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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 October 31, 2000
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number: 0-27597
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NAVISITE, INC.
(Exact name of registrant as specified in its charter)
Delaware 52-2137343
(State or other 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)
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Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period than the
Registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes X No
As of December 8, 2000 there were 58,642,348 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 October 31, 2000
INDEX
Page
Number
------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of October 31, 2000 (unaudited)
and July 31, 2000............................................ 3
Consolidated Statements of Operations for the three months
ended October 31, 2000 and 1999 (unaudited).................. 4
Consolidated Statements of Cash Flows for the three months
ended October 31, 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.......................... 8
Item 3. Quantitative and Qualitative Disclosures About
Market Risk.................................................. 19
PART II. OTHER INFORMATION
Item 1. Legal Proceedings........................................ 20
Item 2. Changes in Securities and Use of Proceeds................ 20
Item 3. Defaults Upon Senior Securities.......................... 20
Item 4. Submission of Matters to a Vote of Security Holders...... 20
Item 5. Other Information........................................ 20
Item 6. Exhibits and Reports on Form 8-K......................... 20
SIGNATURE........................................................ 21
EXHIBIT INDEX.................................................... 22
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,
2000 2000
-------- --------
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents................................ $ 43,041 $ 77,947
Accounts receivable, less allowance for doubtful
accounts of $2,016 and $1,219 at October 31, 2000 and
July 31, 2000, respectively............................. 16,560 14,025
Due from CMGI and affiliates............................. 7,826 5,985
Prepaid expenses......................................... 3,736 3,201
-------- --------
Total current assets................................... 71,163 101,158
-------- --------
Property and equipment, net............................... 80,288 70,651
Deposits.................................................. 3,120 3,051
Goodwill, net of accumulated amortization of $476 and
$424 at October 31, 2000 and July 31, 2000,
respectively.............................................. 549 601
-------- --------
Total assets.............................................. $155,120 $175,461
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Capital lease obligations, current portion............... $ 5,883 $ 5,689
Due to CMGI.............................................. 6,196 5,310
Accounts payable......................................... 20,121 13,457
Accrued expenses and deferred revenue.................... 23,302 27,776
Software vendor payable, current portion................. 784 767
-------- --------
Total current liabilities............................. 56,286 52,999
-------- --------
Capital lease obligations, less current portion........... 22,443 23,999
Software vendor payable, less current portion............. 769 989
-------- --------
Total liabilities......................................... 79,498 77,987
-------- --------
Commitments and contingencies
Stockholders' equity:
Common stock, $.01 par value, 150,000 shares
authorized; 58,600 and 58,364 shares issued and
outstanding at October 31, 2000 and July 31, 2000,
respectively............................................ 586 584
Deferred compensation.................................... (359) (762)
Additional paid-in capital............................... 191,128 190,301
Accumulated deficit...................................... (115,733) (92,649)
-------- -------
Total stockholders' equity................................ 75,622 97,474
-------- --------
Total liabilities and stockholders' equity ............... $155,120 $175,461
======== ========
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,
---------------------
2000 1999
-------- --------
Revenue:
Revenue ................................................. $ 14,998 $ 2,470
Revenue, related parties ................................ 11,038 3,396
-------- --------
Total revenue .......................................... 26,036 5,866
Cost of revenue .......................................... 32,057 9,069
-------- --------
Gross margin ............................................ (6,021) (3,203)
-------- --------
Operating expenses:
Selling and marketing ................................... 8,129 3,806
General and administrative .............................. 5,963 2,601
Product development ..................................... 2,896 891
-------- --------
Total operating expenses ............................... 16,988 7,298
-------- --------
Loss from operations ..................................... (23,009) (10,501)
Other income (expense):
Interest income ......................................... 874 83
Interest expense ........................................ (949) (133)
-------- --------
Net loss ................................................. $(23,084) $(10,551)
======== ========
Basic and diluted net loss per common share .............. $ (.39) $ (1.75)
======== ========
Basic and diluted weighted average number of common shares
outstanding .............................................. 58,535 6,042
======== ========
Pro forma basic and diluted net loss per share............ $ (0.24)
========
Pro forma basic and diluted weighted average number of
shares outstanding........................................ 43,604
========
See accompanying notes to interim consolidated financial statements.
4
NAVISITE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands)
Three months
ended October 31,
-----------------
2000 1999
-------- -------
Cash flows from operating activities:
Net loss.................................................. $(23,084)$(10,551)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization........................... 3,816 793
Provision for bad debts................................. 1,289 154
Amortization of deferred compensation................... 692 --
Changes in operating assets and liabilities:
Accounts receivable................................... (3,824) (1,439)
Due from CMGI and affiliates.......................... (1,841) (2,213)
Prepaid expenses...................................... (535) 752
Deposits.............................................. (69) (2,458)
Accounts payable ..................................... 6,664 3,699
Due to CMGI........................................... 886 --
Accrued expenses and deferred revenue................. (4,474) 3,053
-------- -------
Net cash used in operating activities............... (20,480) (8,210)
-------- -------
Cash flows from investing activities:
Purchases of property and equipment....................... (13,401) (7,389)
-------- -------
Net cash used in investing activities............... (13,401) (7,389)
-------- -------
Cash flows from financing activities:
Proceeds from issuance of common stock, net of issuance
costs.................................................... -- 69,640
Due to CMGI............................................... -- 12,368
Proceeds from exercise of stock options and ESPP.......... 540 13
Payments of capital lease obligations..................... (1,362) (89)
Payments of software vendor obligations................... (203) (125)
-------- -------
Net cash (used in) provided by financing activities (1,025) 81,807
-------- -------
Net (decrease) increase in cash............................. (34,906) 66,208
Cash and cash equivalents, beginning of period.............. 77,947 3,352
-------- -------
Cash and cash equivalents, end of period.................... $ 43,041 $69,560
======== =======
Supplemental disclosure of cash flow information:
Cash paid during the period for interest.................... $ 954 $ 81
======== =======
See accompanying notes to interim consolidated financial statements.
