Navisite, Inc. S-2 Amendment No. 3
Table of Contents

As filed with the Securities and Exchange Commission on June 29, 2004
Registration Statement No. 333-112087


SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


Amendment No. 3

to
Form S-2
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933


NaviSite, Inc.

(Exact name of Registrant as specified in its charter)
     
Delaware   52-2137343
(State or Other Jurisdiction of
Incorporation or Organization)
  (I.R.S. Employer
Identification Number)


400 Minuteman Road

Andover, Massachusetts 01810
(978) 682-8300
(Address, Including Zip Code, and Telephone Number Including Area Code, of Registrant’s Principal Executive Offices)


Arthur P. Becker

Chief Executive Officer and President
NaviSite, Inc.
400 Minuteman Road
Andover, Massachusetts 01810
(978) 682-8300
(Name, Address, Including Zip Code, and Telephone Number Including Area Code, of Agent for Service)


Copies to:

     
Thomas B. Rosedale
Kevin P. Lanouette
Browne Rosedale & Lanouette LLP
31 St. James Avenue, Suite 830
Boston, MA 02116
(617) 399-6931
  Steven B. Stokdyk
Sullivan & Cromwell LLP
1888 Century Park East
Los Angeles, CA 90067
(310) 712-6600


       Approximate date of commencement of proposed sale to the public: As soon as practicable after this registration statement becomes effective.

       If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 of the Securities Act of 1933, check the following box.   o

       If the registrant elects to deliver its latest annual report to security holders, or a complete and legible facsimile thereof, pursuant to Item 11(a)(1) of this Form, check the following box.   o

       If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act of 1933, please check the following box and list the Securities Act of 1933 registration statement number of the earlier effective registration statement for the same offering.   o                       

       If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act of 1933, check the following box and list the Securities Act of 1933 registration statement number of the earlier effective registration statement for the same offering.   o                       

       If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act of 1933, check the following box and list the Securities Act of 1933 registration statement number of the earlier effective registration statement for the same offering.   o                       

       If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box.   o

CALCULATION OF REGISTRATION FEE

                 


Proposed Maximum Proposed Maximum Amount of
Title Of Each Class Of Amount To Be Offering Price Per Aggregate Registration
Securities To Be Registered Registered(1) Share(2) Offering Price(2) Fee

Common Stock, par value $0.01 per share
  10,350,000   $3.90   $40,365,000   $5,406.07(3)


(1)  Includes 1,350,000 shares which may be sold upon exercise of the underwriters’ over-allotment option.
 
(2)  Estimated pursuant to Rule 457(c) solely for the purpose of computing the amount of the registration fee, and based on the average of the high and low prices of the Company’s Common Stock on the Nasdaq SmallCap Market on June 23, 2004.
 
(3)  A registration fee of $4,837.82 was previously paid in connection with the original filing on January 22, 2004 for the registration of 9,200,000 shares at a per share price of $6.50. The registration fee of $568.25 for the additional 1,150,000 shares registered hereby is based on a per share price of $3.90.

       The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until this Registration Statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to said Section 8(a), may determine.




Table of Contents

The information in this prospectus is not complete and may be changed. Neither we nor the selling stockholders may sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted.

SUBJECT TO COMPLETION, DATED JUNE 29, 2004

(PROSPECTUS FRONT COVER)

(NAVISITE LOGO)

9,000,000 Shares
Common Stock


NaviSite, Inc. is selling 7,300,000 shares of common stock and the selling stockholders identified in this prospectus are selling an additional 1,700,000 shares. We will not receive any of the proceeds from the sale of the shares sold by the selling stockholders. Together with a selling stockholder identified in this prospectus, we have granted the underwriters a 30-day option to purchase up to an additional 1,350,000 shares to cover over-allotments, if any.

Our common stock is traded on the Nasdaq SmallCap Market under the symbol “NAVI.” On June 28, 2004, the last reported sale price for our common stock was $3.95 per share. We have applied for listing of our common stock on the American Stock Exchange under the symbol “NVE” to be effective upon completion of this offering.


INVESTING IN OUR COMMON STOCK INVOLVES RISKS. SEE “RISK FACTORS” BEGINNING ON PAGE 8.


                 
Per Share Total
Public offering price
  $       $    
Underwriting discount
  $       $    
Proceeds, before expenses, to us(1)
  $       $    
Proceeds to the selling stockholders
  $       $    


(1)  Expenses estimated to be $850,000, all of which will be paid by us.

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.


Thomas Weisel Partners LLC

  CIBC World Markets
  SG Cowen

The date of this prospectus is                       , 2004


TABLE OF CONTENTS

PROSPECTUS SUMMARY
SUMMARY CONSOLIDATED FINANCIAL DATA
RISK FACTORS
FORWARD-LOOKING STATEMENTS
USE OF PROCEEDS
PRICE RANGE OF COMMON STOCK
DIVIDEND POLICY
DILUTION
CAPITALIZATION
SELECTED CONSOLIDATED FINANCIAL DATA
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
BUSINESS
MANAGEMENT
DESCRIPTION OF CAPITAL STOCK
SHARES ELIGIBLE FOR FUTURE SALE
PRINCIPAL AND SELLING STOCKHOLDERS
MATERIAL UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS FOR NON-UNITED STATES HOLDERS
UNDERWRITING
VALIDITY OF COMMON STOCK
EXPERTS
WHERE YOU CAN FIND MORE INFORMATION
INCORPORATION BY REFERENCE
INDEX TO NAVISITE, INC. CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
CONSOLIDATED STATEMENTS OF OPERATIONS
CONSOLIDATED STATEMENTS OF CASH FLOWS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SIGNATURES
EXHIBIT INDEX
EX-5.1 Opinion of Browne, Rosedale & Lanouette
EX-10.73 Employment Agreement with John Gavin
EX-23.2 Consent of KPMG LLP
EX-23.3 Consent of PWC LLP
EX-23.4 Consent of KPMG LLP


Table of Contents

TABLE OF CONTENTS

         
Page

Prospectus Summary
    1  
Summary Consolidated Financial Data
    6  
Risk Factors
    8  
Forward-Looking Statements
    20  
Use of Proceeds
    20  
Price Range of Common Stock
    22  
Dividend Policy
    22  
Dilution
    23  
Capitalization
    24  
Unaudited Pro Forma Condensed Combined Financial Information
    25  
Selected Consolidated Financial Data
    33  
Management’s Discussion and Analysis of Financial Condition and Results of Operations
    35  
Business
    51  
Management
    61  
Description of Capital Stock
    63  
Shares Eligible for Future Sale
    64  
Principal and Selling Stockholders
    65  
Material United States Federal Income Tax Considerations for Non-United States Holders
    70  
Underwriting
    72  
Validity of Common Stock
    74  
Experts
    74  
Where You Can Find More Information
    75  
Incorporation By Reference
    75  
Index to NaviSite, Inc. Consolidated Financial Statements
    F-1  


   You should rely only on the information contained in this prospectus. We have not authorized anyone to provide you with information different from that contained in this prospectus. We are offering to sell shares of common stock and seeking offers to buy shares of common stock only in jurisdictions where offers and sales are permitted. The information contained in this prospectus is accurate only as to the date of this prospectus, regardless of the time of delivery of this prospectus or of any sale of common stock.

