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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
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(Mark One)
[X]QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934.
For the quarterly period ended April 30, 2000.
OR
[_]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the transition period from to
Commission file number: 0-27597
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NAVISITE, INC.
(Exact name of registrant as specified in its charter)
Delaware 52-2137343
(State or other (I.R.S. Employer
jurisdiction of incorporation) Identification No.)
400 Minuteman Road 01810
Andover, Massachusetts (Zip Code)
(Address of principal executive
offices)
(978) 682-8300
(Registrant's telephone number, including area code)
----------------
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period than the
Registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] No [_]
As of June 12, 2000, there were 56,523,715 shares outstanding of the
registrant's common stock, par value $.01 per share.
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NAVISITE, INC
Form 10-Q for the Quarter ended April 30, 2000
INDEX
Page
Number
------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of April 30, 2000 (unaudited) and July
31, 1999.............................................................. 3
Consolidated Statements of Operations for the three and nine months
ended April 30, 2000 and 1999 (unaudited)............................. 4
Consolidated Statements of Cash Flows for the nine months ended April
30, 2000 and 1999 (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....... 21
PART II. OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds........................ 22
Item 6. Exhibits and Reports on Form 8-K................................. 23
SIGNATURE................................................................ 24
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
NAVISITE, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share amounts)
April 30, July 31,
2000 1999
----------- --------
ASSETS (unaudited)
Current assets:
Cash and cash equivalents............................... $ 17,527 $ 3,352
Accounts receivable, less allowance for doubtful
accounts of $743 and $262, at April 30, 2000 and July
31, 1999, respectively................................. 8,343 1,881
Accounts receivable from related parties................ 5,737 77
Prepaid expenses and other current assets............... 2,423 628
Deferred IPO costs...................................... -- 831
-------- --------
Total current assets.................................... 34,030 6,769
-------- --------
Property and equipment, net.............................. 52,257 13,159
Deposits................................................. 3,001 389
Goodwill, net of accumulated amortization of $372 and
$220 at April 30, 2000 and July 31, 1999, respectively.. 653 794
-------- --------
Total assets............................................ $ 89,941 $ 21,111
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Notes payable, current portion.......................... $ -- $ 1,000
Capital lease obligations, current portion.............. 164 229
Software vendor payable, current portion................ 750 708
Accounts payable........................................ 10,870 2,224
Accrued expenses and deferred revenue................... 10,599 3,963
-------- --------
Total current liabilities............................... 22,383 8,124
-------- --------
Capital lease obligations, less current portion.......... 68 178
Software vendor payable, less current portion............ 1,205 1,757
-------- --------
Total liabilities....................................... 23,656 10,059
-------- --------
Series C Convertible Redeemable Preferred Stock, $.01 par
value, 1,095 shares authorized: 0 and 1,095 shares
issued and outstanding at April 30, 2000 and July 31,
1999, respectively (at liquidation value)............... -- 8,088
Series D Convertible Redeemable Preferred Stock, $.01 par
value, 993 shares authorized: 0 and 993 shares issued
and outstanding at April 30, 2000 and July 31, 1999,
respectively (at liquidation value)..................... -- 7,333
-------- --------
Total redeemable preferred stock........................ -- 15,421
-------- --------
Commitments and contingencies
Stockholders' equity (deficit):
Series A Convertible Preferred Stock, $.01 par value,
1,324 shares authorized: 0 and 1,324 shares issued and
outstanding at April 30, 2000 and July 31, 1999,
respectively........................................... -- 13
Series B Convertible Preferred Stock, $.01 par value,
1,000 shares authorized: 0 and 542 shares issued and
outstanding at April 30, 2000 and July 31, 1999,
respectively........................................... -- 5
Preferred Stock, $.01 par value, 5,000 shares
authorized: 0 shares issued and outstanding at April
30, 2000 and July 31, 1999............................. -- --
Common Stock, $.01 par value, 150,000 shares authorized:
56,186 and 138 shares issued and outstanding at April
30, 2000 and July 31, 1999, respectively............... 562 1
Deferred compensation................................... (2,327) --
Additional paid-in capital.............................. 141,152 30,291
Accumulated deficit..................................... (73,102) (34,679)
-------- --------
Total stockholders' equity (deficit).................... 66,285 (4,369)
-------- --------
Total liabilities & stockholders' equity (deficit)...... $ 89,941 $ 21,111
======== ========
See accompanying notes to interim consolidated financial statements.
3
NAVISITE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
(in thousands, except per share amounts)
Three Months
Ended Nine Months Ended
April 30, April 30,
----------------- ------------------
2000 1999 2000 1999
-------- ------- -------- --------
Revenue................................ $ 6,757 $ 958 $ 13,224 $ 2,052
Revenue, related parties............... 7,438 2,025 16,007 4,765
-------- ------- -------- --------
Total revenue...................... 14,195 2,983 29,231 6,817
Cost of revenue........................ 20,161 5,836 41,552 13,557
-------- ------- -------- --------
Gross profit (loss)................ (5,966) (2,853) (12,321) (6,740)
-------- ------- -------- --------
Operating expenses:
Selling and marketing................ 6,310 1,856 15,380 4,397
General and administrative........... 3,131 1,208 8,395 2,555
Product development.................. 1,357 672 3,304 1,378
-------- ------- -------- --------
Total operating expenses........... 10,798 3,736 27,079 8,330
-------- ------- -------- --------
Loss from operations................... (16,764) (6,589) (39,400) (15,070)
Other income (expense):
Interest income...................... 382 -- 1,221 4
Interest expense..................... (48) (175) (244) (370)
-------- ------- -------- --------
Total other income (expense)....... 334 (175) 977 (366)
-------- ------- -------- --------
Net loss............................... $(16,430) $(6,764) $(38,423) $(15,436)
======== ======= ======== ========
Basic and diluted net loss per common
share................................. $ (.29) $(48.66) $ (.98) $ (1.74)
======== ======= ======== ========
Basic and diluted weighted average
number of common shares outstanding... 56,304 139 39,202 8,867
======== ======= ======== ========
Pro forma basic and diluted net loss
per common share...................... $ (.19) $ (.73) $ (.51)
======= ======== ========
Pro forma basic and diluted weighted
average number of shares outstanding.. 35,718 52,371 30,326
======= ======== ========
See accompanying notes to interim consolidated financial statements.
4
NAVISITE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands)
Nine Months Ended
April 30,
------------------
2000 1999
-------- --------
Cash flows from operating activities:
Net loss................................................. $(38,423) $(15,436)
Adjustments to reconcile net loss to net cash used for
operating activities:
Depreciation and amortization.......................... 5,899 1,280
Amortization of deferred compensation.................. 663 --
Provision for bad debts................................ 481 93
Changes in operating assets and liabilities, net of
impact of acquisition in 2000:
Accounts receivable.................................... (6,628) (939)
Accounts receivable from related parties............... (5,660) --
Prepaid expenses....................................... (960) (1,060)
Deposits............................................... (2,610) (127)
Accounts payable....................................... 8,462 2,337
Accrued expenses and deferred revenue.................. 5,799 1,024
-------- --------
Net cash used for operating activities............... (32,977) (12,828)
Cash flows from investing activities:
Net cash acquired in acquisition......................... 6 --
Purchases of property and equipment...................... (44,804) (1,504)
-------- --------
Net cash used for investing activities............... (44,798) (1,504)
Cash flows from financing activities:
Proceeds from increase in debt to CMGI, net.............. 12,898 15,009
Proceeds from issuance of common stock, net of issuance
costs................................................... 80,382 --
Proceeds from exercise of stock options.................. 25 --
Proceeds from employee stock purchase plan............... 331 --
Repayment of note payable................................ (1,000) --
Repayment of software vendor obligations................. (510) (601)
Repayment of capital lease obligations................... (176) (76)
-------- --------
Net cash provided by financing activities............ 91,950 14,332
Net increase in cash....................................... 14,175 --
Cash and cash equivalents, beginning of period............. 3,352 --
-------- --------
Cash and cash equivalents, end of period................... $ 17,527 $ --
======== ========
Supplemental disclosure of cash flow information:
Cash paid during the period for interest................. $ 274 $ 263
======== ========
See accompanying notes to interim consolidated financial statements.