5
NAVISITE, INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
October 31, 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. 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 Form 10-K which was filed with the Securities and
Exchange Commission on October 30, 2000.
The information furnished reflects all adjustments which, in the opinion of
management, are of a normal reoccurring nature and are considered necessary for
a fair presentation of results for the interim periods. Such adjustments consist
only of normal recurring items. It should also be noted that results for the
interim periods are not necessarily indicative of the results expected for the
full year or any future period.
The preparation of these consolidated financial statements in conformity with
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. 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 fiscal year 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.
3. Cash and Cash Equivalents
Cash equivalents consist of a money market fund which invests in high quality
short-term debt obligations, including commercial paper, asset-backed commercial
paper, corporate bonds, U.S. government agency obligations, taxable municipal
securities and repurchase agreements.
CMGI has committed to advance NaviSite, if needed by July 31, 2001, the sum of
$80 million, subject to negotiation of a mutually acceptable vehicle and related
terms and conditions and approval of both companies' respective board of
directors. See note (7) for subsequent event.
During the fiscal 2000 first quarter, non-cash financing activities included the
issuance of 175,096 shares of the Company's Series B convertible preferred stock
in exchange for a $12,257,000 reduction in debt to CMGI.
4. 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 either the "as-if-
converted" method for convertible preferred stock or the treasury stock method
for options, unless such amounts are anti-dilutive.
For the three months ended October 31, 2000 and 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. For
the three months ended October 31, 1999, a pro forma basic and diluted loss per
share calculation, assuming the conversion of all amounts due to CMGI and all
outstanding shares of preferred stock into common stock using the "as-if-
converted" method from the later of the date of issuance or beginning of the
period, is presented. All amounts due to CMGI were converted to preferred stock,
and all outstanding preferred stock was converted into 43,244,630 shares of
common stock in connection with the closing of the Company's initial public
offering. The following table provides a reconciliation of the denominators used
in calculating the pro forma basic and diluted earnings (loss) per share for the
three months ended October 31, 1999:
6
Numerator:
Net loss.............................................. $(10,551)
Denominator:
Basic weighted average number of common shares
outstanding........................................... 6,042
Assumed conversion of amounts due to CMGI and
preferred stock....................................... 37,562
-------
Weighted average number of pro forma basic and diluted
shares outstanding..................................... 43,604
=======
Pro forma basic and diluted net loss per share......... $ (0.24)
=======
5. Capital Leases
In June 2000, the Company 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. The Company entered into a capital lease,
which we refer to as the Capital Lease, (the "Capital Lease") upon the leaseback
of those assets. The Capital Lease bears interest at a nominal rate of 9.15% and
an effective interest rate of 12.49% and is payable in monthly installments
ending June 2004. The Capital Lease contains a mandatory balloon payment, for
repurchase by us, equal to 10% of the bank's acquisition cost of the equipment.
Borrowings under the lease are secured by the leased property. The lease
contains certain financial covenants, including the maintenance of not less than
$15 million of cash and cash equivalents and the maintenance of not less than
$1.0 billion of market capitalization. As of October 31, 2000, the Company was
not in compliance with the market capitalization covenant. Effective December
11, 2000, the Company obtained a waiver from the lessor for the market
capitalization covenant noncompliance as of October 31, 2000. In connection with
the waiver, the Company renegotiated the Capital Lease and eliminated certain
negative covenants. Specifically, the mandatory market capitalization covenant
has been eliminated and the minimum cash requirement has been replaced with a
restricted cash covenant that requires the Company to maintain on deposit with
the lessor a restricted cash balance equal to the lesser of (i) $23,250,000 or
(ii) 100% of the stipulated loss value, calculated as of the next following
rental payment date. In addition, the Company granted the lessor a security
interest in this cash collateral account. At October 31, 2000, a restricted cash
balance was not required.
6. New Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 133, Accounting for Derivative
Instruments and Hedging Activities ("SFAS 133"). SFAS 133 was amended by SFAS
138 in June 2000. SFAS 133 and 138 will require that Company record all
derivatives on the balance sheet at fair value. The Company adopted these
statements on August 1, 2000. Since the Company does not have any derivative
financial instruments and does not engage in hedging activities, the adoption of
SFAS 133 and SFAS 138 had no impact on the consolidate financial statements.
In December 1999, the SEC issued Staff Accounting Bulletin No. 101 "Revenue
Recognition in Financial Statements" ("SAB 101"). SAB 101 expresses the views of
the SEC staff in applying generally accepted accounting principles to certain
revenue recognition issues. SAB 101 was adopted by the Company as of August 1,
2000 and had no impact on the consolidated financial statements.
7. Subsequent Events
On December 12, 2000, the Company entered into a Note and Warrant Purchase
Agreement (the "Agreement") with CMGI, Inc. The Agreement provides for the sale
of a subordinated, unsecured, convertible note in the principal amount of
$50,000,000 (the "Initial Note") and a subordinated, unsecured, convertible note
in the principal amount of $30,000,000 (the "Second Note") (collectively the
"Notes"). The Notes are convertible at CMGI's option, and by NaviSite under
defined circumstances, into NaviSite common stock at a conversion price equal to
120% of the average of the closing price per share on the Nasdaq National Market
on the five consecutive trading days ending on December 14, 2000 (the "Closing
Price"). In connection with the Agreement, the Company will grant to CMGI,
effective December 15, 2000, a warrant to purchase a number of shares of
NaviSite common stock equal to $12,000,000 divided by the Closing Price, as
defined, at an exercise price equal to 125% of the Closing Price, and a warrant
to purchase a number of shares of NaviSite common stock equal to $12,000,000
divided by the Closing Price, as defined, at an exercise price equal to 150% of
the Closing Price. The warrants are exercisable upon issuance and expire on
December 15, 2005. The Company plans to fair value the warrants and record this
fair value as an additional component of interest expense over the life of the
Initial Note.