   We obtained the market data and industry information contained in this prospectus from internal surveys, reports and studies, as appropriate, as well as from market research, publicly available information and industry publications.

   In this prospectus “we,” “us” and “our” refer to NaviSite, Inc. and its subsidiaries. Unless otherwise indicated, all information in this prospectus assumes no exercise of the underwriters’ over-allotment option.

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PROSPECTUS SUMMARY

   You should read the following summary together with the more detailed information and consolidated financial statements and related notes thereto appearing elsewhere in this prospectus and in the documents incorporated by reference in this prospectus. You should read the entire prospectus, including the documents incorporated by reference in this prospectus, before you invest in our common stock. This prospectus contains forward-looking statements. The outcome of the events described in these forward-looking statements is subject to risks, and actual results could differ materially. Read this entire prospectus carefully, especially the risks described under “Risk Factors.”

Our Business

   We provide a broad range of outsourced hosting and managed application services for middle-market organizations, which include mid-sized companies, divisions of large multi-national companies and government agencies. Our service offerings allow our customers to outsource the hosting and management of their information technology infrastructure and applications, such as commerce systems, enterprise software applications and e-mail. We offer services that are designed to focus on the needs of middle-market organizations, where we believe the need for outsourcing is most acute. We believe that by using our services, our customers are able to focus on, and apply resources to, their core business operations by avoiding the significant ongoing investments required to replicate our infrastructure, performance, reliability and expertise.

   We currently operate 16 data centers in the United States and one data center in the United Kingdom. We believe that our data centers and infrastructure have the capacity necessary to expand our business for the foreseeable future. Our services combine our developed infrastructure with established processes and procedures for delivering hosting and application management services.

   We currently service approximately 1,100 customers, including approximately 191 customers through our sales channel relationships. Our customers typically enter into service agreements with us for a term of one to three years, which provide for monthly payment installments, providing us with a base of recurring revenue.

   Since September 2002, we have completed six acquisitions. As a result, we believe we have developed a disciplined acquisition strategy and significant integration expertise that will allow us to further expand our service offering, grow our customer base and improve our overall profitability. As of April 30, 2004, we had incurred losses since our incorporation resulting in an accumulated deficit of approximately $428.3 million. During the fiscal quarter and nine months ended April 30, 2004, we had a net loss of approximately $3.0 million and $9.8 million, respectively. The audit report from KPMG LLP, our independent auditors, relating to our fiscal year 2003 financial statements contains KPMG’s opinion that our recurring losses from operations since inception and accumulated deficit, as well as other factors, raise substantial doubt about our ability to continue as a going concern.

Our Services

   We offer a range of application, infrastructure and messaging services that can be deployed quickly and cost-effectively. We specialize in developing, deploying and managing information technology infrastructure and applications for our customers. Since 1999, we have invested approximately

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$56 million in our operating platform and automation capabilities and have refined our processes over time across a large base of customers. Our services include:
       
Managed Application Services
  Application Hosting
 
(A-Services)
  Application Management
    Application Development
Managed Infrastructure Services
  Content and Electronic Software Distribution
 
(I-Services)
  Colocation
    Bandwidth
    Security
    Disaster Recovery
Managed Messaging Services
  Managed Messaging
 
(M-Services)
   

   Following our acquisition of Surebridge described below, we support a broad portfolio of outsourced application services including financial management, supply chain management, human resources management, and customer relationship management. We provide these services to a range of vertical industries through our direct sales force and channel relationships. The applications we provide include PeopleSoft, Siebel Systems, Progress Software and the Microsoft Business Solutions suite.

   Our service offerings are facilitated by our proprietary Collaborative Application Management platform, or CAM. Our CAM platform enables us, with our customers, to provide highly efficient, effective and customized management of their outsourced enterprise applications and information technology. Comprised of a suite of third-party and proprietary products, CAM provides tools designed specifically to meet the needs of customers who outsource or want to provide on-demand application services.

   We believe that the combination of CAM with our physical infrastructure and technical staff gives us a unique ability to provision on-demand application services for software providers for use by their customers. Because this on-demand provisioning capability is not dependent on the individual software application, CAM is application and operating platform neutral. Designed to enable enterprise software applications to be provisioned and used as an on-demand solution, the CAM technology allows us to offer new solutions to our software vendors and new products to our current customers.

Our Industry

   Many businesses are deploying Internet-enabled applications to enhance their core business operations, increase efficiency and remain competitive. The proliferation of these applications has created a strong demand for specialized information technology support and application expertise. The trend towards outsourced hosting and management of Internet-enabled applications is driven by the need to improve reliability and overall performance of the applications, the need to focus on core business operations, and the complexity and cost of managing the applications.

   Independent market research firms indicate that the markets for our services are large and expected to grow rapidly over the next few years. According to Gartner Dataquest, or Gartner, the North American Web-hosting market will grow from $5.8 billion in 2002 to $20.0 billion in 2007. Gartner also estimates that the North American content distribution network and software delivery services market will grow from $173 million in 2002 to $814 million by 2007. According to The Radicati Group, the hosted and managed business email market will grow from approximately $2.3 billion in 2003 to approximately $3.1 billion in 2007.

   Notwithstanding increasing demand for these services, we believe the number of providers of outsourced application hosting and management services has decreased over the past three years, primarily as a result of industry consolidation and bankruptcies. We believe this consolidation trend will continue, and will benefit a small number of service providers that have the resources and

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infrastructure to cost effectively provide the scalability, performance, reliability and business continuity that customers expect.

Our Strategy

   Our goal is to become the leading provider of outsourced hosting and managed application services for middle-market organizations, which include mid-sized companies, divisions of large multi-national companies and government agencies. Key elements of our strategy are to:

  •  Deepen Existing Customer Relationships and Expand Our Customer Base. Most of our customers currently utilize only one of our service offerings. We plan to further penetrate our existing customer base with minimal additional costs by cross-selling our broad suite of services. We also plan to increase our customer base through direct sales and by expanding our channel relationships with key systems integrators and independent software vendors.
 
  •  Improve Operating Margins Through Efficiencies. We have made significant improvements to our overall cost structure during the last twelve months. We intend to continue to improve operating margins as we improve the efficiency of our operations.
 
  •  Grow Through Disciplined Acquisitions. We intend to derive much of our future growth through acquisitions of technologies, products and companies that enhance our services portfolio and strengthen our position in our target markets.
 
  •  Emphasize and Invest in New High-Growth Service Areas. We plan to target emerging high growth service areas and increase the number of value-add services we provide to our customers.

Recent Developments

   On June 10, 2004, we completed the acquisition of substantially all of the assets and liabilities of Surebridge, Inc., or Surebridge, a privately held provider of managed application services for mid-market companies, in exchange for two promissory notes in the aggregate principal amount of approximately $39.3 million, three million shares of our common stock and the assumption of certain liabilities of Surebridge at closing. Our acquisition of Surebridge broadens our portfolio of outsourced application services, particularly in the areas of financial management, supply chain management, human resources management and customer relationship management. Surebridge provides these services to a range of vertical industries through its direct sales force as well as channel relationships. The applications that Surebridge supports include PeopleSoft, Siebel Systems and Microsoft Business Solutions suite.