5
NAVISITE, INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
April 30, 2000
1. Basis of Presentation
The accompanying consolidated financial statements have been prepared by
NaviSite, Inc. ("NaviSite" or the "Company") in accordance with generally
accepted accounting principles and pursuant to the rules and regulations of
the Securities and Exchange Commission ("SEC"). Certain information and
footnote disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles 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 Registration
Statement on Form S-1 (File No. 333-83501), which was declared effective by
the SEC on October 21, 1999.
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 generally accepted accounting principles 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. Two-For-One Stock Split
The consolidated financial statements have been retroactively adjusted for
all periods presented to reflect the two-for-one stock split paid in the form
of a stock dividend on April 5, 2000 to holders of record at the close of
business on March 22, 2000.
3. Initial Public Offering
On October 21, 1999, the Company's Registration Statement on Form S-1 (File
No. 333-83501) was declared effective by the SEC. Pursuant to the Registration
Statement, the Company sold 11,000,000 shares of its common stock, par value
$.01 per share (the "Common Stock") at $7.00 per share. On November 18, 1999,
the underwriters of the Company's initial public offering exercised their
over-allotment option in full to purchase an additional 1,650,000 shares of
Common Stock at $7.00 per share. The closing in connection with the exercise
of the over-allotment option was held on November 23, 1999. The Company
received proceeds of approximately $80,382,000, net of offering costs of
approximately $8,169,000, from its initial public offering and the subsequent
exercise by the underwriters of the over-allotment option.
In connection with the closing of the Company's initial public offering on
October 27, 1999, all of the outstanding shares of Series A, Series B, Series
C and Series D convertible preferred stock, par value $.01 per share, of the
Company automatically converted into 43,244,630 shares of Common Stock.
Immediately following the automatic conversion of all of the Company's
outstanding shares of convertible preferred stock, the Company filed an
amended and restated certificate of incorporation. Under the amended and
restated certificate of incorporation, the Company is authorized to issue
150,000,000 shares of Common Stock and 5,000,000 shares of preferred stock,
par value $.01 per share. There currently are no shares of preferred stock
issued and outstanding.
6
NAVISITE, INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
4. Principles of Consolidation
The accompanying financial statements include the accounts of the Company
and its wholly owned subsidiary, ClickHear, Inc. ("ClickHear"), after
elimination of all significant intercompany balances and transactions. During
the quarter ended April 30, 2000, Servercast Communications, L.L.C.
("Servercast"), previously a subsidiary, was legally dissolved and all of its
accounts were combined with those of the Company.
5. Cash and Cash Equivalents
Cash equivalents consist of a money market fund which invests in high
quality short-term debt obligations, including commercial paper, asset-backed
commercial paper, corporate bonds, U.S. government agency obligations, taxable
municipal securities and repurchase agreements.
6. Accrued Expenses and Deferred Revenue
July
April 30, 31,
2000 1999
--------- ------
Accrued expenses consist of the following:
Accrued payroll, benefits and commissions.................... $ 2,712 $1,157
Accrued accounts payable..................................... 1,608 423
Deferred revenue............................................. 719 701
Accrued IPO costs............................................ -- 496
Accrued lease payments....................................... 1,546 257
Other........................................................ 4,014 929
------- ------
$10,599 $3,963
======= ======
7. Net Loss Per Common Share
The Company calculates earnings (loss) per share in accordance with
Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per
Share" ("SFAS 128"). In accordance with SFAS 128, 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 either the "if-converted" method
for convertible preferred stock or the treasury stock method for options,
unless such amounts are anti-dilutive.
For the nine months ended April 30, 2000 and the three and nine months ended
April 30, 1999, net loss per basic and diluted share is based on weighted
average common shares and excludes any common stock equivalents, as they would
be anti-dilutive due to the reported loss. Anti-dilutive potential common
shares outstanding at April 30, 2000 and 1999 were 7,876,020 and 4,574,116,
respectively. For the nine months ended April 30, 2000 and the three and nine
months ended April 30, 1999, a pro forma basic and diluted loss per share
calculation, assuming the conversion of all amounts due to CMGI, Inc. ("CMGI")
and all outstanding shares of preferred stock into common stock using the "if-
converted" method from the later of the date of issuance or beginning of the
period, is presented. The following table provides a reconciliation of the
denominators used in calculating the pro forma basic and diluted earnings
(loss) per share for the nine months ended April 30, 2000 and the three and
nine months ended April 30, 1999:
7
NAVISITE, INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Three
Months
Ended
April Nine Months
30, Ended April 30,
------- -----------------
1999 2000 1999
------- -------- -------
Numerator:
Net loss..................................... $(6,764) $(38,423) (15,436)
Denominator:
Basic weighted average number of common
shares outstanding.......................... 139 39,202 8,867
Assumed conversion of amounts due to CMGI and
preferred stock............................. 35,579 13,169 21,459
------- -------- -------
Weighted average number of pro forma basic and
diluted shares outstanding.................... 35,718 52,371 30,326
======= ======== =======
Pro forma basic and diluted net loss per
share......................................... $ (0.19) $ (0.73) $ (0.51)
======= ======== =======
8. New Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"),
SFAS 133 establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts (collectively referred to as derivatives) and for hedging
activities. SFAS 133 requires the recognition of all derivatives as either
assets or liabilities in the statement of financial position and the
measurement of those instruments at fair value. The Company is required to
adopt this standard in the first quarter of fiscal year 2001 pursuant to SFAS
No. 137 (issued in June 1999), which delays the adoption of SFAS 133 until
that time. The Company expects that the adoption of SFAS 133 will not have a
material impact on its consolidated financial statements.
In November 1999, the SEC issued Staff Accounting Bulletin ("SAB") No. 100,
"Restructuring and Impairment Charges" ("SAB 100"). In December 1999, the SEC
issued SAB No. 101, "Revenue Recognition in Financial Statements" ("SAB 101").
SAB No. 100 expresses the views of the SEC staff regarding the accounting for
and disclosure of certain expenses not commonly reported in connection with
exit activities and business combinations. This includes the accrual of exit
and employee termination costs and the recognition of impairment charges. The
Company does not expect the provisions of SAB No. 100 to have a material
impact on its consolidated financial statements. SAB No. 101 expresses the
views of the SEC staff in applying generally accepted accounting principles to
certain revenue recognition issues. The Company does not expect the provisions
of SAB No. 101 to have a material impact on its consolidated financial
statements.