On December 12, 2000 the Company issued the Initial Note to CMGI in the amount
of $50,000,000. The annual interest rate on the Initial Note is 7.5% payable
quarterly in, at the Company's discretion, either cash or the Company's common
stock. The principal amount is due in full by December 12, 2003. The Agreement
provides that the use of proceeds from the Second Note are restricted to
satisfying the Company's lease obligation with Fleet Bank.
On December 12, 2000, the Company sold certain equipment in a sale-leaseback
transaction to an equipment vendor for approximately $10.9 million. The Company
simultaneously entered into a lease of the equipment with the vendor. The lease
is payable in monthly installments through December 2002.
7
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 the our other filings with the Securities and Exchange
Commision. 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 reflects the two-for-one stock
split.
Overview
We provide enhanced, integrated hosting and management services for business
Web sites and Internet applications. We also provide application rentals to
customers and developers and supply related consulting services. Our Internet
application service offerings allow businesses to outsource the deployment,
configuration, hosting, management and support of their Web sites and Internet
applications in a cost-effective and rapid manner. Our focus on enhanced
management services, beyond basic co-location services, allows us to meet the
expanding needs of businesses as their Web sites and Internet applications
become more complex. The cost for our services varies from customer to customer
based on the number of hosted or managed servers and the nature and level of
services provided.
We intend to expand domestically and internationally. During fiscal year 2000,
we opened two new data center facilities, one at Zanker Road, San Jose,
California and one at 400 Minuteman Road, Andover, Massachusetts. In addition to
our new domestic data centers, during fiscal year 2000, we entered into an
agreement with Level 3 Communications, Inc. to provide domestic data center
space, as needed.
As of January 31, 2000, our corporate headquarters are located at 400
Minuteman Road, Andover, Massachusetts. Before this date, our corporate
headquarters were shared with CMGI and several other CMGI affiliates. CMGI
allocated rent, facility maintenance and service costs among these affiliates
based upon headcount within each affiliate and within each department of each
affiliate. Other services provided by CMGI to us included support for enterprise
services, human resources and benefits and Internet marketing and business
development. Actual expenses could have varied had we been operating on a stand-
alone basis. Costs are allocated to us on the basis of the fair market value for
the facilities used and the services provided.
We derive our revenue from a variety of services, including: Web site and
Internet application hosting, which includes access to our state-of-the-art data
centers, bandwidth and basic back-up, storage and monitoring services; enhanced
server management, which includes custom reporting, hardware options, load
balancing, system security, advanced back-up options, and the services of our
business solution managers; specialized application management, which includes
management of e-commerce and other sophisticated applications support services,
including ad-serving, streaming, databases and transaction processing services;
and
8
application rentals and related consulting and other professional services.
Revenue also includes income from the rental of equipment to customers and one-
time installation fees. Revenue is recognized in the period in which the
services are performed and installation fees are recognized in the period of
installation. Our contracts generally are a one to three year commitment.
Our revenue from sales to related parties principally consists of sales of
services to CMGI and other customers that are CMGI affiliates. In general, in
pricing the services provided to CMGI and its affiliates, we have: negotiated
the services and levels of service to be provided; calculated the price of the
services at those service levels based on our then-current, standard prices;
and, in exchange for customer referrals provided to us by CMGI, discounted these
prices by 10%.
Three-month period ended October 31, 2000 compared to the three-month period
ended October 31, 1999
Revenue
Total revenue increased 344% to approximately $26.0 million for the three-
month period ended October 31, 2000, from approximately $5.9 million for the
same period in 1999. The increase in revenue is due primarily to both the
increase in the number of unaffiliated customers and additional business with
existing unaffiliated customers, CMGI and CMGI affiliates. Revenue from
unaffiliated customers increased to approximately $15.0 million or 58% of total
revenue for the three-month period ended October 31, 2000, from approximately
$2.5 million or 42% of total revenue for the same period in 1999. The number of
unaffiliated customers increased 173% to 366 at October 31, 2000 from 134 as of
October 31, 1999.
Cost of Revenue
Cost of revenue principally includes labor and headcount expenses, equipment
and maintenance costs, bandwidth and connectivity charges and depreciation
and lease expense from our data centers. Cost of revenue increased 253% to
approximately $32.1 million for the three-month period ended October 31, 2000,
from approximately $9.1 million for the same period in 1999. As a percentage of
revenue, cost of revenue decreased to 123% for the three-month period ended
October 31, 2000, from 155% for the same period in 1999. The dollar-value
increase in each period is due primarily to the costs associated with the
increased investment in our existing data centers.
Gross Margin
The gross margin improved to approximately (23%) of total revenue for the
three-month period ended October 31, 2000, from approximately (55%) of total
revenue for the same period in 1999. The improvement in the gross margin for the
three-months ended October 31, 2000, as compared to the same period in 1999 is a
direct result of scaling the fixed infrastructure costs across a larger customer
base.
