue.
YOU MAY EXPERIENCE DILUTION BECAUSE OF OUR RECENT FINANCING ARRANGEMENTS
WITH CFS AND CMGI. The financing arrangement, as of October 29, 2001, with CFS
and CMGI includes terms that allow CFS and CMGI at their discretion, to convert
the debt obligation of $65 million into our common stock at a conversion price
of $0.26 per share, subject to our stockholder approval. This conversion would
increase the number of shares of our common stock issued by approximately 250
million shares. In addition, we may pay a portion of interest due to CFS and all
interest due to CMGI with our common shares. Moreover, if additional funds are
raised through the issuance of additional equity or convertible debt securities,
your percentage of ownership in us will be reduced and you may experience
additional dilution. In certain circumstances, if we issue equity or convertible
debt securities at values below those provided to CFS, we must issue CFS
additional shares of our common stock which will further dilute existing
stockholders.
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
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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 for 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
telecommunications failures, sabotage or other intentional acts of vandalism.
Even if we take precautions, the occurrence of a natural disaster, equipment
failure or other unanticipated problem at one or more of our data centers could
result in interruptions in the services we provide to our customers. We cannot
assure you that our disaster recovery plan will address all, or even most, of
the problems we may encounter in the event of such a disaster.
We have experienced service interruptions in the past, and any future
service interruptions could: require us to spend substantial amounts of money to
replace equipment or facilities; entitle customers to claim service credits
under our service level guarantees; cause customers to seek damages for losses
incurred; or make it more difficult for us to attract new customers, retain
current customers or enter into additional strategic relationships. Any of these
occurrences could result in significant operating losses.
THE MISAPPROPRIATION OF OUR PROPRIETARY RIGHTS COULD RESULT IN THE LOSS
OF OUR COMPETITIVE ADVANTAGE IN THE MARKET. We rely on a combination of
trademark, service mark, copyright and trade secret laws and contractual
restrictions to establish and protect our proprietary rights. We do not own any
patents that would prevent or inhibit competitors from using our technology or
entering our market. We cannot assure you that the contractual arrangements or
other steps taken by us to protect our proprietary rights will prove sufficient
to prevent misappropriation of our proprietary rights or to deter independent,
third-party development of similar proprietary assets. In addition, we provide
our services in other countries where the laws may not afford adequate
protection for our proprietary rights.
THIRD-PARTY INFRINGEMENT CLAIMS AGAINST OUR TECHNOLOGY SUPPLIERS, CUSTOMERS
OR US COULD RESULT IN DISRUPTIONS IN SERVICE, THE LOSS OF CUSTOMERS OR COSTLY
AND TIME-CONSUMING LITIGATION. We license or lease most technologies used in the
Internet application services that we offer. Our technology suppliers may become
subject to third-party infringement or other claims and assertions, which could
result in their inability or unwillingness to continue to license their
technology to us. We expect that we and our customers increasingly will be
subject to third-party infringement claims as the number of Web sites and third-
party service providers for Web-based businesses grows. In addition, we have
received notices alleging that our service marks infringe the trademark rights
of third parties. We cannot assure you that third parties will not assert claims
against us in the future or that these claims will not be successful. Any
infringement claim as to our technologies or services, regardless of its merit,
could result in delays in service, installation or upgrades, the loss of
customers or costly and time-consuming litigation, or require us to enter into
royalty or licensing agreements.
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THE LOSS OF KEY OFFICERS, KEY MANAGEMENT AND OTHER PERSONNEL COULD IMPAIR
OUR ABILITY TO SUCCESSFULLY EXECUTE OUR BUSINESS STRATEGY, BECAUSE WE
SUBSTANTIALLY RELY ON THEIR EXPERIENCE AND MANAGEMENT SKILLS, OR COULD
JEOPARDIZE OUR ABILITY TO CONTINUE TO PROVIDE SERVICE TO OUR CUSTOMERS. We
believe that the continued service of key personnel, including Tricia Gilligan,
our President and Chief Executive Officer, is a key component of the future
success of our business. None of our key officers or personnel is currently a
party to an employment agreement with us. This means that any officer or
employee can terminate his or her relationship with us at any time. In addition,
we do not carry life insurance for any of our key personnel to insure our
business in the event of their death. In addition, the loss of key members of
our sales and marketing teams or key technical service personnel could
jeopardize our positive relations with our customers. Any loss of key technical
personnel would jeopardize the stability of our infrastructure and our ability
to provide the guaranteed service levels our customers expect. On July 31, 2001,
we initiated a reduction in force eliminating 126 full-and part-time employees,
representing approximately 25 percent of our total staff. We also announced the
departure of 7 of 13 vice presidents, in the areas of sales, human resources,
international, strategic planning, managed services, marketing and technology
planning, as well as our general counsel. In addition, since July 31, 2001, Joel
B. Rosen, our then Chief Executive Officer, and Kenneth W. Hale, our then Chief
Financial Officer, have left our company. Although further reductions are not
presently anticipated, we cannot assure you that future reductions or departures
will not occur 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 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.