In March 2000, the Financial Accounting Standards Board issued FASB
Interpretation No. 44, "Accounting for Certain Transactions involving Stock
Compensation" - an interpretation of APB Opinion No. 25 (FIN 44). FIN 44
applies prospectively to new stock option awards, exchanges of awards in a
business combination, modifications to outstanding awards, and changes in
grantee status that occur on or after July 1, 2000. Although the Company is
still in the process of analyzing the impact of FIN 44, if any, on its
consolidated statements and related disclosures, the Company expects that
there will be no material impact on its financial position or its results of
operations.
9. Acquisition of ClickHear
On February 22, 2000, the Company acquired ClickHear for consideration
preliminarily valued at approximately $4,693,000, including approximately
$50,000 of direct costs of the acquisition. The consideration for the
acquisition consisted of 41,968 shares of CMGI common stock valued at
approximately $4,643,000. On
8
NAVISITE, INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
February 22, 2000, CMGI contributed its ClickHear common stock to NaviSite in
exchange for 67,906 shares of NaviSite Common Stock. NaviSite's direct costs
of acquisition were recorded as a component of purchase price. Based on the
terms of the acquisition agreement, the value of the CMGI shares issued will
be recorded as deferred compensation by NaviSite. The CMGI shares issued are
subject to forfeiture by the ClickHear stockholders based on employment
criteria as well as performance goals. The deferred compensation component of
the consideration initially valued at $4,643,000 is accounted for on a
variable basis at market value at the end
of each reporting period, and will be amortized to compensation expense over
the eleven month performance contingency period. As CMGI and NaviSite are
entities under common control, upon settlement of the employment and
performance contingencies, NaviSite will record the difference in fair value
between the value of NaviSite's common shares issued to CMGI and the value of
the CMGI common shares issued to the ClickHear stockholders as an equity
transaction.
The Company records the amortization of the deferred compensation in cost of
sales. For the quarter ended April 30, 2000, the Company recorded
approximately $663,000 of compensation expense related to the amortization of
the deferred compensation.
The allocation of this purchase price over the acquired assets and
liabilities of ClickHear as of the acquisition date is outlined as follows (in
thousands):
Working capital deficit................................................... $(3)
Property and equipment.................................................... 40
Other assets.............................................................. 2
Goodwill and other intangible assets...................................... 11
---
Purchase price.......................................................... $50
===
10. Subsequent Events
In June 2000, the Company sold certain of its equipment and leasehold
improvements in its two new data centers in a sale-leaseback transaction to a
bank for approximately $30.0 million. The Company simultanously entered into a
capital lease (the "Capital Lease") of those assets with the bank. The Capital
Lease bears interest at a rate of 9.15% and is payable in monthly installments
ending April 2004. The Capital Lease contains certain financial covenants, as
defined, and a mandatory balloon payment, for repurchase by the Company, equal
to 10% of the bank's acquisition cost of the equipment.
On June 8, 2000, the Company sold 980,873 shares of its common stock to CMGI
for the sum of $50.0 million, in a private placement transaction. The number
of shares was determined by dividing $50.0 million by the average of the
closing prices per share of the company's common stock as reported on the
Nasdaq National Market System on June 6, 7, 8, 9 and 12, 2000, rounded up to
the nearest whole share.
9
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
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 the Company's 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.
In March 2000, our board of directors approved a two-for-one common stock
split, effected in the form of a stock dividend of one share of common stock
for each share of common stock outstanding. The stock dividend was paid on
April 5, 2000 to stockholders of record at the close of business on March 22,
2000. Accordingly, the consolidated financial statements have been
retroactively adjusted for all periods presented to reflect this event. Unless
otherwise indicated, all share information in this Management's Discussion and
Analysis of Financial Condition and Results of Operations reflect the two-for-
one stock split.
Overview
We provide enhanced, integrated hosting and management services for business
Web sites and Internet applications. We also provide application rentals to
customers and developers and supply related professional services. Our
Internet application service offerings allow businesses to outsource the
deployment, configuration, hosting, management and support of their Web sites
and Internet applications in a cost-effective and rapid manner. Our focus on
enhanced management services, beyond basic co-location services, allows us to
meet the expanding needs of businesses as their Web sites and Internet
applications become more complex. The cost for our services varies from
customer to customer based on the number of hosted or managed servers and the
nature and level of services provided.
We intend to expand both domestically and internationally. As part of this
expansion, we completed construction of a new 153,000 square foot facility in
Andover, Massachusetts, which includes a new data center. In May 1999, we
executed a 12-year lease for this new facility. On December 3, 1999, we
executed a $10.3 million letter of credit in connection with the construction
of the Massachusetts facility. The letter of credit expired in March 2000. The
new Massachusetts facility opened on schedule on January 7, 2000. In addition,
during the nine month period ended April 30, 2000, construction was completed
on a new 66,000 square foot facility located in San Jose, California, which
also includes a new data center. In May 1999, we executed a seven-year lease
for the San Jose facility. The new San Jose data center opened on schedule on
November 18, 1999.
We derive our revenue from a variety of services, including: Web site and
Internet application hosting, which includes access to our state-of-the-art
data centers, bandwidth, basic and advanced back-up, storage and monitoring
services; enhanced server management, which includes custom reporting,
hardware options, load balancing and mirroring, system security, remote
management and the services of our technical account managers; specialized
application management, which includes management of e-commerce and other
sophisticated applications and their underlying services, including ad-
serving, streaming, databases and transaction processing; application rentals
and related consulting and other professional services. Revenue also includes
income from the rental of equipment to customers and one-time installation
fees. Revenue is recognized
10
in the period in which the services are performed and installation fees are
recognized in the period of installation. Our contracts typically range from
one to three year commitments.
Our revenue from sales to related parties consists principally of sales of
services to CMGI, Inc. and other entities in which CMGI holds an equity
interest. In general, in pricing the services provided to CMGI and these CMGI
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%.
Three-month period ended April 30, 2000 compared to the three-month period
ended April 30, 1999.
Revenue
Total revenue increased 376% to approximately $14.2 million for the three-
month period ended April 30, 2000, from approximately $3.0 million for the
same period in 1999. The increase in revenue is due to both the increase in
the number of unaffiliated customers and additional business with unaffiliated
customers, CMGI subsidiaries and affiliates.
Cost of Revenue
Cost of revenue principally includes labor and headcount expenses,
equipment, maintenance and facilities costs, and bandwidth and connectivity
charges. Cost of revenue increased 245% to approximately $20.2 million for the
three-month period ended April 30, 2000, from approximately $5.8 million for
the same period in 1999. As a percentage of revenue, cost of revenue decreased
to 142% for the three-month period ended April 30, 2000, from 196% for the
same period in 1999. The cost of revenue increase in absolute dollars for the
quarter ended April 30, 2000 is due primarily to costs associated with the
increased revenue, the increased depreciation resulting from the investments
in our new data centers in San Jose, California and Andover, Massachusetts,
the continuing investments in our existing data centers and the non-cash
amortization of the deferred compensation related to the ClickHear, Inc.
acquisition.
The San Jose facility became operational on November 18, 1999 and the
Andover facility on January 7, 2000; both facilities commenced operations on
schedule. The three months ended April 30, 2000 represent the first quarter to
reflect expenses of operating the new data centers for a full quarter.