Operating Expenses
Selling and Marketing. Selling and marketing expenses primarily include
salaries and commissions and expenses for marketing programs, advertising and
product literature. Selling and marketing expenses increased 114% to
approximately $8.1 million for the three-month period ended October 31, 2000,
from approximately $3.8 million for the same period in 1999. On a percentage of
revenue basis, selling and marketing expenses decreased to 31% of total revenue
for the three-months ended October 31, 2000 from 65% of total revenue for the
same period in 1999. The increase in absolute dollars is due primarily to the
continued development of our sales and marketing capability, in the form of
increased headcount and marketing programs, and the increase of commission
expense resulting from increased revenue levels. The reduction of sales and
marketing expense as a percentage of revenue is a result of the scaling of the
sales and marketing infrastructure over a larger customer base with low
incremental customer costs.
General and Administrative. General and administrative expenses primarily
include the costs of financial, leasing and administrative personnel,
professional services,
9
corporate overhead and bad debt expense. General and administrative expenses
increased 129% to approximately $6.0 million for the three-month period ended
October 31, 2000, approximately $2.6 million for the same period in 1999.
On a percentage of revenue basis, general and administrative expenses decreased
to 23% of total revenue for the three months ended October 31, 2000 from 44% of
total revenue for the same period in 1999. The increase in absolute dollars is
due to the hiring of additional administrative and finance personnel to support
our growing operations and an increase in the allowance for doubtful accounts,
offset by a reduction in Y2K related expenses. The reduction of general and
administrative costs as a percentage of revenue is a result of the scaling of
the general and administrative infrastructure over a larger customer base
combined with a low cost per incremental customer.
Product Development. Product development expenses consist mainly of salaries
and related costs. Product development expenses increased 225% to approximately
$2.9 million for the three-month period ended October 31, 2000, from
approximately $891,000 for the same period in 1999. This increase is due
primarily to the costs associated with an increase in product development
personnel as of October 31, 2000 to 64, from 21 employees for the same period in
1999 and the use of consultants. This growth in product development personnel
reflects our increased service offerings and emphasis on application services.
Interest Income
Interest income increased to approximately $874,000 for three-month period
ended October 31, 2000, from approximately $83,000 for the same period in 1999.
The increase is due primarily to the funds available for investment resulting
from our various fiscal year 2000 financing activities, primarily from the sale
of common stock and sale-leaseback transaction.
Interest Expense
Interest expense increased to approximately $949,000 for the three-month
period ended October 31, 2000, from approximately $133,000 fro the same period
in 1999. This increase is due primarily to interest incurred on capital lease
obligations.
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, the issuance
of preferred stock to strategic investors, and our initial public offering and
related underwriters' over-allotment in November 1999.
Net cash used for operating activities for the three-month period ended
October 31, 2000 amounted to $20.5 million, resulting primarily from net
operating losses, increases in accounts receivable, and decreases in accrued
expenses, which are partially offset by non-cash depreciation and amortization
charges and increases in accounts payable and amounts due to CMGI. The net
increase in accounts receivable is a result of the revenue growth for the
period. The dollar value increase in accounts receivable is a result of the
related increase in revenue for the period. The available for collection days
sales outstanding is approximately 47 and 45 at October 31, 2000 and 1999,
respectively. Available for collection days sales outstanding represents the
weighted average number of days sales are outstanding based on the date that
services rendered during the period are billed.
Net cash used for investing activities for the three-month period ended
October 31, 2000 amounted to $13.4 million. The net cash used for investing
activities was utilized to acquire property and equipment required to support
the growth of the business and to expand data center infrastructure.
Net cash used for financing activities for the three-month period ended
October 31, 2000 amounted to $1.0 million. The net cash used was primarily used
for payments made under capital leases associated with our data centers
partially offset by proceeds received upon the exercise of stock options and
from the employee stock purchase plan.
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 and other receipts were
remitted
10
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 provided 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.
Under this note, CMGI converted intercompany debt in the aggregate amount of
approximately $12.3 million, representing funds advanced during the period from
July 31, 1999 through October 21, 1999 (the effective date of the registration
statement relating to our initial public offering), into 175,096 shares of
Series B convertible preferred stock (based upon a conversion price of $70.00,
ten times the initial public offering price of $7.00 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.
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.
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, which we refer to
as the Capital Lease, upon the leaseback of those assets. The Capital Lease
bears interest at a nominal rate of 9.15% and an effective interest rate of
12.49% and is payable in monthly installments ending June 2004. The Capital
Lease contains a mandatory balloon payment, for repurchase by us, equal to 10%
of the bank's acquisition cost of the equipment and certain financial covenants
as defined. The mandatory repurchase amount is included in the carrying value of
the Capital Lease on our Balance Sheet. As of October 2000, we were not in
compliance with the market capitalization covenant. Effective December 11, 2000,
we obtained a waiver from the lessor for the market capitalization covenant
noncompliance as of October 31, 2000. In connection with the waiver, we
renegotiated the Capital Lease and eliminated certain negative covenants.
Specifically, the mandatory market capitalization covenant has been eliminated
and the minimum cash requirement has been replaced with a restricted cash
covenant that requires us to maintain on deposit with the lessor a restricted
cash balance equal to the lesser of (i) $23,250,000 or (ii) 100% of the
stipulated loss value, calculated as of the next following rental payment date.
In addition, we granted the lessor a security interest in this cash collateral
account. At October 31, 2000, a restricted cash balance was not required.