   The promissory notes that we issued to Surebridge accrue interest on the unpaid balance at an annual rate of 10%, however no interest accrues on any principal paid within nine months of the closing. In the event that we realize net proceeds in excess of $1 million from equity or debt financings or sales of assets, including this offering, we are obligated to use a significant portion of the proceeds to make payments on the notes. The notes must be paid in full no later than the second anniversary of the closing.

   The outstanding principal of and accrued interest on the notes are convertible into shares of NaviSite common stock at a conversion price of $4.642 at the election of the holder:

  •  at any time following the first anniversary of the closing if the aggregate principal outstanding under the notes at such time is greater than or equal to $20 million;
 
  •  at any time following the 18-month anniversary of the closing if the aggregate principal outstanding under the notes at such time is greater than or equal to $10 million;
 
  •  at any time following the second anniversary of the closing; and
 
  •  at any time following an event of default thereunder.

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   For a period of one year following the closing of the acquisition, Surebridge may not sell, transfer, assign, convey, encumber, gift, distribute or otherwise dispose of its shares of our common stock or the notes; provided, however, if we do not make certain payments under the notes or otherwise suffer an event of default thereunder, Surebridge may sell its shares at any time thereafter.

Corporate Information

   We were formed in 1996 within CMGI, Inc., our former majority stockholder, to support the networks and host Web sites of CMGI, its subsidiaries and several of its affiliated companies. In 1997, we began offering and supplying Web site hosting and management services to companies not affiliated with CMGI. We were incorporated in Delaware in December 1998. In October 1999, we completed our initial public offering of common stock and remained a majority-owned subsidiary of CMGI until September 2002. In September 2002, ClearBlue Technologies, Inc., or CBT, and its subsidiaries became our majority stockholder upon CBT’s acquisition from CMGI and Hewlett-Packard Financial Services Company of all of their shares of our common stock then held, warrants to purchase our common stock and convertible promissory notes issued by us in exchange for shares of CBT common stock. In December 2002 and August 2003, CBT transferred shares of our common stock held by it to its stockholders, including the shares of our common stock currently held by Hewlett-Packard Financial Services Company. In connection with CBT’s August 2003 transfers to its stockholders of its remaining shares of our common stock, Atlantic Investors, LLC, the indirect majority stockholder of CBT, became our majority stockholder. As of June 17, 2004, Atlantic Investors owned approximately 61% of the issued and outstanding shares of our common stock. Following the completion of this offering, Atlantic Investors will own approximately 49% of our common stock, allowing it to continue to have significant influence over our management and affairs and the outcome of any corporate action requiring stockholder approval.

   Our corporate headquarters are located at 400 Minuteman Road, Andover, Massachusetts, and our telephone number is (978) 682-8300. Our Web site is found at www.navisite.com. The information available on, or that can be accessed through, our Web site is not a part of this prospectus.

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The Offering

 
Common stock offered by us 7,300,000 shares
 
Common stock offered by selling stockholders 1,700,000 shares
 
Common stock to be outstanding after the offering 35,218,049 shares
 
Underwriters’ over-allotment option 1,350,000 shares(1)
 
Use of proceeds We expect to receive net proceeds from this offering of approximately $33.5 million. We intend to use the net proceeds to us from this offering as follows:
 
• approximately $3.3 million for the repayment of outstanding indebtedness owed to Atlantic Investors, LLC;
 
• approximately $16.7 million for the repayment of a portion of indebtedness owed to Surebridge, Inc.; and
 
• approximately $13.5 million for general corporate purposes, including working capital, and potential acquisitions of technologies, products and companies, although we have no current specific plans with respect to the $13.5 million.
 
We will not receive any proceeds from the sale of our common stock by the selling stockholders.
 
Proposed American Stock Exchange symbol(2) NVE

   The number of shares of our common stock outstanding after this offering is based on 27,918,049 shares outstanding as of June 17, 2004 and excludes as of June 17, 2004:

  •  3,595,332 shares of common stock issuable upon exercise of outstanding stock options, at a weighted average exercise price of $3.54 per share, under our Amended and Restated 2003 Stock Incentive Plan;
 
  •  3,708 shares of common stock issuable upon exercise of outstanding stock options, at a weighted average exercise price of $128.44 per share, under our 2000 Stock Option Plan;
 
  •  232,053 shares of common stock issuable upon exercise of outstanding stock options, at a weighted average exercise price of $55.40 per share, under our 1998 Equity Incentive Plan; and
 
  •  62,848 additional shares of common stock reserved for future issuance under all of our stock plans.

   Unless otherwise specifically stated, information throughout this prospectus assumes:

  •  no exercise of outstanding options or warrants to purchase shares of common stock; and
 
  •  no exercise of the underwriters’ over-allotment option.

   We have never declared or paid cash dividends on our common stock and do not anticipate declaring or paying any cash dividends on our common stock for the foreseeable future. We expect that we will retain all future earnings to fund the growth and development of our business. We are also restricted from paying any cash dividends on our common stock by the terms of our amended accounts receivable financing agreement with Silicon Valley Bank.


(1)  Consists of 700,000 shares to be sold by us and 650,000 shares to be sold by a selling stockholder.
 
(2)  We have applied for listing of our common stock on the American Stock Exchange to be effective upon completion of this offering.

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SUMMARY CONSOLIDATED FINANCIAL DATA

(In thousands, except per share data)

   You should read the summary consolidated financial data set forth below together with the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section included later in this prospectus, and our consolidated financial statements and related notes beginning on page F-1 of this prospectus.

   On August 8, 2003, we completed the acquisition of certain assets and the assumption of certain liabilities of CBT in a business combination accounted for in a manner similar to a pooling-of-interest due to common control ownership. Accordingly, our consolidated financial statements have been restated for all periods prior to the business combination to include CBT’s financial results beginning on September 11, 2002, the date on which CBT acquired the controlling interest in us, after the elimination of intercompany balances.