Operating Expenses
Selling and Marketing. Selling and marketing expenses primarily include
salaries and commissions and expenses for marketing programs, including
advertising, events, sponsorship, direct marketing, product literature, and
agency fees. Selling and marketing expenses increased 240% to approximately
$6.3 million for the quarter ended April 30, 2000, from approximately $1.9
million for the same period in 1999. This increase is due primarily to the
development of our sales and marketing capability to support our growth. As a
percentage of revenue, sales and marketing decreased to 44% for the quarter
ended April 30, 2000, from 62% for the same period in 1999.
General and Administrative. General and administrative expenses primarily
include the costs of financial, leasing, human resource, information
technology, business development and administrative personnel, professional
services and corporate overhead. General and administrative expenses increased
159% to approximately $3.1 million for the quarter ended April 30, 2000, from
approximately $1.2 million for the same period in 1999. The increase is due to
hiring additional personnel to support our growing operations and also
reflects the higher cost associated with becoming a publicly traded company.
Product Development. Product development expenses consist primarily of
salaries and related costs. Product development expenses increased 102% to
approximately $1.4 million for the quarter ended April 30, 2000, from
approximately $672,000 for the same period in 1999. This increase is due
primarily to the costs
11
associated with an increase in product development personnel to 34 as of April
30, 2000, from 16 employees at April 30, 1999. This growth in product
development personnel reflects our increased service offerings and emphasis on
application services.
Interest Income
Interest income increased to approximately $382,000 for the quarter ended
April 30, 2000, from $0 in interest income for the same period in 1999. This
increase is due primarily to the funds available for investment during the
quarter ended April 30, 2000 resulting from the proceeds from our initial
public offering in October 1999 and the exercise of an over-allotment option
granted to the underwriters in November 1999.
Interest Expense
Interest expense decreased to approximately $48,000 for the quarter ended
April 30, 2000, from $175,000 for the same period in 1999 due to decreased
interest expense on long-term capital lease obligations and the decrease in
intercompany interest expense to CMGI. Other interest expense is due to
imputed interest on a software license purchase.
Nine-month period ended April 30, 2000 compared to the nine-month period ended
April 30, 1999.
Revenue
Total revenue increased 329% to approximately $29.2 million for the nine-
month period ended April 30, 2000, from approximately $6.8 million for the
same period in 1999. The increase in revenue is due to both the increase in
the number of unaffiliated customers and additional business with unaffiliated
customers, CMGI subsidiaries and affiliates. Unaffiliated revenue increased
544%, while related party revenue increased 236% over the same nine-month
period in 1999.
Cost of Revenue
Cost of revenue principally includes labor and headcount expenses,
additional equipment, maintenance and facilities costs and increased bandwidth
and connectivity charges. Cost of revenue increased 206% to approximately
$41.6 million for the nine-month period ended April 30, 2000, from
approximately $13.6 million for the same period in 1999. As a percentage of
revenue, cost of revenue decreased to 142% for the nine-month period ended
April 30, 2000, from 199% for the same period in 1999. The dollar-value
increase in each period is due primarily to the costs associated with
increased investment in our existing and our new data centers in San Jose,
California and Andover, Massachusetts. The nine-month period ended April 30,
2000 reflects approximately five months of expenses related to the new San
Jose data center, and approximately four months of expenses related the new
Andover data center.
Operating Expenses
Selling and Marketing. Selling and marketing expenses primarily include
salaries and commissions and expenses for marketing programs, including
advertising, events, sponsorships, direct marketing, product literature and
agency fees. Selling and marketing expenses increased 250% to approximately
$15.4 million for the nine-month period ended April 30, 2000, from
approximately $4.4 million for the same period in 1999. This increase is due
primarily to the development of our sales and marketing capability to support
our growth. As a percentage of revenue, sales and marketing decreased to 53%
for the nine-month period ended April 30, 2000, from 65% for the same period
in 1999.
General and Administrative. General and administrative expenses primarily
include the costs of financial, leasing, human resource, information
technology, business development and administrative personnel, professional
services, and corporate overhead. General and administration expenses
increased 229% to
12
approximately $8.4 million for the nine-month period ended April 30, 2000,
from approximately $2.6 million for the same period 1999. The increase is due
to hiring of additional personnel in all areas of administration to support
our growing operations and also reflects the higher cost associated with Year
2000 projects and becoming a publicly traded company.
Product Development. Product development expenses consist primarily of
salaries and related costs. Product development expenses increased 140% to
approximately $3.3 million for the nine-month period ended April 30, 2000,
from approximately $1.4 million for the same period in 1999. This increase is
due primarily to the costs associated with an increase in product development
personnel as of April 30, 2000 to 34, from 16 employees at April 30, 1999.
This growth in product development personnel reflects our increased service
offerings and increased emphasis on application services.
Interest Income
Interest income increased to approximately $1.2 million in the nine-month
period ended April 30, 2000, from $4,000 interest income for the same period
in 1999. This increase is due primarily to the funds available for investment
resulting from the proceeds from our initial public offering in October 1999
and the over-allotment exercise in November 1999.
Interest Expense
Interest expense, net decreased for the nine-month period ended April 30,
2000 to approximately $244,000 compared to $370,000 in interest expense for
the same period in 1999. This interest expense is due primarily to
intercompany interest expense to CMGI and other interest expense due to the
Term Notes issued in connection with our acquisition, in July 1998, of
Servercast, interest expense on long-term capital lease obligations and
imputed interest on a software license purchase. The Term Notes were paid in
full in January 2000.
Liquidity and Capital Resources
Since our inception, our operations have been funded primarily by CMGI
through the issuance of preferred stock and convertible debt, the issuance of
preferred stock and our initial public offering and related underwriters'
over-allotment in October 1999 and November 1999, respectively.
Net cash used for operating activities for the nine-month period ended April
30, 2000 amounted to $33 million, resulting primarily from net operating
losses, increases in accounts receivable and a $2.5 million lease deposit,
partially offset by non-cash depreciation and amortization charges and
increases in accounts payable and accrued expenses. The net increase in
accounts receivable is a result of the revenue growth for the period. The
available for collection days sales outstanding is approximately 48 days at
April 30, 2000 as compared to 30 at January 31, 2000. Available for collection
days sales outstanding represents the weighted average number of days sales
are outstanding based on the date that services rendered during the period are
billed.
Net cash used for investing activities for the nine-month period ended April
30, 2000 amounted to $44.8 million. The net cash used for investing activities
was used primarily to build and equip two new data centers and acquire
property and equipment required to support the growth of the business.
Net cash provided by financing activities for the nine-month period ended
April 30, 2000 amounted to $92.0 million. Cash provided by financing
activities included $80.4 million of combined net proceeds from our initial
public offering and exercise of the underwriters' over-allotment option, as
well as funds advanced from CMGI, totaling $12.9 million, to fund our
operations for the period from August 1, 1999 through the closing of our
initial public offering on October 27, 1999. The cash provided by financing
activities was partially offset by the repayment of a $1.0 million note
payable related to the Servercast acquisition.