On December 12, 2000, we entered into a Note and Warrant Purchase Agreement,
which we refer to as the Agreement, with CMGI. The Agreement provides for
the sale of a subordinated, unsecured, convertible note in the principal amount
of $50,000,000, which we refer to as the Initial Note, and a subordinated,
unsecured, convertible note in the principal amount of $30,000,000, which we
refer to as the Second Note. The Initial Note and the Second Note are
collectively referred to as the Notes. The Notes are convertible at CMGI's
option, and by NaviSite under defined circumstances, into NaviSite common stock
at a conversion price equal to 120% of the average of the closing price per
share on the Nasdaq National Market on the five consecutive trading days ending
on December 14, 2000, which we refer to as the Closing Price. In connection with
the Agreement, we will grant to CMGI, effective December 15, 2000, a warrant to
purchase a number of shares of NaviSite common stock equal to $12,000,000
divided by the Closing Price at an exercise price equal to 125% of the Closing
Price, and a warrant to purchase a number of shares of NaviSite common stock
equal to $12,000,000 divided by the Closing Price at an exercise price equal to
150% of the Closing Price. The warrants are exercisable upon issuance and expire
on December 15, 2005. We plan to fair value the warrants and record this fair
value as an additional component of interest expense over the life of the
Initial Note.
On December 12, 2000, we issued the Initial Note to CMGI in the amount of
$50,000,000. The annual interest rate on the Initial Note is 7.5% payable
quarterly in, at the Company's discretion, either cash or the Company's common
stock. The principal amount is due in full by December 12, 2003. The Agreement
provides that the use of proceeds from the Second Note are restricted to
satisfying our lease obligation with Fleet Bank.
On December 12, 2000, we sold certain equipment in a sale-leaseback
transaction to an equipment vendor for approximately $10.9 million. We
simultaneously entered into a lease of the equipment with the vendor. The lease
is payable in monthly installments through December 2002.
We have experienced a substantial increase in our expenditures since inception
consistent with our growth in operations and staffing. We anticipate that
expenditures will continue to increase as we grow our business. Additionally, we
will continue to evaluate investment opportunities in businesses that management
believes will complement our technologies and market strategies.
We currently anticipate that our available cash resources at October 31, 2000
combined with the sale of the Notes to CMGI, as described above and our ability
to obtain additional lease financing credit lines, will be sufficient to meet
our anticipated needs, barring unforeseen circumstances, for working capital and
capital expenditures over the next twelve months. However, we may need to raise
additional funds in order to fund more rapid expansion, to fund our domestic and
international
11
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 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.
12
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, 2000, we had an accumulated deficit of $115.73
million. We anticipate increased expenses as we continue to expand and improve
our infrastructure, introduce new services, enhance our application management
expertise, expand our sales and marketing efforts, expand internationally and
pursue additional industry relationships. As a result, we expect to incur
operating losses for at least the next fiscal year.
Fluctuations in our quarterly operating results may negatively impact our
stock price. Our quarterly operating results may fluctuate significantly in the
future as a result of a variety of factors, many of which are outside our
control. These factors include: continued market demand and acceptance for our
Web site and Internet application hosting and management services; our ability
to develop, market and introduce new services on a timely basis; downward price
adjustments by our competitors; changes in the mix of services provided by our
competitors; technical difficulties or system downtime affecting the Internet
generally or our hosting operations specifically; our ability to meet any
increased technological demands of our customers; the amount and timing of costs
related to our marketing efforts and service introductions; and economic
conditions specific to the Internet application service provider industry. Our
operating results for any particular quarter may fall short of our expectations
or those of investors or securities analysts. In this event, the market price of
our common stock would be likely to fall.
CMGI is a majority stockholder, and CMGI may have interests that conflict with
the interests of our other stockholders. As of October 31, 2000, CMGI
beneficially owned approximately 68.46% of our outstanding common stock.
Accordingly, CMGI has the power, acting alone, to elect a majority of our board
of directors and has the ability to determine the outcome of any corporate
actions requiring stockholder approval, regardless of how our other stockholders
may vote. Under Delaware law, CMGI may exercise its voting power by written
consent, without convening a meeting of the stockholders, meaning that CMGI
could affect a sale or merger of our company without prior notice to, or the
consent of, our other stockholders. CMGI's interests could conflict with the
interests of our other stockholders. The possible need of CMGI to maintain
control of us in order to avoid becoming a registered investment company could
influence future decisions by CMGI as to the disposition of any or all of its
ownership position in our company. CMGI would be subject to numerous regulatory
requirements with which it would have difficulty complying if it were required
to register as an investment company. As a result, CMGI may be motivated to
maintain at least a majority ownership position in us, even if our other
stockholders might consider a sale of control of our company to be in their best
interests. As long as it is a majority stockholder, CMGI has contractual rights
to purchase shares in any of our future financing sufficient to maintain its
majority ownership position. CMGI's ownership may have the effect of delaying,
deferring or preventing a change in control of our company or discouraging a
potential acquirer from attempting to obtain control of us, which in turn could
adversely affect the market price of our common stock.
A significant portion of our revenue currently is generated by services
provided to CMGI and companies affiliated with CMGI, and the loss of this
revenue would substantially impair the growth of our business. We anticipate
that we will continue to receive a significant portion of our revenue in the
future from CMGI and CMGI affiliates. CMGI and CMGI affiliates accounted for
approximately 42% of our revenue in the quarter ended October 31, 2000 and
approximately 50% of our revenue for the
13
fiscal year ended July 31, 2000. We cannot assure you that revenues generated by
CMGI and CMGI affiliates will continue or that we will be able to secure
business from unaffiliated customers to replace this revenue in the future. The
loss of revenue from CMGI and CMGI affiliates, or our inability to replace this
operating revenue, would substantially impair the growth of our business.