Consolidated Statement of Operations Data:

                                                             
Pro Forma(2) Pro Forma(2)
Three Months Nine Months
Nine Months Ended Ended Ended
Year Ended July 31, April 30, April 30, April 30,




2003 2002 2001 2004 2003 2004 2004







(Unaudited) (Unaudited)
(Unaudited)
Revenue
  $ 75,281     $ 40,968     $ 66,358     $ 65,975     $ 52,942     $ 31,886     $ 98,285  
Revenue, related parties
    1,310       18,453       36,368       12       1,310       239       781  
     
     
     
     
     
     
     
 
Total revenue
    76,591       59,421       102,726       65,987       54,252       32,125       99,066  
     
     
     
     
     
     
     
 
Cost of revenue
    70,781       67,000       127,155       48,899       50,821       21,994       71,824  
Impairment, restructuring and other
          68,317       1,930       633                   633  
     
     
     
     
     
     
     
 
Total cost of revenue
    70,781       135,317       129,085       49,532       50,821       21,994       72,457  
     
     
     
     
     
     
     
 
Gross profit (deficit)
    5,810       (75,896 )     (26,359 )     16,455       3,431       10,131       26,609  
     
     
     
     
     
     
     
 
Operating expenses:
                                                       
 
Product development
    950       5,281       14,072       890       624       230       890  
 
Selling and marketing
    5,960       9,703       32,251       5,724       3,759       3,809       12,257  
 
General and administrative
    20,207       19,272       33,011       16,342       13,718       8,631       24,975  
 
Impairment, restructuring and other
    8,882       (2,633 )     8,011       1,608       6,274       206       1,608  
     
     
     
     
     
     
     
 
   
Total operating expenses
    35,999       31,623       87,345       24,564       24,375       12,876       39,730  
     
     
     
     
     
     
     
 
Loss from operations
    (30,189 )     (107,519 )     (113,704 )     (8,109 )     (20,944 )     (2,745 )     (13,121 )
Other income (expense):
                                                       
 
Interest income
    851       1,060       2,753       115       685       20       125  
 
Interest expense
    (43,403 )     (14,718 )     (8,042 )     (1,935 )     (20,170 )     (1,728 )     (5,133 )
 
Other income (expense), net
    (733 )     (516 )     292       111       (1,111 )     25       111  
     
     
     
     
     
     
     
 
Loss before cumulative effect of change in accounting principle and income tax expense
    (73,474 )     (121,693 )     (118,701 )     (9,818 )     (41,540 )     (4,428 )     (18,018 )
Income tax expense
    (153 )                                    
     
     
     
     
     
     
     
 
Loss before cumulative effect of change in accounting principle
    (73,627 )     (121,693 )     (118,701 )     (9,818 )     (41,540 )     (4,428 )     (18,018 )
Cumulative effect of change in accounting principle
                (4,295 )                        
     
     
     
     
     
     
     
 
Net loss
  $ (73,627 )   $ (121,693 )   $ (122,996 )   $ (9,818 )   $ (41,540 )   $ (4,428 )   $ (18,018 )
     
     
     
     
     
     
     
 

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Pro Forma(2) Pro Forma(2)
Three Months Nine Months
Nine Months Ended Ended Ended
Year Ended July 31, April 30, April 30, April 30,




2003 2002 2001 2004 2003 2004 2004







(Unaudited) (Unaudited)
(Unaudited)
Basic and diluted net loss per common share:(1)
                                                       
Before cumulative effect of change in accounting principle
  $ (6.32 )   $ (22.30 )   $ (30.18 )   $ (0.40 )   $ (4.33 )   $ (0.16 )   $ (0.65 )
Cumulative effect of change in accounting principle
                (1.09 )                        
     
     
     
     
     
     
     
 
Basic and diluted net loss per common share
  $ (6.32 )   $ (22.30 )   $ (31.27 )   $ (0.40 )   $ (4.33 )   $ (0.16 )   $ (0.65 )
     
     
     
     
     
     
     
 
Basic and diluted weighted average number of common shares outstanding
    11,654       5,457       3,933       24,685       9,587       27,809       27,685  
     
     
     
     
     
     
     
 

Consolidated Balance Sheet Data:

                 
As of April 30, 2004

Pro Forma
Actual As Adjusted(2)(3)


(Unaudited)
Cash and cash equivalents
  $ 7,630     $ 22,785  
Working capital (deficit)
    (16,618 )     (4,259 )
Total assets
    61,488       141,866  
Accrued expenses, current portion
    13,628       15,771  
Debt
    27,186       51,393  
Long-term liabilities, excluding long-term notes payable
    3,349       3,444  
Stockholders’ equity
    8,720       56,550  


(1)  As discussed in the notes to our consolidated financial statements, in January 2003 we completed a 1-for-15 reverse stock split of our outstanding shares of common stock. All historical share and per share data have been adjusted for the reverse stock split.
 
(2)  The pro forma consolidated statement of operations data combines the unaudited condensed consolidated statement of operations of NaviSite for the three and nine months ended April 30, 2004 with the unaudited condensed consolidated statement of operations of Surebridge for the three and nine months ended March 31, 2004.
 
(3)  Adjusted to give effect to this offering and the application of the net proceeds to us, including the repayment of approximately $20.0 million of indebtedness.

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RISK FACTORS

   You should carefully consider the risks described below before making an investment decision. Our business could be harmed by any of these risks. The trading price of our common stock could decline due to any of these risks, and you may lose all or part of your investment. In assessing these risks, you should also refer to the other information contained or incorporated by reference in this prospectus, including our consolidated financial statements and related notes.

Risks Relating to Our Business

We have a history of losses and may never achieve or sustain profitability and may not continue as a going concern.

   We have never been profitable and may never become profitable. Since our incorporation in 1998, we have experienced operating losses and negative cash flows for each quarterly and annual period. As of April 30, 2004, we had incurred losses since our incorporation resulting in an accumulated deficit of approximately $428.3 million. During the fiscal quarter and nine months ended April 30, 2004, we had a net loss of approximately $3.0 million and $9.8 million, respectively. The audit report from KPMG LLP, our independent auditors, relating to our fiscal year 2003 financial statements contains KPMG’s opinion that our recurring losses from operations since inception and accumulated deficit, as well as other factors, raise substantial doubt about our ability to continue as a going concern. We anticipate that we will continue to incur net losses in the future. We also have significant fixed commitments, including with respect to real estate, bandwidth commitments, machinery and equipment leases. As a result, we can give no assurance that we will achieve profitability or be capable of sustaining profitable operations. If we are unable to reach and sustain profitability, we risk depleting our working capital balances and our business may not continue as a going concern.

We may need to obtain additional financing, which may not be available on favorable terms, or at all.

   As of April 30, 2004 we had approximately $7.6 million of cash and cash equivalents and a working capital deficit of approximately $16.6 million. On June 11, 2004, we borrowed approximately $3.9 million under our Silicon Valley Bank amended accounts receivable financing agreement to repay indebtedness owed to Silicon Valley Bank by Surebridge that we assumed as part of the Surebridge acquisition. Our outstanding balance under the amended agreement as of June 11, 2004 was $15.2 million. If we do not complete this offering, or if we do complete this offering and then use a significant portion of the net proceeds we receive to acquire a company, technology or product, we may need to raise additional capital through various other equity or debt financings.

   Our projections for cash usage are based on a number of assumptions, including:

  •  our ability to retain customers in light of market uncertainties and our uncertain future;
 
  •  our ability to collect accounts receivables in a timely manner;
 
  •  our ability to effectively integrate Surebridge and other recent acquisitions and realize forecasted cash savings; and
 
  •  our ability to achieve other expected cash expense reductions.

Further, our projected use of cash and business results could be affected by continued market uncertainties, including delays or restrictions in information technology spending by customers or potential customers and any merger or acquisition activity.