Until the completion of our initial public offering on October 27, 1999,
CMGI funded our operations as needed, increasing our obligations to CMGI and
allowing us to maintain a zero-balance cash account. Customer
13
and other receipts were remitted to CMGI and applied to reduce our obligations
to CMGI. We issued a secured convertible demand note to CMGI in exchange for
the cancellation of all outstanding intercompany debt incurred by us to CMGI
prior to April 30, 1999. This note also provides for additional advances by
CMGI to us after April 30, 1999. Prior to the completion of our initial public
offering, the amount of each borrowing represented by the note was convertible
from time to time into the number of shares of Series B convertible preferred
stock equal to one-tenth of the quotient of the aggregate amount of principal
and interest to be so converted, divided by the applicable conversion price
for that fiscal quarter. The conversion price applicable to advances made
during the fiscal quarter in which our initial public offering occurred was
determined by the offering price of the initial public offering. Any future
advances from CMGI under this note will be convertible from time to time into
the number of shares of common stock equal to the quotient of the aggregate
amount of principal and interest to be so converted, divided by the applicable
conversion price for that fiscal quarter.
Under this note, CMGI converted intercompany debt in the aggregate amount of
approximately $12.3 million, representing funds advanced during the period
subsequent to the quarter ended July 31, 1999 through October 21, 1999 (the
effective date of the registration statement relating to our initial public
offering), into 87,548 shares of Series B convertible preferred stock (based
upon a conversion price of $140.00, ten times the initial public offering
price of $14.00 per share). Upon the closing of our initial public offering,
each issued and outstanding share of Series B convertible preferred stock
converted into 20 shares of common stock, or 12,588,140 shares of common stock
in the aggregate. We have not borrowed funds from CMGI since the completion of
our initial public offering on October 27, 1999, and we do not expect to
borrow funds from CMGI in the future.
On December 3, 1999, in connection with the construction contract for our
new Andover, Massachusetts facility, we obtained a letter of credit in the
amount of $10.3 million, representing the remaining balance due under the
construction contract. Under the letter of credit arrangement the Company was
required to maintain on deposit a compensating balance, restricted as to use,
of 110% of the outstanding liability under the letter of credit. The
obligation under the letter of credit expired on March 1, 2000, and the
corresponding compensating balance requirement was ended.
We have experienced a substantial increase in our expenditures since
inception consistent with our growth in operations and staffing. We anticipate
that expenditures will continue to increase for at least three years as we
accelerate the growth of our business. Additionally, we will continue to
evaluate investment opportunities in businesses that management believes will
complement our technologies and market strategies.
In June 2000, we sold certain of our equipment and leasehold improvements in
our two new data centers in a sale-leaseback transaction to a bank for
approximately $30.0 million. We entered into a capital lease (the "Capital
Lease") upon the leaseback of those assets. The Capital Lease bears interest
at a rate of 9.15% and is payable in monthly installments ending April 2004.
The Capital Lease contains certain financial covenants, as defined, and a
mandatory balloon payment, for repurchase by us, equal to 10% of the bank's
acquisition cost of the equipment.
On June 8, 2000, we sold 980,873 shares of our common stock to CMGI for the
sum of $50.0 million, in a private placement transaction. The number of shares
was determined by dividing $50.0 million by the average of the closing prices
per share of our common stock as reported on the Nasdaq National Market System
on June 6, 7, 8, 9 and 12, 2000, rounded up to the nearest whole share.
We currently anticipate that our available cash resources at April 30, 2000
combined with the cash received from the private placement with CMGI and the
sale-leaseback, as described above, will be sufficient to meet our anticipated
needs, barring unforeseen circumstances, for working capital and capital
expenditures over the next six months, assuming we obtain additional lease
financing credit lines. However, we may need to raise additional funds in
order to fund more rapid expansion, to fund our geographic expansion, to
develop new, or enhance existing, services or products, to respond to
competitive pressures or to acquire complementary businesses, products or
technologies. In addition, on a long-term basis, we may require additional
external financing for working capital and capital expenditures through credit
facilities, sales of additional equity or other financing vehicles. If
additional funds are raised through the issuance of equity or convertible debt
securities, the percentage ownership of our stockholders will be reduced and
our stockholders may experience additional
14
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 revenues and results of 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 expects 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 April 30, 2000, we had an accumulated deficit of
$73.1 million. The income potential of our business is unproven, and our
limited operating history makes it difficult to evaluate our prospects. We
anticipate increased expenses as we continue to expand and improve our
infrastructure, invest in additional applications, 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 two years.
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: the demand for and market acceptance of our
Web site and Internet application hosting and management services; our ability
to develop, market and introduce new services on a timely basis; downward
price adjustments by our competitors; changes in the mix of services provided
by our competitors; technical difficulties or system downtime affecting the
Internet generally or our hosting operations specifically; our ability to meet
any increased technological demands of our customers; the amount and timing of
costs related to our marketing efforts and service introductions; and economic
conditions specific to the Internet application service provider industry. Our
operating results for any particular quarter may fall short of our
expectations or those of investors or securities analysts. In this event, the
market price of our common stock would be likely to fall.
We are controlled by CMGI, and CMGI may have interests that conflict with
the interests of our other stockholders. As of April 30, 2000, CMGI
beneficially owned approximately 69.5% of our outstanding common stock. As of
June 12, 2000, after giving effect for the subsequent June 2000 private
placement of our common stock, CMGI beneficially owned approximately 69.8% 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 effect 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
15
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 acquiror from
attempting to obtain control of us, which in turn could adversely affect the
market price of our common stock.
A significant portion of our revenue currently is generated by services
provided to CMGI and companies affiliated with CMGI, and the loss of this
revenue would substantially impair the growth of our business. We anticipate
that we will continue to receive a significant portion of our revenue in the
future from CMGI and CMGI affiliates. CMGI and CMGI affiliates accounted for
approximately 55% of our revenue in the nine-month period ended April 30, 2000
and approximately 70% of our revenue in the nine-month period ended April 30,
1999. We cannot assure you that revenues generated by CMGI and CMGI affiliates
will continue or that we will be able to secure business from unaffiliated
customers to replace this revenue in the future. The loss of revenue from CMGI
and CMGI affiliates, or our inability to replace this operating revenue, would
substantially impair the growth of our business.
Certain of the equipment that we use or provide to our customers for their
use in connection with our services is provided under leases executed or
guaranteed by CMGI. We do not expect CMGI to continue this practice, and
accordingly, we or our customers will have to obtain this equipment for new
leases and renewal of existing leases directly, on an stand alone basis. Our
ability to grow our business would be substantially impaired if we were unable
to obtain, on commercially reasonable terms, leases for this equipment. We
cannot assure you that it or its customers can do so on similar financial
terms.
If the growth of the market for Internet commerce and communication does not
continue, 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. In addition, in order for the market for our services
to grow, consumers who have historically purchased and communicated through
traditional means must elect to purchase products and services and conduct
their communication online. These transitions must continue to ensure a
growing market for our Web site and Internet application hosting and
management services.
Our growth could be substantially limited if the market for Internet
application services fails to continue to develop or if we cannot continue to
achieve broad market acceptance. The market for Internet application services
has only developed recently and is evolving rapidly. There is significant
uncertainty as to whether the Internet application service market will
ultimately prove to be viable or, if it becomes viable, that it will continue
to grow. Historically, businesses have been reluctant to outsource the hosting
and management of sophisticated applications and have considered third-party
service vendors to be unequipped to manage Internet applications critical to
their businesses. If the market for outsourced system and network management
of Web sites and Internet applications fails to continue to develop, or
develops more slowly than we expect, or if our Web site and Internet
application hosting and management services do not continue to achieve broad
market acceptance, our growth could be substantially limited.