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THE EMERGENCE AND GROWTH OF A MARKET FOR OUR INTERNET APPLICATION SERVICES
WILL BE IMPAIRED IF THIRD PARTIES DO NOT CONTINUE TO DEVELOP AND IMPROVE THE
INTERNET INFRASTRUCTURE. The recent growth in the use of the Internet has caused
frequent periods of performance degradation, requiring the upgrade of routers
and switches, telecommunications links and other components forming the
infrastructure of the Internet-by-Internet service providers and other
organizations with links to the Internet. Any perceived degradation in the
performance of the Internet as a means to transact business and communicate
could undermine the benefits and market acceptance of our Web site and Internet
application hosting and management services. Our services are ultimately limited
by, and dependent upon, the speed and reliability of hardware, communications
services and networks operated by third parties. Consequently, the market for
our Internet application services will be impaired if improvements are not made
to the entire Internet infrastructure to alleviate overloading and congestion.
WE COULD BE SUBJECT TO INCREASED OPERATING COSTS, AS WELL AS CLAIMS,
LITIGATION OR OTHER POTENTIAL LIABILITY, IN CONNECTION WITH RISKS ASSOCIATED
WITH INTERNET SECURITY AND THE SECURITY OF OUR SYSTEMS. A significant barrier to
the growth of e-commerce and communications over the Internet has been the need
for secure transmission of confidential information. Several of our Internet
application services utilize encryption and authentication technology licensed
from third parties to provide the protections necessary to ensure secure
transmission of confidential information. We also rely on security systems
designed by third parties and the personnel in our network operations centers to
secure those data centers. Any unauthorized access, computer viruses, accidental
or intentional actions and other disruptions could result in increased operating
costs. For example, we may incur additional significant costs to protect against
these interruptions and the threat of security breaches or to alleviate problems
caused by such interruptions or breaches, and we expect to expend additional
financial resources in the future to equip our data centers with enhanced
security measures. If a third party were able to misappropriate a consumer's
personal or proprietary information, including credit card information, during
the use of an application solution provided by us, we could be subject to
claims, litigation or other potential liability.
WE MAY BECOME SUBJECT TO BURDENSOME GOVERNMENT REGULATION AND LEGAL
UNCERTAINTIES THAT COULD SUBSTANTIALLY IMPAIR OUR BUSINESS OR EXPOSE US TO
UNANTICIPATED LIABILITIES. It is likely that laws and regulations directly
applicable to the Internet or to Internet application service providers may be
adopted. These laws may cover a variety of issues, including user privacy and
the pricing, characteristics and quality of products and services. The adoption
or modification of laws or regulations relating to commerce over the Internet
could substantially impair the growth of our business or expose us to
unanticipated liabilities. Moreover, the applicability of existing laws to the
Internet and Internet application service providers is uncertain. These existing
laws could expose us to substantial liability if they are found to be applicable
to our business. For example, we provide services over the Internet in many
states in the United States and elsewhere and facilitate the activities of our
customers in such jurisdictions. As a result, we may be required to qualify to
do business, be subject to taxation or be subject to other laws and regulations
in these jurisdictions, even if we do not have a physical presence, employees or
property there.
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WE MAY BE SUBJECT TO LEGAL CLAIMS IN CONNECTION WITH THE INFORMATION
DISSEMINATED THROUGH OUR NETWORK, WHICH COULD HAVE THE EFFECT OF DIVERTING
MANAGEMENT'S ATTENTION AND REQUIRE US TO EXPEND SIGNIFICANT FINANCIAL RESOURCES.