   In recent years, we have generally financed our operations with proceeds from selling shares of our stock and borrowing funds. There can be no assurance that additional financing will be available on favorable terms, or at all. In addition, even if we find outside funding sources, we may be required to

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issue securities with greater rights than those currently possessed by holders of our common stock. We may also be required to take other actions that may lessen the value of our common stock or dilute our common stockholders, including borrowing money on terms that are not favorable to us or issuing additional equity securities. If we are required to raise money in the future and we experience difficulties doing so, our business and liquidity will be materially adversely affected.

We may not realize all of the anticipated benefits of our recent acquisition of Surebridge.

   On June 10, 2004, pursuant to an asset purchase agreement dated May 6, 2004, we completed the acquisition of substantially all of the assets of Surebridge for three million shares of our common stock, two promissory notes in the aggregate principal amount of approximately $39.3 million and the assumption of certain liabilities.

   The success of the acquisition depends, in part, on our ability to realize the anticipated synergies, cost savings and growth and marketing opportunities from integrating the businesses of Surebridge with the businesses of NaviSite. Our success in realizing these benefits and the timing of this realization depend upon the successful integration of the technology, personnel and operations of Surebridge. The integration of two independent companies is a complex, costly and time-consuming process. The difficulties of combining the operations of the companies include, among others:

  •  retaining key employees;
 
  •  consolidating corporate and administrative infrastructures;
 
  •  maintaining customer service levels;
 
  •  coordinating sales and marketing functions;
 
  •  preserving the distribution, marketing, promotion and other important internal operations and third-party relationships of Surebridge;
 
  •  minimizing the diversion of management’s attention from our current business;
 
  •  coordinating geographically disparate organizations and data centers; and
 
  •  retaining key customers.

   There can be no assurance that the integration of Surebridge with NaviSite will result in the realization of the full benefits that we anticipate in a timely manner or at all.

The promissory notes we issued in the Surebridge acquisition may negatively affect our liquidity and our ability to obtain additional financing and operate and manage our business.

   On June 10, 2004, in connection with our acquisition of the Surebridge business, we issued two convertible promissory notes in the aggregate principal amount of approximately $39.3 million. We must repay the outstanding principal of the notes with all interest accrued thereon, no later than June 10, 2006. In addition, in the event that we realize net proceeds in excess of $1.0 million from certain equity or debt financings or sales of assets, including this offering, we are obligated to use a significant portion of the proceeds to make payments on the notes. The notes, or the prepayment obligation thereon, may adversely affect our ability to raise or retain additional capital. If we commit an event of default under any of the promissory notes, which may include a default of obligations owed to other third parties, prior to the respective maturity dates of the promissory notes, then the holders of the promissory notes may declare the notes immediately due and payable, which would adversely affect our liquidity and our ability to manage our business. Furthermore, the promissory notes contain certain restrictive covenants, including with respect to our ability to incur indebtedness.

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NaviSite’s common stockholders may suffer significant dilution in the future upon the conversion of outstanding securities and the issuance of additional securities in potential future acquisitions.

   The outstanding principal and accrued interest on the two Surebridge promissory notes shall be convertible into shares of our common stock at a conversion price of $4.642, at the election of the holder:

  •  at any time following the first anniversary of the closing if the aggregate principal outstanding under the notes at such time is greater than or equal to $20.0 million;
 
  •  at any time following the 18-month anniversary of the closing if the aggregate principal outstanding under the notes at such time is greater than or equal to $10.0 million;
 
  •  at any time following the second anniversary of the closing; and
 
  •  at any time following an event of default thereunder.

   If the promissory notes are converted into shares of common stock, Surebridge may obtain a significant equity interest in NaviSite and other stockholders may experience significant and immediate dilution. Should Surebridge elect to convert all of the initial principal amount of its two convertible promissory notes into shares of our common stock, Surebridge would own approximately 11,466,000 shares of our common stock, which, based on our capitalization as of June 17, 2004, would be approximately 32% of our outstanding shares of common stock.

   In addition, our stockholders will experience further dilution to the extent that additional shares of our common stock are issued in potential future acquisitions.

Our financing agreement with Silicon Valley Bank includes various covenants and restrictions that may negatively affect our liquidity and our ability to operate and manage our business.

   As of June 11, 2004, we owed Silicon Valley Bank approximately $15.2 million under our amended accounts receivable financing agreement following a borrowing of approximately $3.9 million on June 11, 2004 to repay a Surebridge loan that we assumed as part of the Surebridge acquisition. The accounts receivable financing agreement generally restricts or limits, among other things, our ability to:

  •  create or incur indebtedness;
 
  •  sell, or permit any lien or security interest in, any of our assets;
 
  •  enter into or permit any material transaction with any of our affiliates;
 
  •  merge or consolidate with any other party, or acquire all or substantially all of the capital stock or property of another party, unless, among other things, the other party is in the same, or a similar line of business as us;
 
  •  relocate our principal executive office or add any new offices or business locations;
 
  •  change our state of formation;
 
  •  change our legal name;
 
  •  make investments;
 
  •  pay dividends or make any distribution or payment or redeem, retire or purchase our capital stock; and
 
  •  make or permit any payment on subordinated debt or amend any provision in any document relating to any subordinated debt.

Further, the accounts receivable financing agreement requires that we maintain EBITDA of at least $1.00 for every fiscal quarter. The agreement defines EBITDA as earnings before interest, taxes, depreciation

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and amortization in accordance with generally accepted accounting principles and excluding acquisition-related costs and one-time extraordinary charges.

   If we breach our accounts receivable financing agreement with Silicon Valley Bank, which may be deemed to have occurred upon an event of default under the promissory notes issued in the Surebridge transaction, a default could result. A default, if not waived, could result in, among other things, us not being able to borrow additional amounts from Silicon Valley Bank and all or a portion of our outstanding amounts may become due and payable on an accelerated basis, which would adversely affect our liquidity and our ability to manage our business. A default under the accounts receivable financing agreement could also result in a cross-default under the promissory notes issued in the Surebridge transaction thereby accelerating the repayment obligation on the notes and also allowing the holder to elect to convert the principal and accrued interest thereon into shares of our common stock.

Our limited operating history with our current operating structure makes it difficult for us and our investors to evaluate our past performance and future prospects.

   We have completed a number of acquisitions since December 2002. Until a significant period of time elapses, it will be difficult to determine if we correctly valued these acquired businesses or adequately anticipated all of the demands that our growth will impose on our personnel, procedures and structures, including our financing and reporting control systems and management structure. Our limited operating history with our current structure makes it very difficult for you and us to evaluate or predict our ability to, among other things, retain customers, generate and sustain a revenue base sufficient to meet our operating expenses, and achieve and sustain profitability.

A significant portion of our revenue comes from one customer and, if we lost this customer, it would have a significant adverse impact on our business results and cash flows.

   The New York State Department of Labor represented approximately 21% of our consolidated revenue for the fiscal year ended July 31, 2003 and 12% for the fiscal quarter ended April 30, 2004 on a larger revenue base. The New York State Department of Labor has been a long-term customer of ours, but there can be no assurance that we will be able to retain this customer. Further, there can be no assurance that we will be able to maintain the same level of service to this customer or that our revenue from this customer will not decline or suffer a material reduction in future periods. The New York State Department of Labor is not obligated under our agreement to buy a minimum amount of services from us or designate us as its sole supplier of any particular service. This contract with The New York State Department of Labor, and its funding allowance, expires in June 2005. Further, The New York State Department of Labor has the right to terminate this contract at any time by providing us with 60 days notice. If we were to lose this customer or suffer a material reduction in the revenue generated from this customer, it would have a significant adverse impact on our business results and cash flows.