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
16
our services could be greatly hindered and our ability to attract new
customers could be adversely affected. We cannot assure you that new
applications deployed by us will be free from any reliability, quality or
compatibility problems. If we incur increased costs or are unable, for
technical or other reasons, to host and manage new Internet applications or
enhancements of existing applications, our ability to successfully market our
services could be substantially impaired.
The market we serve is highly competitive, and as an early stage company, we
may lack the financial and other resources, expertise or capability needed to
capture increased market share. We compete in the Internet application service
market. This market is rapidly evolving, highly competitive and likely to be
characterized by an increasing number of market entrants and by industry
consolidation. We believe that participants in this market must grow rapidly
and achieve a significant presence to compete effectively. As an early stage
company, our business is not as developed as that of many of our competitors.
For example, we estimate that the growth capacity of our facilities may be
sufficient only for the next two years. Insufficient growth capacity in our
facilities could impair our ability to achieve rapid growth through an
increase in our customer base.
Moreover, many of our competitors have substantially greater financial,
technical and marketing resources, greater name recognition and more
established relationships in the industry than we have. We may lack the
financial and other resources, expertise or capability needed to capture
increased market share in this environment in the future.
Any interruptions in, or degradation of, our private transit Internet
connections could result in the loss of customers or hinder our ability to
attract new customers. Our customers rely on our ability to move their digital
content as efficiently as possible to the people accessing their Web sites and
Internet applications. We utilize our direct private transit Internet
connections to major backbone providers as a means of avoiding congestion and
resulting performance degradation at public Internet exchange points. We rely
on these telecommunications network suppliers to maintain the operational
integrity of their backbones so that our private transit Internet connections
operate effectively.
Increased costs associated with our private transit Internet connections
could result in the loss of customers or significant increases in operating
costs. Our private transit Internet connections are already more costly than
alternative arrangements commonly utilized to move Internet traffic. If
providers increase the pricing associated with utilizing their bandwidth, we
may be required to identify alternative methods to distribute our customers'
digital content. We cannot assure you that our customers will continue to be
willing to pay the higher costs associated with direct private transit or that
we could effectively move to another network approach. If we are unable to
access alternative networks to distribute our customers' digital content on a
cost- effective basis or to pass any additional costs on to our customers, our
operating costs would increase significantly.
If we are unable to maintain existing and develop additional relationships
with Internet application software vendors, the sale, marketing and provision
of our Internet application services may be unsuccessful. We believe that to
penetrate the market for our 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 our software applications from
Internet application software vendors. The loss of any of these applications
could materially impair our ability to provide services to our customers or
require us to obtain substitute software applications of lower quality or
performance standards or at greater cost. In addition, because we generally
license applications on a non-exclusive basis, our competitors may license and
utilize the same software applications. In fact, many of the companies with
which we have strategic relationships currently have, or could enter into,
similar license agreements with our competitors or prospective competitors. We
cannot assure you that software applications will continue to be available to
us from Internet application software vendors on commercially reasonable
terms. If we are unable to identify and license software applications which
meet our targeted criteria for new application introductions, we may have to
discontinue or delay introduction of services relating to these applications.
We purchase from a limited number of suppliers key components of our
infrastructure, including networking equipment, that are available only from
limited sources in the quantities and with the quality that we demand.
17
For example, we purchase most of the routers and switches used in our
infrastructure from Cisco Systems Inc. and most of the intelligent Web
switching technology from ArrowPoint Communications Inc. Subsequent to the
quarter ended April 30, 2000, these companies merged. We cannot assure you
that we will have the necessary hardware or parts on hand or that our
suppliers will be able to provide them in a timely manner in the event of
equipment failure. Our inability or failure to obtain the necessary hardware
or parts on a timely basis could result in sustained equipment failure and a
loss of revenue due to customer loss or claims for service credits under our
service level guarantees.
Our inability to scale our infrastructure or otherwise manage our
anticipated growth and the related expansion of our operations could result in
decreased revenue and continued operating losses. We have experienced rapid
growth in our service offerings and our customer base. As of April 30, 1999,
we were a Web site hosting provider with approximately 82 customers. As of
April 30, 2000, we were providing Web site and Internet application hosting
and management services to approximately 283 customers. In order to service
our growing customer base, we will need to continue to improve and expand our
network infrastructure, in particular through the construction of new data
centers. The ability of our network to connect and manage a substantial number
of customers at high transmission speeds while maintaining superior
performance is largely unproven. If our network infrastructure is not
scalable, we may not be able to provide our services to additional customers,
which would result in decreased revenue.
In addition, between April 30, 1999 and April 30, 2000, we increased the
number of our employees from 172 to 425. This growth has placed, and likely
will continue to place, a significant strain on our financial, management,
operational and other resources. To effectively manage our anticipated growth,
we will be required to continue to enhance our operating and financial
procedures and controls, to upgrade or replace our operational, financial and
management information systems and to attract, train, motivate, manage and
retain key employees. If we are unable to effectively manage our rapid growth,
we could experience continued operating losses.
You may experience additional dilution because our historical source of
funding is expected to change, and other funding may not be available to us on
favorable terms, if at all. Until the completion of our initial public
offering, CMGI funded our operations as needed, increasing our obligations to
CMGI and allowing us to maintain a zero-balance cash account. Upon completion
of our initial public offering, our net obligations to CMGI, together with all
convertible preferred stock held by CMGI, were converted into common stock. We
do not expect to borrow additional funds from CMGI in the future. We may need
to raise additional funds from time to time and in fact recently completed a
$30 million sale-leaseback transaction with a bank and a $50 million private
placement sale of common stock to CMGI in this regard. We cannot assure you
that additional financing will be available on terms favorable to us, if at
all. If adequate funds were not available or were not available on acceptable
terms, our ability to respond to competitive pressures would be significantly
limited. Moreover, if additional funds are raised through the issuance of
equity or convertible debt securities, your percentage ownership in us will be
reduced, and you may experience additional dilution.
Our network infrastructure could fail, which would impair our ability to
provide guaranteed levels of service and could result in significant operating
losses. To provide our customers with guaranteed levels of service, we must
operate our network infrastructure 24 hours a day, seven days a week without
interruption. In order to operate in this manner, we must protect our network
infrastructure, equipment and customer files against damage from human error,
natural disasters, unexpected equipment failure, power loss or
telecommunications failures, sabotage or other intentional acts of vandalism.
Even if we take precautions, the occurrence of a natural disaster, equipment
failure or other unanticipated problem at one or more of our data centers
could result in interruptions in the services we provide to our customers. We
cannot assure you that our disaster recovery plan will address all, or even
most, of the problems we may encounter in the event of such a disaster.
We have experienced service interruptions in the past, and any future
service interruptions could: require us to spend substantial amounts of money
to replace equipment or facilities; entitle customers to claim service credits
under our service level guarantees; cause customers to seek damages for losses
incurred; or make it more
18
difficult for us to attract new customers or enter into additional strategic
relationships. Any of these occurrences could result in significant operating
losses.