Our ability to grow our business would be substantially impaired if we were
unable to obtain, on commercially reasonable terms, certain equipment that is
currently provided under leases executed or guaranteed by CMGI. Certain of the
equipment that we use or provide to our customers for their use in connection
with our services is provided under leases executed or guaranteed by CMGI prior
to our October 1999 initial public offering. CMGI has not continued this
practice, and accordingly, we or our customers will have to obtain this
equipment for new leases and renewal of existing leases directly, on a stand
alone basis. Our ability to grow our business would be substantially impaired if
we were unable to obtain, on commercially reasonable terms, leases for this
equipment. We cannot assure you that it or its customers can do so on similar
financial terms.
If the growth of the market for Internet commerce and communication does not
continue, or it decreases, there may be insufficient demand for our services,
and as a result, our business strategy may not be successful. The increased use
of the Internet for retrieving, sharing and transferring information among
businesses and consumers has developed only recently, and the market for the
purchase of products and services over the Internet is new and emerging. If
acceptance and growth of the Internet as a medium for commerce and communication
does not continue, our business strategy may not be successful because there may
not be a continuing market demand for our Web site and Internet application
hosting and management services. Our growth could be substantially limited if
the market for Internet application services fails to continue to develop or if
we cannot continue to achieve broad market acceptance.
Our ability to successfully market our services could be substantially
impaired if we are unable to deploy new Internet applications or if new Internet
applications deployed by us prove to be unreliable, defective or incompatible.
We cannot assure you that we will not experience difficulties that could delay
or prevent the successful development, introduction or marketing of Internet
application services in the future. If any newly introduced Internet
applications suffer from reliability, quality or compatibility problems, market
acceptance of our services could be greatly hindered and our ability to attract
new customers could be adversely affected. We cannot assure you that new
applications deployed by us will be free from any reliability, quality or
compatibility problems. If we incur increased costs or are unable, for technical
or other reasons, to host and manage new Internet applications or enhancements
of existing applications, our ability to successfully market our services could
be substantially impaired.
The market we serve is highly competitive, and as a rapidly growing company,
we may lack the financial and other resources, expertise or capability needed to
capture increased market share. We compete in the Internet application service
market. This market is rapidly evolving, highly competitive and likely to be
characterized by an increasing number of market entrants and by industry
consolidation. We believe that participants in this market must grow rapidly and
achieve a significant presence to compete effectively. As a rapidly growing
company, our business is not as developed as that of many of our competitors.
For example, we estimate that the growth capacity of our facilities may be
sufficient only for the next two fiscal years. Insufficient growth capacity in
our facilities or the lack of availability of non-owned facilities could impair
our ability to achieve rapid growth through an increase in our customer base.
Moreover, many of our competitors have substantially greater financial,
technical and marketing resources, greater name recognition and more established
relationships in the industry than we have. We may lack the financial and other
resources, expertise or capability needed to capture increased market share in
this environment in the future.
Any interruptions in, or degradation of, our private transit Internet
connections could result in the loss of customers or hinder our ability to
attract new customers. Our customers rely on our ability to move their digital
content as efficiently as possible to the people accessing their Web sites and
Internet applications. We utilize our direct private transit Internet
connections to major
14
backbone providers as a means of avoiding congestion and resulting performance
degradation at public Internet exchange points. We rely on these
telecommunications network suppliers to maintain the operational integrity of
their backbones so that our private transit Internet connections operate
effectively.
Increased costs associated with our private transit Internet connections could
result in the loss of customers or significant increases in operating costs. Our
private transit Internet connections are already more costly than alternative
arrangements commonly utilized to move Internet traffic. If providers increase
the pricing associated with utilizing their bandwidth, we may be required to
identify alternative methods to distribute our customers' digital content. We
cannot assure you that our customers will continue to be willing to pay the
higher costs associated with direct private transit or that we could effectively
move to another network approach. If we are unable to access alternative
networks to distribute our customers' digital content on a cost-effective basis
or to pass any additional costs on to our customers, our operating costs would
increase significantly.
If we are unable to maintain existing and develop additional relationships
with Internet application software vendors, the sale, marketing and provision of
our Internet application services may be unsuccessful. We believe that to
penetrate the market for Web site and Internet application hosting and
management services we must maintain existing and develop additional
relationships with industry-leading Internet application software vendors and
other third parties. We license or rent select software applications from
Internet application software vendors. The loss of our ability to continually
obtain any of these applications could materially impair our ability to provide
services to our customers or require us to obtain substitute software
applications of lower quality or performance standards or at greater cost. In
addition, because we generally license applications on a non-exclusive basis,
our competitors may license and utilize the same software applications. In fact,
many of the companies with which we have strategic relationships currently have,
or could enter into, similar license agreements with our competitors or
prospective competitors. We cannot assure you that software applications will
continue to be available to us from Internet application software vendors on
commercially reasonable terms. If we are unable to identify and license software
applications which meet our targeted criteria for new application introductions,
we may have to discontinue or delay introduction of services relating to these
applications.
We purchase from a limited number of suppliers key components of our
infrastructure, including networking equipment, that are available only from
limited sources in the quantities and with the quality that we demand. For
example, we purchase most of the routers and switches used in our infrastructure
from Cisco Systems Inc. We cannot assure you that we will have the necessary
hardware or parts on hand or that our suppliers will be able to provide them in
a timely manner in the event of equipment failure. Our inability or failure to
obtain the necessary hardware or parts on a timely basis could result in
sustained equipment failure and a loss of revenue due to customer loss or claims
for service credits under our service level guarantees.