Atlantic Investors may have interests that conflict with the interests of our other stockholders and, as our majority stockholder, can prevent new and existing investors from influencing significant corporate decisions.

   Atlantic Investors owns approximately 61% of our outstanding capital stock as of June 17, 2004. Following completion of this offering, Atlantic Investors will own approximately 49% of our outstanding capital stock. In addition, Atlantic Investors holds a note in the principal amount of $3.0 million due upon the earlier to occur of August 1, 2004, and five business days after our receipt of gross proceeds from a financing or a sale of assets of at least $13 million. Atlantic Investors, prior to the offering, has the power, acting alone, to elect a majority of our Board of Directors and has the ability to control our management and affairs and determine the outcome of any corporate action requiring stockholder approval, regardless of how our other stockholders may vote, including the election of directors, any merger, consolidation or sale of all or substantially all of our assets, and any other significant corporate transaction. Under Delaware law, Atlantic Investors is able to exercise its voting power by written

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consent, without convening a meeting of the stockholders, which means that Atlantic Investors could effect a sale or merger of us without the consent of our other stockholders. Atlantic Investors’ ownership of a majority of our outstanding common stock may have the effect of delaying, deterring or preventing a change in control of us 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. Following the completion of this offering, Atlantic Investors will continue to have significant influence over our management and affairs and the outcome of any corporate action requiring stockholder approval.

Members of our management group also have significant interests in Atlantic Investors, which may create conflicts of interest.

   Some of the members of our management group also serve as members of the management group of Atlantic Investors and its affiliates. Specifically, Andrew Ruhan, our Chairman of the Board, holds a 10% equity interest in Unicorn Worldwide Holdings Limited, a managing member of Atlantic Investors. Arthur Becker, our President and Chief Executive Officer, is the managing member of Madison Technology LLC, a managing member of Atlantic Investors. As a result, these NaviSite officers and directors may face potential conflicts of interest with each other and with our stockholders. They may be presented with situations in their capacity as our officers or directors that conflict with their fiduciary obligations to Atlantic Investors, which in turn may have interests that conflict with the interests of our other stockholders.

Acquisitions may result in disruptions to our business or distractions of our management due to difficulties in integrating acquired personnel and operations, and these integrations may not proceed as planned.

   Since December 2002, we have acquired ClearBlue Technologies Management, Inc., or CBTM, Avasta, Conxion, selected assets of Interliant, all of the shares of ten wholly-owned subsidiaries of ClearBlue Technologies, Inc., or CBT, and substantially all of the assets and liabilities of Surebridge. We intend to continue to expand our business through the acquisition of companies, technologies, products and services. Acquisitions involve a number of special problems and risks, including:

  •  difficulty integrating acquired technologies, products, services, operations and personnel with the existing businesses;
 
  •  difficulty maintaining relationships with important third parties, including those relating to marketing alliances and providing preferred partner status and favorable pricing;
 
  •  diversion of management’s attention in connection with both negotiating the acquisitions and integrating the businesses;
 
  •  strain on managerial and operational resources as management tries to oversee larger operations;
 
  •  inability to retain and motivate management and other key personnel of the acquired businesses;
 
  •  changes in management and key personnel of acquired businesses may harm relationships with the acquired businesses’ customers, suppliers and employees;
 
  •  exposure to unforeseen liabilities of acquired companies;
 
  •  potential costly and time-consuming litigation, including stockholder lawsuits;
 
  •  potential issuance of securities in connection with an acquisition with rights that are superior to the rights of holders of our common stock, or which may have a dilutive effect on our common stockholders;
 
  •  the need to incur additional debt or use cash; and
 
  •  the requirement to record potentially significant additional future operating costs for the amortization of intangible assets.

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   As a result of these problems and risks, businesses we acquire may not produce the revenues, earnings or business synergies that we anticipated, and acquired products, services or technologies might not perform as we expected. As a result, we may incur higher costs and realize lower revenues than we had anticipated. We may not be able to successfully address these problems and we cannot assure you that the acquisitions will be successfully identified and completed or that, if acquisitions are completed, the acquired businesses, products, services or technologies will generate sufficient revenue to offset the associated costs or other harmful effects on our business.

A failure to meet customer specifications or expectations could result in lost revenues, increased expenses, negative publicity, claims for damages and harm to our reputation and cause demand for our services to decline.

   Our agreements with customers require us to meet specified service levels for the services we provide. In addition, our customers may have additional expectations about our services. Any failure to meet customers’ specifications or expectations could result in:

  •  delayed or lost revenue;
 
  •  requirements to provide additional services to a customer at reduced charges or no charge;
 
  •  negative publicity about us, which could adversely affect our ability to attract or retain customers; and
 
  •  claims by customers for substantial damages against us, regardless of our responsibility for such failure, which may not be covered by insurance policies and which may not be limited by contractual terms of our engagement.

Our ability to successfully market our services could be substantially impaired if we are unable to deploy new infrastructure systems and applications or if new infrastructure systems and applications deployed by us prove to be unreliable, defective or incompatible.

   We may experience difficulties that could delay or prevent the successful development, introduction or marketing of hosting and application management services in the future. If any newly introduced infrastructure systems and 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 significantly reduced. 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 infrastructure systems and applications or enhancements of existing applications, our ability to successfully market our services could be substantially limited.

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 infrastructure systems and applications. We utilize our direct private transit Internet connections to major network providers, such as Level 3, Internap, WilTel and XO Communications, 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 networks so that our private transit Internet connections operate effectively. If our private transit Internet connections are interrupted or degraded, we may face claims by, or lose, customers, and our reputation in the industry may be harmed, which may cause demand for our services to decline.

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If we are unable to maintain existing and develop additional relationships with software vendors, the sales and marketing of our service offerings may be unsuccessful.

   We believe that to penetrate the market for hosting and application management services we must maintain existing and develop additional relationships with industry-leading software vendors. We license or lease select software applications from software vendors, including IBM, Microsoft, Micromuse and Oracle. Our relationships with Microsoft and PeopleSoft are critical to the operations and success of our recently acquired business from Surebridge. The loss of our ability to continually obtain, utilize or depend on any of these applications or relationships could substantially weaken our ability to provide services to our customers or require us to obtain substitute software applications that may be 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 software vendors on commercially reasonable terms. If we are unable to identify and license software applications that meet our targeted criteria for new application introductions, we may have to discontinue or delay introduction of services relating to these applications.

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. We must, therefore, protect our network infrastructure, equipment and customer files against damage from human error, natural disasters, unexpected equipment failure, power loss or telecommunications failures, terrorism, 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 a disaster or other unanticipated problem. 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 or seek damages for losses under our service level guarantees;
 
  •  cause customers to seek alternate providers; or
 
  •  impede our ability to attract new customers, retain current customers or enter into additional strategic relationships.