The misappropriation of our proprietary rights could result in the loss of
our competitive advantage in the market. We rely on a combination of
trademark, service mark, copyright and trade secret laws and contractual
restrictions to establish and protect our proprietary rights. We do not own
any patents that would prevent or inhibit competitors from using our
technology or entering our market. We cannot assure you that the contractual
arrangements or other steps taken by us to protect our proprietary rights will
prove sufficient to prevent misappropriation of our proprietary rights or to
deter independent, third-party development of similar proprietary assets. In
addition, we provide our services in other countries where the laws may not
afford adequate protection for our proprietary rights.
Third-party infringement claims against our technology suppliers, customers
or us could result in disruptions in service, the loss of customers or costly
and time consuming litigation. We license or lease most technologies used in
the Internet application services that we offer our technology suppliers may
become subject to third-party infringement claims which could result in their
inability or unwillingness to continue to license their technology to us. We
expect that we and our customers increasingly will be subject to third-party
infringement claims as the number of Web sites and third-party service
providers for Web-based businesses grows. In addition, we have received
notices alleging that our service marks infringe the trademark rights of third
parties. We cannot assure you that third parties will not assert claims
against us in the future or that these claims will not be successful. Any
infringement claim as to our technologies or services, regardless of its
merit, could result in delays in service, installation or upgrades, the loss
of customers or costly and time-consuming litigation, or require us to enter
into royalty or licensing agreements.
The loss of key officers and personnel could impair our ability to
successfully execute our business strategy, because we substantially rely on
their experience and management skills, or could jeopardize our ability to
continue to provide service to our customers. We believe that the continued
service of key personnel, including Joel B. Rosen, our Chief Executive
Officer, is a key component of the future success of our business. None of our
key officers or personnel is currently a party to an employment agreement with
us. This means that any officer or employee can terminate his or her
relationship with us at any time. In addition, we do not carry life insurance
for any of our key personnel to insure our business in the event of their
death. In addition, the loss of key members of our sales and marketing teams
or key technical service personnel could jeopardize our positive relations
with our customers. Any loss of key technical personnel would jeopardize the
stability of our infrastructure and our ability to provide the guaranteed
service levels our customers expect.
If we fail to attract and retain additional skilled personnel, our ability
to provide Web site and Internet application management and technical support
may be limited, and as a result, we may be unable to attract customers and our
business. Our business requires individuals with significant levels of
Internet application expertise, in particular to win consumer confidence in
outsourcing the hosting and management of mission-critical applications.
Competition for such personnel is intense, and qualified technical personnel
are likely to remain a limited resource for the foreseeable future. Locating
candidates with the appropriate qualifications, particularly in the desired
geographic location, can be costly and difficult. We may not be able to hire
the necessary personnel to implement our business strategy, or may need to
provide higher compensation to such personnel than we currently anticipate.
Any future acquisitions we make of companies or technologies may result in
disruptions to our business or distractions of our management due to
difficulties in assimilating acquired personnel and operations. Our business
strategy contemplates future acquisitions of complementary businesses or
technologies. If we do pursue additional acquisitions, our risks may increase
because our ongoing business may be disrupted and management's attention and
resources may be diverted from other business concerns. In addition, through
acquisitions, we may enter into markets or market segments in which we have
limited prior experience.
Once we complete an acquisition, we will face additional risks. These risks
include: difficulty assimilating acquired operations, technologies and
personnel; inability to retain management and other key personnel of the
19
acquired business; and changes in management or other key personnel that may
harm relationships with the acquired business's customers and employees.
In addition, while we are a consolidated subsidiary of CMGI, and for a
period of two years afterwards were we ever to become no longer a consolidated
subsidiary of CMGI, our acquisitions must be accounted for using the purchase
method of accounting, which could result in unfavorable accounting for
acquisitions. We cannot assure you that any acquisitions will be successfully
identified and completed or that, if one or more acquisitions are completed,
the acquired business, assets or technologies will generate sufficient revenue
to offset the associated costs or other adverse effects.
The international market for our services is unproven, and as a result, the
revenue generated by any current or future international operations may not be
adequate to offset the expense of establishing and maintaining those
operations. One component of our long-term strategy is to expand into
international markets. We cannot assure you that we will be able to market,
sell and provide our services successfully outside the United States. We could
suffer significant operating losses if the revenue generated by any current or
future international data center or other operations is not adequate to offset
the expense of establishing and maintaining those international operations.
NaviSite faces risks inherent in doing business in international markets
which could adversely affect the success of our international operations.
There are risks inherent in doing business in international markets, including
different regulatory requirements, trade barriers, challenges in staffing and
managing foreign operations, currency risk, different technology standards,
different tax structures which may adversely impact earnings, different
privacy, censorship and service provider liability standards and regulations
and foreign political and economic instability, any of which could adversely
affect the success of our international operations.
The emergence and growth of a market for our Internet application services
will be impaired if third parties do not continue to develop and improve the
Internet infrastructure. The recent growth in the use of the Internet has
caused frequent periods of performance degradation, requiring the upgrade of
routers and switches, telecommunications links and other components forming
the infrastructure of the Internet by Internet service providers and other
organizations with links to the Internet. Any perceived degradation in the
performance of the Internet as a means to transact business and communicate
could undermine the benefits and market acceptance of our Web site and
Internet application hosting and management services. Our services are
ultimately limited by, and dependent upon, the speed and reliability of
hardware, communications services and networks operated by third parties.
Consequently, the emergence and growth of the market for our Internet
application services will be impaired if improvements are not made to the
entire Internet infrastructure to alleviate overloading and congestion.
We could be subject to increased operating costs, as well as claims,
litigation or other potential liability, in connection with risks associated
with Internet security and the security of our systems. A significant barrier
to the growth of e-commerce and communications over the Internet has been the
need for secure transmission of confidential information. Several of our
Internet application services utilize encryption and authentication technology
licensed from third parties to provide the protections necessary to ensure
secure transmission of confidential information. We also rely on security
systems designed by third parties and the personnel in our network operations
centers to secure those data centers. Any unauthorized access, computer
viruses, accidental or intentional actions and other disruptions could result
in increased operating costs. For example, we may incur significant costs to
protect against these interruptions and the threat of security breaches or to
alleviate problems caused by such interruptions or breaches, and we expect to
expend significant financial resources in the future to equip our new and
existing data centers with state-of-the-art security measures. If a third
party were able to misappropriate a consumer's personal or proprietary
information, including credit card information, during the use of an
application solution provided by us, we could be subject to claims, litigation
or other potential liability.
We may become subject to burdensome government regulation and legal
uncertainties that could substantially impair the growth of our business or
expose us to unanticipated liabilities. It is likely that laws and regulations
directly applicable to the Internet or to Internet application service
providers may be adopted. These
20
laws may cover a variety of issues, including user privacy and the pricing,
characteristics and quality of products and services. The adoption or
modification of laws or regulations relating to commerce over the Internet
could substantially impair the growth of our business or expose us to
unanticipated liabilities. Moreover, the applicability of existing laws to the
Internet and Internet application service providers is uncertain. These
existing laws could expose us to substantial liability if they are found to be
applicable to our business. For example, we provide services over the Internet
in many states in the United States and in the United Kingdom and facilitate
the activities of our customers in these jurisdictions. As a result, we may be
required to qualify to do business, be subject to taxation or be subject to
other laws and regulations in these jurisdictions, even if we do not have a
physical presence, employees or property there.