We may face potential direct and indirect liability for claims of defamation,
negligence, copyright, patent or trademark infringement, violation of securities
laws and other claims based on the nature and content of the materials
disseminated through our network. For example, lawsuits may be brought against
us claiming that content distributed by some of our current or future customers
may be regulated or banned. In these and other instances, we may be required to
engage in protracted and expensive litigation that could have the effect of
diverting management's attention and require us to expend significant financial
resources. Our general liability insurance may not necessarily cover any of
these claims or may not be adequate to protect us against all liability that may
be imposed.
In addition, on a limited number of occasions in the past, businesses,
organizations and individuals have sent unsolicited commercial e-mails from
servers hosted at our facilities to a number of people, typically to advertise
products or services. This practice, known as spamming, can lead to complaints
against service providers that enable such activities, particularly where
recipients view the materials received as offensive. We have in the past
received, and may in the future receive, letters from recipients of information
transmitted by our customers objecting to such transmission. Although we
prohibit our customers by contract from spamming, we cannot assure you that our
customers will not engage in this practice, which could subject us to claims for
damages.
THE MARKET PRICE OF OUR COMMON STOCK MAY EXPERIENCE EXTREME PRICE AND
VOLUME FLUCTUATIONS. The market price of our common stock may fluctuate
substantially due to a variety of factors, including: any actual or anticipated
fluctuations in our financial condition and operating results; public
announcements concerning us or our competitors, or the Internet industry; the
introduction or market acceptance of new service offerings by us or our
competitors; changes in industry research analysts' earnings estimates; changes
in accounting principles; sales of our common stock by existing stockholders;
and the loss of any of our key personnel.
In addition, the stock market has experienced extreme price and volume
fluctuations. The market prices of the securities of technology and Internet-
related companies have been especially volatile. This volatility often has been
unrelated to the operating performance of particular companies. In the past,
securities class action litigation often has been brought against companies that
experience volatility in the market price of their securities. Whether or not
meritorious, litigation brought against us could result in substantial costs and
a diversion of management's attention and resources.
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
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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. Nevertheless, if the minimum bid price requirement for continued
listing on Nasdaq is reinstated on January 2, 2002, new delisting proceedings
may be inititated 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, few
business development opportunities and greater difficulty in obtaining
financing.
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 due to the
fixed nature of such obligations. We do not currently have any foreign
operations and thus are not exposed to foreign currency fluctuations.
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
Not applicable.
Item 2. Changes in Securities and Use of Proceeds
(c) Recent Sales of Unregistered Securities
On November 8, 2001, in connection with an agreement dated October 29, 2001
among NaviSite, CMGI, Inc. (CMGI) and Compaq Financial Services Corporation
(CFS), a wholly-owned subsidiary of Compaq Computer Corporation, we purchased
certain equipment previously leased by NaviSite from CFS under operating lease
agreements expiring through 2003 in exchange for a note payable in the face
amount of approximately $35 million. Additionally, we received $20 million and
$10 million in cash from CFS and CMGI, respectively, in exchange for six-year
convertible notes payable in the face amounts of $20 million and $10 million to
CFS and CMGI, respectively, making the total notes payable issued by NaviSite to
CFS and CMGI approximately $55 million and $10 million, respectively. The notes
require payment of interest only, at 12% per annum, for the first three years
from the date of issuance and then repayment of principal and interest, on a
straight-line basis, over the next three years until maturity on the sixth
anniversary of the date of issuance. At NaviSite's option, we may make interest
payments (i) 100% in shares of NaviSite common stock, in the case of amounts
owed to CMGI, through December 2007 and (ii) approximately 16.67% in shares of
NaviSite common stock, in the case of amounts owed to CFS, through December
2003. The convertible notes payable are secured by substantially all of the
assets of NaviSite and cannot be prepaid.
Subject to NaviSite stockholder approval, the principal balances may be
converted into NaviSite common stock at the option of the holders at any time
prior to or at maturity at a conversion rate of $0.26 per share. CMGI also
converted its $80 million in aggregate principal outstanding under its existing
notes payable, plus the accrued interest thereon, into approximately 14.7
million shares of NaviSite common stock. CMGI also converted approximately $16.2
million in other amounts due by NaviSite to CMGI into approximately 9.9 million
shares of NaviSite common stock.