Our dependence on third parties increases the risk that we will not be able to meet our customers’ needs for software, systems and services on a timely or cost-effective basis, which could result in the loss of customers.

   Our services and infrastructure rely on products and services of third-party providers. We purchase key components of our infrastructure, including networking equipment, from a limited number of suppliers, such as IBM, Cisco Systems and F5 Networks. Our recently acquired business from Surebridge relies on products and services of Microsoft and PeopleSoft. There can be no assurance that we will not experience operational problems attributable to the installation, implementation, integration, performance, features or functionality of third-party software, systems and services. 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 ability to obtain and continue to maintain the necessary hardware or parts on a timely basis could result in sustained equipment failure

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and a loss of revenue due to customer loss or claims for service credits under our service level guarantees.

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 infrastructure systems and application services utilize encryption and authentication technology licensed from third parties to provide the protections necessary to ensure secure transmission of confidential information. We also rely on security systems designed by third parties and the personnel in our network operations centers to secure those data centers. Any unauthorized access, computer viruses, accidental or intentional actions and other disruptions could result in increased operating costs. For example, we may incur additional significant costs to protect against these interruptions and the threat of security breaches or to alleviate problems caused by such interruptions or breaches. Further, we expect to continue to invest in and expend additional financial resources to equip our data centers with enhanced security measures. If a third party were able to misappropriate a consumer’s personal or proprietary information, including credit card information, during the use of an application solution provided by us, we could be subject to claims, litigation or other potential liability.

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 infrastructure systems and application services that we offer. Our technology suppliers may become subject to third-party infringement or other claims and assertions, which could result in their inability or unwillingness to continue to license their technologies to us. 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.

We may be subject to legal claims in connection with the information disseminated through our network, which could divert 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 and other claims based on the nature and content of the materials disseminated through our network. For example, lawsuits may be brought against us claiming that content distributed by some of our current or future customers may be regulated or banned. In these and other instances, we may be required to engage in protracted and expensive litigation that could have the effect of diverting management’s attention from our business and require us to expend significant financial resources. Our general liability insurance may not cover any of these claims or may not be adequate to protect us against all liability that may be imposed. In addition, on a limited number of occasions in the past, businesses, organizations and individuals have sent unsolicited commercial e-mails from servers hosted at our facilities to a number of people, typically to advertise products or services. This practice, known as “spamming,” can lead to statutory liability as well as complaints against service providers that enable such activities, particularly where recipients view the materials received as offensive. We have in the past received, and may in the future receive, letters from recipients of information transmitted by our customers objecting to such transmission. Although we prohibit our customers by contract from spamming, we cannot assure you that our customers will not engage in this practice, which could subject us to claims for damages.

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If we fail to attract or retain key officers, management and technical personnel, our ability to successfully execute our business strategy or to continue to provide services and technical support to our customers could be adversely affected and we may not be successful in attracting new customers.

   We believe that attracting, training, retaining and motivating technical and managerial personnel, including individuals with significant levels of infrastructure systems and application expertise, is a critical component of the future success of our business. Qualified technical personnel are likely to remain a limited resource for the foreseeable future and competition for these personnel is intense. The departure of any of our executive officers, particularly Arthur P. Becker, our Chief Executive Officer and President, or core members of our sales and marketing teams or technical service personnel, would have negative ramifications on our customer relations and operations, including adversely affecting the stability of our infrastructure and our ability to provide the guaranteed service levels our customers expect. Any officer or employee can terminate his or her relationship with us at any time. In addition, we do not carry life insurance on any of our personnel. Over the past 18 months, we have had significant reductions-in-force due to redundancies and restructurings resulting from the consolidation of our acquired companies. We have also had a number of departures of several members of senior management due primarily to the change of control of NaviSite on September 11, 2002. In the event future reductions or departures of employees occur, our ability to successfully execute our business strategy, or to continue to provide services to our customers or attract new customers, could be adversely affected.

The unpredictability of our quarterly results may cause the trading price of our common stock to fluctuate or decline.

   Our quarterly operating results may vary significantly from quarter-to-quarter and period-to-period as a result of a number of factors, many of which are outside of our control and any one of which may cause our stock price to fluctuate. The primary factors that may affect our operating results include the following:

  •  reduction of market demand and/or acceptance of our services;
 
  •  oversupply of data center space in the industry;
 
  •  our ability to develop, market and introduce new services on a timely basis;
 
  •  the length of the sales cycle for our services;
 
  •  the timing and size of sales of our services, which depends on the budgets of our customers;
 
  •  downward price adjustments by our competitors;
 
  •  changes in the mix of services provided by our competitors;
 
  •  technical difficulties or system downtime affecting the Internet or our hosting operations;
 
  •  our ability to meet any increased technological demands of our customers; and
 
  •  the amount and timing of costs related to our marketing efforts and service introductions.

   Due to the above factors, we believe that quarter-to-quarter or period-to-period comparisons of our operating results may not be a good indicator of our future performance. Our operating results for any particular quarter may fall short of our expectations or those of stockholders or securities analysts. In this event, the trading price of our common stock would likely fall.

If we are unsuccessful in pending and potential litigation matters, our financial condition may be adversely affected.

   We are currently involved in various pending and potential legal proceedings, including a class action lawsuit related to our initial public offering, an arbitration matter involving the former stockholders of

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Avasta, counterclaims by the defendant in a suit in which we are the plaintiff, and a payment demand by an investment bank. If we are ultimately unsuccessful in any of these matters, we could be required to pay substantial amounts of cash and/or shares of our common stock to the other parties. The amount and timing of any such payments could adversely affect our financial condition.

Risks Related to Our Industry

If the markets for outsourced information technology infrastructure and applications, Internet commerce and communication decline, there may be insufficient demand for our services and, as a result, our business strategy and objectives may fail.

   The increased use of the Internet for retrieving, sharing and transferring information among businesses and consumers is developing, and the market for the purchase of products and services over the Internet is still relatively new and emerging. Our industry has experienced periods of rapid growth, followed by a sharp decline in demand for products and services, which related to the failure in the last few years of many companies focused on developing Internet-related businesses. If acceptance and growth of the Internet as a medium for commerce and communication declines, our business strategy and objectives may fail because there may not be sufficient market demand for our hosting and application management services.

If we do not respond to rapid changes in the technology sector, we will lose customers.

   The markets for the technology-related services we offer are characterized by rapidly changing technology, evolving industry standards, frequent new service introductions, shifting distribution channels and changing customer demands. We may not be able to adequately adapt our services or to acquire new services that can compete successfully. In addition, we may not be able to establish and maintain effective distribution channels. We risk losing customers to our competitors if we are unable to adapt to this rapidly evolving marketplace.

The market in which we operate is highly competitive and is likely to consolidate, and we may lack the financial and other resources, expertise or capability needed to capture increased market share or maintain market share.

   We compete in the hosting and application management services market. This market is rapidly evolving, highly competitive and likely to be characterized by over-capacity and industry consolidation. Our competitors may consolidate with one another or acquire software application vendors or technology providers, enabling them to more effectively compete with us. Many participants in this market have suffered significantly in the last several years. We believe that participants in this market must grow rapidly and achieve a significant presence to compete effectively. This consolidation could affect prices and other competitive factors in ways that would impede our ability to compete successfully in the hosting and application management services market.