We may be subject to legal claims in connection with the information
disseminated through our network which could have the effect of diverting
management's attention and require us to expend significant financial
resources. We may face potential direct and indirect liability for claims of
defamation, negligence, copyright, patent or trademark infringement, violation
of securities laws and other claims based on the nature and content of the
materials disseminated through our network. For example, lawsuits may be
brought against us claiming that content distributed by some of our current or
future customers may be regulated or banned. In these and other instances, we
may be required to engage in protracted and expensive litigation which could
have the effect of diverting management's attention and require us to expend
significant financial resources. Our general liability insurance may not
necessarily cover any of these claims or may not be adequate to protect us
against all liability that may be imposed.
In addition, on a limited number of occasions in the past, businesses,
organizations and individuals have sent unsolicited commercial e-mails from
servers hosted at our facilities to massive numbers of people, typically to
advertise products or services. This practice, known as "spamming," can lead
to complaints against service providers that enable such activities,
particularly where recipients view the materials received as offensive. We
have in the past received, and may in the future receive, letters from
recipients of information transmitted by our customers objecting to such
transmission. Although we prohibit our customers by contract from spamming, we
cannot assure you that our customers will not engage in this practice, which
could subject us to claims for damages.
The market price of our common stock may experience extreme price and volume
fluctuations. The market price of our common stock may fluctuate substantially
due to a variety of factors, including: any actual or anticipated fluctuations
in our financial condition and operating results; public announcements
concerning us or our competitors, or the Internet industry; the introduction
or market acceptance of new service offerings by us or our competitors;
changes in industry research analysts' earnings estimates; changes in
accounting principles; sales of our common stock by existing stockholders; and
the loss of any of our key personnel.
In addition, the stock market has experienced extreme price and volume
fluctuations. The market prices of the securities of technology and Internet-
related companies have been especially volatile. This volatility often has
been unrelated to the operating performance of particular companies. In the
past, securities class action litigation often has been brought against
companies that experience volatility in the market price of their securities.
Whether or not meritorious, litigation brought against us could result in
substantial costs and a diversion of management's attention and resources.
Item 3. Quantitative and Qualitative Disclosure About Market Risk.
We are exposed to market risk related to changes in interest rates. We
invest excess cash balances in cash equivalents. We believe that the effect,
if any, of reasonably possible near-term changes in interest rates on our
financial position, results of operations and cash flows will not be material.
21
PART II. OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds.
(c) Since October 31, 1999, the Registrant has issued the following
securities that were not registered under the Securities Act of 1933, as
amended (the "Securities Act"):
(i) Issuance of Capital Stock
During the quarterly period ended April 30, 2000, the Registrant
issued a total of 27,167 shares of common stock upon the exercise of
employee stock options. The aggregate consideration received for such
shares was $12,125.
(ii) Recent Sales of Unregistered Securities
On June 8, 2000, the Registrant sold 980,873 shares of its common
stock to CMGI, Inc. for an aggregate offering price of $50,000,000.
These shares were issued on June 13, 2000, representing the number of
shares of common stock equal to $50,000,000 divided by the average of
the closing prices per share of common stock as reported on the Nasdaq
National Market on June 6, 7, 8, 9 and 12, 2000, rounded up to the
nearest whole share. The common stock was issued in reliance upon the
exemptions from registration under Section 4(2) of the Securities Act
and Regulation D promulgated thereunder, relative to sales by an issuer
not involving a public offering.
No underwriters were involved in the foregoing sales of securities. These
sales were made in reliance upon an exemption from the registration provisions
of the Securities Act set forth in Section 4(2) thereof relative to sales by
an issuer not involving any public offering or the rules and regulations
thereunder, or, in the case of options to purchase common stock granted prior
to October 21, 1999 and in the case of common stock purchased pursuant to the
Amended and Restated 1998 Equity Incentive Plan, Rule 701 of the Securities
Act. All of the foregoing securities are deemed restricted securities for
purposes of the Securities Act.
(d) Use of Proceeds of the Initial Public Offering
On July 22, 1999, the Registrant filed a Registration Statement on Form S-1
(File No. 333-83501) to register under the Securities Act 5,500,000 shares of
its common stock, par value $.01 per share (plus an additional 825,000 shares
subject to an over-allotment option granted to the underwriters). The
Registration Statement was declared effective by the Securities and Exchange
Commission on October 21, 1999.
The aggregate proceeds of the initial public offering (including the over-
allotment option) were $88,550,000. The Registrant's aggregate proceeds from
the initial public offering (including the proceeds received in connection
with the exercise of the over-allotment option), net of underwriting discounts
and commissions, were $82,351,500.
From the effective date of the Registration Statement through the end of the
fiscal 2000 third quarter (April 30, 2000), the Registrant has used the
proceeds from the initial public offering and underwriters' over-allotment as
follows:
Construction of new datacenters................................. $31,260,000
Working capital requirements.................................... 26,560,000
Repayment of notes payable...................................... 1,000,000
Fixed asset acquisitions........................................ 4,034,000
-----------
Total......................................................... $62,854,000
===========
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None of the expenses incurred by the Registrant in connection with the
initial public offering were paid, directly or indirectly, to directors,
officers, persons owning ten percent or more of the Registrant's equity
securities or affiliates of the Registrant.
In July 1998, in connection with the Registrant's acquisition of Servercast
Communications, L.L.C., the Registrant issued $1,000,000 in term notes with
principal payable on January 2, 2000. In January 2000, the Registrant paid the
principal and remaining interest due on these term notes to certain
individuals, including Peter C. Kirwan, Jr., the Chief Technology Officer of
the Registrant. Apart from this payment, none of the net proceeds of the
initial public offering were paid, directly or indirectly, to directors,
officers, persons owning ten percent or more of the Registrant's equity
securities or affiliates of the Registrant.
Unused proceeds of the initial public offering are currently invested in a
U.S. Treasury Money Market Fund.
All of the foregoing share information in Item 2 reflects the Registrant's
two-for-one stock split, effected as a 100% stock dividend. Such stock
dividend was paid on April 5, 2000 to all stockholders of record at the close
of business on March 22, 2000.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
Exhibit
Number Exhibit
------- -------
10.1 Common Stock Purchase Agreement, dated as of June 8, 2000, by and
between the Registrant and CMGI, Inc.
10.2 Amendment No. 1 to the Investors Rights Agreement, dated as of October
27, 1999, by and between the Registrant and CMGI, Inc.
10.3 Master Equipment Lease Agreement No. 35076, dated as of May 26, 2000,
by and between the Registrant and Fleet Capital Corporation, along
with related schedules and transaction documents.
27 Financial Data Schedule
(b) Reports Submitted on Form 8-K
On March 8, 2000, the Registrant filed a Current Report on Form 8-K, dated
February 22, 2000, to report under Item 2 (Acquisition or Disposition of
Assets) the consummation of a Stock Purchase Agreement for the acquisition of
ClickHear, Inc. The financial statements required to be filed with such report
were filed on May 8, 2000 on Amendment No. 1 to Current Report on Form 8-K/A.
23
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.
/s/ Kenneth W. Hale
By __________________________________
Kenneth W. Hale
Chief Financial Officer
(Principal Financial Officer and
Chief Accounting Officer)
Date: June 14, 2000
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