Our inability to scale our infrastructure or otherwise manage our anticipated
growth and the related expansion of our operations could result in decreased
revenue and continued operating losses. We have experienced rapid growth in our
service offerings and our customer base. We were a Web site hosting provider
with approximately 158 customers as of October 31, 1999. As of October 31, 2000,
we were providing Web site and Internet application hosting and management
services to 392 customers. In order to service our growing customer base, we
will need to continue to improve and expand our network infrastructure. Our
ability to continue to meet the needs of a substantial and growing number of
customers while maintaining superior performance is largely unproven. If our
network infrastructure is not scalable, we may not be able to provide our
services to additional customers, which would result in decreased revenue.
In addition, between October 31, 1999 and October 31, 2000, we increased the
number of our employees from 253 to 547. 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
15
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.
Our customer base includes a significant number of 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. If this occurs, we could experience a
loss of revenue associated with these customers and will then have to increase
sales to other businesses using the Internet in order to preserve and grow our
revenue.
You may experience dilution because our historical source of funding is
expected to change, and other funding may not be available to us on favorable
terms, if at all. Until the completion of our initial public offering, CMGI
funded our operations as needed, increasing our obligations to CMGI and allowing
us to maintain a zero-balance cash account. Upon completion of our initial
public offering, our net obligations to CMGI, together with all convertible
preferred stock held by CMGI, were converted into common stock. We may need to
raise additional funds from time to time. In December 2000, we entered into an
agreement to sell CMGI convertible notes with warrants for total proceeds of
$80.0 million and completed a $10.9 million sale-leaseback transaction with an
equipment vendor, and in June 2000 we completed a $30 million sale-leaseback
transaction with a bank and a $50 million private placement sale of common stock
to CMGI. We cannot assure you that additional financing will be available on
terms favorable to us, if at all. If adequate funds were not available or were
not available on acceptable terms, our ability to respond to competitive
pressures would be significantly limited. Moreover, if additional funds are
raised through the issuance of equity or convertible debt securities, your
percentage ownership in us will be reduced, and you may experience additional
dilution.
Our network infrastructure could fail, which would impair our ability to
provide guaranteed levels of service and could result in significant operating
losses. To provide our customers with guaranteed levels of service, we must
operate our network infrastructure 24 hours a day, seven days a week without
interruption. In order to operate in this manner, we must protect our network
infrastructure, equipment and customer files against damage from human error,
natural disasters, unexpected equipment failure, power loss or
telecommunications failures, sabotage or other intentional acts of vandalism.
Even if we take precautions, the occurrence of a natural disaster, equipment
failure or other unanticipated problem at one or more of our data centers could
result in interruptions in the services we provide to our customers. We cannot
assure you that our disaster recovery plan will address all, or even most, of
the problems we may encounter in the event of such a disaster.
We have experienced service interruptions in the past, and any future
service interruptions could: require us to spend substantial amounts of money
to replace equipment or facilities; entitle customers to claim service credits
under our service level guarantees; cause customers to seek damages for losses
incurred; or make it more difficult for us to attract new customers or enter
into additional strategic relationships. Any of these occurrences could result
in significant operating losses.
The misappropriation of our proprietary rights could result in the loss of
our competitive advantage in the market. We rely on a combination of trademark,
service mark, copyright and trade secret laws and contractual restrictions to
establish and protect our proprietary rights. We do not own any patents that
would prevent or inhibit competitors from using our technology or entering our
market. We cannot assure you that the contractual arrangements or other steps
taken by us to protect our proprietary rights will prove sufficient to prevent
misappropriation of our proprietary rights or to deter independent, third-party
development of similar proprietary assets. In addition, we provide our services
in other countries where the laws may not afford adequate protection for our
proprietary rights.
Third-party infringement claims against our technology suppliers, customers
16
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
acquired business; and changes in management or other key personnel that may
harm relationships with the acquired business's customers and employees. We
cannot assure you that any acquisitions will be successfully identified and
completed or that, if one or more acquisitions are completed, the acquired
business, assets or technologies will generate sufficient revenue to offset the
associated costs or other adverse effects.
The market for our services in international territories is unproven, and as a
result, the revenue generated by any future international operations may not be
adequate to offset the expense of establishing and maintaining those
17
operations. One component of our strategy is to expand into international
markets. We cannot assure you that we will be able to market, sell and provide
our services successfully outside the United States. We could suffer significant
operating losses if the revenue generated by any current or future international
data center or other operations adequate to offset the expense of establishing
and maintaining those international operations. Our present international
strategy is based upon the creation of alliances with foreign telecommunications
companies that own or operate data centers into which we intend to place our
infrastructure and to service our current customers as well as the customers of
those telecommunications companies desiring our services. In the event that we
are unable to negotiate favorable agreements with or successfully market our
services together with such telecommunications companies, our international
strategy will be significantly impaired, curtailed or eliminated.
We face risks inherent in doing business in international markets that could
adversely affect the success of our international operations. There are risks
inherent in doing business in international markets, including different
regulatory requirements, trade barriers, challenges in staffing and managing
foreign operations, currency risk, different technology standards, different tax
structures which may adversely impact earnings, different privacy, censorship
and service provider liability standards and regulations and foreign political
and economic instability, any of which could adversely affect the success of our
international operations.
The emergence and growth of a market for our Internet application services
will be impaired if third parties do not continue to develop and improve the
Internet infrastructure. The recent growth in the use of the Internet has caused
frequent periods of performance degradation, requiring the upgrade of routers
and switches, telecommunications links and other components forming the
infrastructure of the Internet by Internet service providers and other
organizations with links to the Internet. Any perceived degradation in the
performance of the Internet as a means to transact business and communicate
could undermine the benefits and market acceptance of our Web site and Internet
application hosting and management services. Our services are ultimately limited
by, and dependent upon, the speed and reliability of hardware, communications
services and networks operated by third parties. Consequently, the emergence and
growth of the market for our Internet application services will be impaired if
improvements are not made to the entire Internet infrastructure to alleviate
overloading and congestion.