Holders of the convertible notes payable are entitled to both demand and
"piggyback" registration rights, and CFS is entitled to anti-dilution protection
under certain circumstances. The agreement with CFS also contains certain
restrictive covenants, including but not limited to limitations on the issuance
of additional debt, the sale of equity securities to affiliates and certain
acquisitions and dispositions of assets.
The convertible notes to CFS and CMGI were issued in reliance upon the
exemptions from registration under Section 4(2) of the Securities Act and
Regulation D promulgated thereunder, relative to sales by an issuer not
involving a public offering. No underwriters were involved in the sale of these
securities.
Item 3. Defaults Upon Senior Securities.
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders.
Not applicable.
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Item 5. Other Information.
Not applicable.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
Exhibit
Number Exhibit
------- -------
10.1 Letter Agreement by and between the Registrant and Kenneth W.
Hale, dated August 2, 2001.
10.2 Form of Executive Retention Agreement by and between the
Registrant and each of Kevin Lo, Martin Sinozich and Wayne
Whitcomb, dated October 17, 2001.
10.3 Letter Amendment, dated November 8, 2001, to Transaction
Agreement, dated as of October 29, 2001, by and among CMGI, Inc.,
AltaVista Company, Compaq Computer Corporation, Compaq Financial
Services Corporation, Compaq Financial Services Company, Compaq
Financial Services Canada Corporation and the Registrant.
10.4 12% Convertible, Senior, Secured Note due December 31, 2007,
issued by the Registrant to Compaq Financial Services
Corporation, dated November 8, 2001.
10.5 12% Convertible, Senior, Secured Note due December 31, 2007,
issued by the Registrant to CMGI, Inc., dated November 8, 2001.
10.6 Guarantee and Security Agreement, dated as of November 8, 2001,
by and among Compaq Financial Services Corporation, the
guarantors party thereto and the Registrant.
10.7 Amendment to and Restatement of the Investor Rights Agreement,
dated as of November 8, 2001, by and among Compaq Financial
Services Corporation, CMGI, Inc., and the Registrant.
(b) Reports on Form 8-K
On August 15, 2001, we filed a Current Report on Form 8-K, dated June 21,
2001, under Item 5 with respect to a class-action lawsuit filed against us.
On August 17, 2001, we filed a Current Report on Form 8-K, dated July 18,
2001, under Items 5 and 7 with respect to the voluntary resignation of our then
President and Chief Executive Officer, Joel B. Rosen, effective July 31, 2001
(publicly announced on July 18, 2001), and the reduction of our workforce by 126
full and part-time employees, representing approximately 25 percent of our total
staff (publicly announced on July 31, 2001).
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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 hereunto duly authorized.
NAVISITE, INC.
Date: December 17, 2001 By /s/ Patricia Gilligan
--------------------------
Patricia Gilligan
President and Chief Executive
Officer (Principal Executive
Officer, Principal Financial
Officer and Principal
Accounting Officer)
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Exhibit Index
Exhibit No. Exhibit
----------- -------
10.1 Letter Agreement by and between the Registrant and Kenneth W.
Hale, dated August 2, 2001.
10.2 Form of Executive Retention Agreement by and between the
Registrant and each of Kevin Lo, Martin Sinozich and Wayne
Whitcomb, dated October 17, 2001.
10.3 Letter Amendment, dated November 8, 2001, to Transaction
Agreement, dated as of October 29, 2001, by and among CMGI, Inc.,
AltaVista Company, Compaq Computer Corporation, Compaq Financial
Services Corporation, Compaq Financial Services Company, Compaq
Financial Services Canada Corporation and the Registrant.
10.4 12% Convertible, Senior, Secured Note due December 31, 2007,
issued by the Registrant to Compaq Financial Services Corporation,
dated November 8, 2001.
10.5 12% Convertible, Senior, Secured Note due December 31, 2007,
issued by the Registrant to CMGI, Inc., dated November 8, 2001.
10.6 Guarantee and Security Agreement, dated as of November 8, 2001, by
and among Compaq Financial Services Corporation, the guarantors
party thereto and the Registrant.
10.7 Amendment to and Restatement of the Investor Rights Agreement,
dated as of November 8, 2001, by and among Compaq Financial
Services Corporation, CMGI, Inc., and the Registrant.
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