We could be subject to increased operating costs, as well as claims,
litigation or other potential liability, in connection with risks associated
with Internet security and the security of our systems. A significant barrier to
the growth of e-commerce and communications over the Internet has been the need
for secure transmission of confidential information. Several of our Internet
application services utilize encryption and authentication technology licensed
from third parties to provide the protections necessary to ensure secure
transmission of confidential information. We also rely on security systems
designed by third parties and the personnel in our network operations centers to
secure those data centers. Any unauthorized access, computer viruses, accidental
or intentional actions and other disruptions could result in increased operating
costs. For example, we may incur significant costs to protect against these
interruptions and the threat of security breaches or to alleviate problems
caused by such interruptions or breaches, and we expect to expend significant
financial resources in the future to equip our new and existing data centers
with state-of-the-art security measures. If a third party were able to
misappropriate a consumer's personal or proprietary information, including
credit card information, during the use of an application solution provided by
us, we could be subject to claims, litigation or other potential liability.
We may become subject to burdensome government regulation and legal
uncertainties that could substantially impair the growth of our business or
expose us to unanticipated liabilities. It is likely that laws and regulations
directly applicable to the Internet or to Internet application service providers
may be adopted. These laws may cover a variety of issues, including
18
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 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.
19
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
None.
Item 2. Changes in Securities and Use of Proceeds
(c) Recent Sales of Unregistered Securities
On December 12, 2000, the Registrant sold to CMGI, Inc. for an aggregate
offering price of $50,000,000 a 7.5% Convertible Subordinated Note due December
12, 2003 (the "Initial Note"). The Initial Note is convertible, according to its
terms, by CMGI into the Registrant's common stock at a conversion price equal to
120% of the average closing price per share on the Nasdaq National Market on the
five consecutive days ending on December 14, 2000 (the "Closing Price").
On December 12, 2000, the Registrant granted CMGI effective December 15,
2000 (i) a warrant to purchase a number of shares of the Registrant's common
stock equal to $12,000,000 divided by the Closing Price at an exercise price
equal to 125% of the Closing Price; and (ii) a warrant to purchase a number of
shares of the Registrant's common stock equal to $12,000,000 divided by the
Closing Price at an exercise price equal to 150% of the Closing Price.
No underwriters were involved in the foregoing sales of securities.
These sales were made in reliance upon an exemption from registration provisions
of the Securities Act of 1933, as amended (the "Securities Act"), set forth in
Section 4(2) thereof relative to sales by an issuer not involving any public
offering and Regulation D promulgated under the Securities Act.
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Submission of Matters to a Vote of Security Holders.
None.
Item 5. Other Information.
None.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
Exhibit
Number Exhibit
------- -------
10.1 Waiver and Second Amendment to Lease Schedule No. 35076-00002 to
Master Equipment Lease Agreement No. 35076, dated as of December 8,
2000, by and between the Registrant and Fleet Capital Corporation.
10.2 Cash Collateral Agreement, dated as of December 11, 2000, by and
between the Registrant and Fleet Capital Corporation.
10.3 Note and Warrant Purchase Agreement, dated as of December 12, 2000,
by and between the Registrant and CMGI, Inc.
10.4 7.5% Convertible Subordinated Note due December 12, 2003 issued by
the Registrant to CMGI, Inc., dated as of December 12, 2000.
10.5 Form of 7.5% Convertible Subordinated Note due December 12, 2003,
issued by the Registrant to CMGI, Inc.
10.6 Form of Common Stock Warrant No. 1 issued by the Registrant to CMGI,
Inc., dated as of December 15, 2000.
10.7 Form of Common Stock Warrant No. 2 issued by the Registrant to CMGI,
Inc., dated as of December 15, 2000.
10.8 Amendment No.2 to the Investor Rights Agreement, dated as of October
27, 1999 and first amended on June 8, 2000, by and between the
Registrant and CMGI, Inc.
10.9 Subordination Agreement, dated as of December 12, 2000, by and
between the Registrant and CMGI, Inc.
27 Financial Data Schedule.
(b) Reports on Form 8-K
None.
20
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 12, 2000
By /s/ Kenneth W. Hale
-----------------------------------
Kenneth W. Hale
Chief Financial Officer (Principal
Financial and Accounting
Officer)
21
Exhibit Index
10.1 Waiver and Second Amendment to Lease Schedule No. 35076-00002 to
Master Equipment Lease Agreement No. 35076, dated as of December 8,
2000, by and between the Registrant and Fleet Capital Corporation.
10.2 Cash Collateral Agreement, dated as of December 11, 2000, by and
between the Registrant and Fleet Capital Corporation.
10.3 Note and Warrant Purchase Agreement, dated as of December 12, 2000,
by and between the Registrant and CMGI, Inc.
10.4 7.5% Convertible Subordinated Note due December 12, 2003 issued by
the Registrant to CMGI, Inc., dated as of December 12, 2000.
10.5 Form of 7.5% Convertible Subordinated Note due December 12, 2003,
issued by the Registrant to CMGI, Inc.
10.6 Form of Common Stock Warrant No. 1 issued by the Registrant to CMGI,
Inc., dated as of December 15, 2000.
10.7 Form of Common Stock Warrant No. 2 issued by the Registrant to CMGI,
Inc., dated as of December 15, 2000.
10.8 Amendment No.2 to the Investor Rights Agreement, dated as of October
27, 1999 and first amended on June 8, 2000, by and between the
Registrant and CMGI, Inc.
10.9 Subordination Agreement, dated as of December 12, 2000, by and
between the Registrant and CMGI, Inc.
27 Financial Data Schedule.
22