   Further, our business is not as developed as that of many of our competitors. Many of our competitors have substantially greater financial, technical and market resources, greater name recognition and more established relationships in the industry. Many of our competitors may be able to:

  •  develop and expand their network infrastructure and service offerings more rapidly;
 
  •  adapt to new or emerging technologies and changes in customer requirements more quickly;
 
  •  take advantage of acquisitions and other opportunities more readily; or
 
  •  devote greater resources to the marketing and sale of their services and adopt more aggressive pricing policies than we can.

We may lack the financial and other resources, expertise or capability needed to maintain or capture increased market share in this environment in the future. Because of these competitive factors and due to our comparatively small size and our lack of financial resources, we may be unable to successfully compete in the hosting and application management services market.

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The emergence and growth of a market for our hosting and managed application services will be impaired if third parties do not continue to develop and improve 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. 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 services. Consequently, the market for our services will be impaired if improvements are not made to the entire Internet infrastructure to alleviate overloading and congestion.

Difficulties presented by international economic, political, legal, accounting and business factors could harm our business in international markets.

   We operate a data center in the United Kingdom and revenue from our foreign operations accounted for approximately 9% of our total revenues during the third quarter of fiscal year 2004. Although we expect to focus most of our growth efforts in the United States, we may enter into joint ventures or outsourcing agreements with third parties, acquire complementary businesses or operations, or establish and maintain new operations outside of the United States. Some risks inherent in conducting business internationally include:

  •  unexpected changes in regulatory, tax and political environments;
 
  •  longer payment cycles and problems collecting accounts receivable;
 
  •  geopolitical risks such as political and economic instability and the possibility of hostilities among countries;
 
  •  reduced protection of intellectual property rights;
 
  •  fluctuations in currency exchange rates;
 
  •  our ability to secure and maintain the necessary physical and telecommunications infrastructure;
 
  •  challenges in staffing and managing foreign operations;
 
  •  employment laws and practices in foreign countries; and
 
  •  laws and regulations on content distributed over the Internet that are more restrictive than those currently in place in the United States.

Any one or more of these factors could adversely affect our contemplated future international operations and consequently, our business.

We may become subject to burdensome government regulation and legal uncertainties that could substantially harm our business or expose us to unanticipated liabilities.

   It is likely that laws and regulations directly applicable to the Internet or to hosting and managed application service providers may be adopted. These laws may cover a variety of issues, including user privacy and the pricing, characteristics and quality of products and services. The adoption or modification of laws or regulations relating to commerce over the Internet could substantially impair the growth of our business or expose us to unanticipated liabilities. Moreover, the applicability of existing laws to the Internet and hosting and managed application service providers is uncertain. These existing laws could expose us to substantial liability if they are found to be applicable to our business. For example, we provide services over the Internet in many states in the United States and elsewhere and facilitate the activities of our customers in such jurisdictions. As a result, we may be required to qualify to do business, be subject to taxation or be subject to other laws and regulations in these jurisdictions, even if we do not have a physical presence, employees or property in those states.

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Risks Related to this Offering

The price of our common stock has been volatile, and may continue to experience wide fluctuations.

   Since January 2003, our common stock has closed as low as $1.02 per share and as high as $9.97 per share. The trading price of our common stock has been and may continue to be subject to wide fluctuations due to the risk factors discussed in this section and elsewhere in this prospectus. Fluctuations in the market price of our common stock may cause you to lose some or all of your investment. In addition, should the market price of our common stock be below $1.00 per share for an extended period, Nasdaq may delist our common stock, which would have an adverse effect on the trading of our common stock. On June 10, 2002, the listing of our common stock transferred from the Nasdaq National Market to the Nasdaq SmallCap Market because the market price of our common stock had failed to maintain compliance with the Nasdaq National Market’s minimum $1.00 per share continued listing requirement. We have applied for listing of our common stock on the American Stock Exchange to be effective upon completion of this offering. A delisting of our common stock from Nasdaq could materially reduce the liquidity of our common stock and result in a corresponding material reduction in the price of our common stock. In addition, any such delisting could harm our ability to raise capital through alternative financing sources on terms acceptable to us, or at all, and may result in the potential loss of confidence by suppliers, customers and employees.

A large number of shares may be sold in the market following this offering, which may depress the market price of our common stock.

   In recent years, our common stock has had limited trading activity. We cannot predict the extent to which investor interest in our stock will lead to the development of a more active trading market, how liquid that market might become or whether it will be sustained. As a result, sales of a substantial number of shares of our common stock in the public market following this offering, or the perception that such sales could occur, could cause the price of our common stock to decline. The number of shares of common stock available for sale in the public market is limited by restrictions under federal securities law and under lock-up agreements that the members of our Board of Directors, our executive officers and some of our stockholders have entered into with us or the underwriters. Those lock-up agreements restrict holders of approximately 23,496,859 shares of our common stock from selling, pledging or otherwise disposing of their shares for a period of 90 days after the date of this prospectus without the prior written consent of Thomas Weisel Partners LLC. However, Thomas Weisel Partners LLC may, in its sole discretion, release all or any portion of the common stock from the restrictions of the lock-up agreements at any time. Upon the expiration of the lock-up agreements, approximately 20,283,792 shares of our common stock previously covered by the lock-up agreements will be eligible for sale into the public market under Rule 144 of the Securities Act.

Anti-takeover provisions in our corporate documents may discourage or prevent a takeover.

   Provisions in our certificate of incorporation and our by-laws may have the effect of delaying or preventing an acquisition or merger in which we are acquired or a transaction that changes our Board of Directors. These provisions:

  •  authorize the board to issue preferred stock without stockholder approval;
 
  •  prohibit cumulative voting in the election of directors;
 
  •  limit the persons who may call special meetings of stockholders; and
 
  •  establish advance notice requirements for nominations for the election of directors or for proposing matters that can be acted on by stockholders at stockholder meetings.

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The value of your investment in our common stock will be immediately and substantially diluted because the price you will pay for your shares in the offering is much greater than the tangible book value per share of our common stock.

   As of April 30, 2004, we had a negative tangible book value per share of $0.20, which represents the amount of our total tangible assets less our total liabilities, divided by the number of shares of our common stock outstanding. As a result, if you pay $5.00 per share in this offering, your investment will be diluted by approximately $4.11 per share and therefore, valued at only approximately $0.89 per share. In the past, we have issued options and warrants to buy our common stock at prices below the offering price. You will experience further dilution to the extent that additional shares of our common stock are issued upon the exercise of outstanding stock options and warrants.

   Our net tangible book value as of April 30, 2004, on a pro forma basis giving effect to the Surebridge acquisition, was $(41,345,000), or $(1.49) per share of common stock. After giving effect to this offering, net tangible book value per share, on a pro forma basis giving effect to the Surebridge acquisition, as of April 30, 2004 would have been approximately $(0.23) per share, or approximately ($0.13) per share if the underwriters exercise their option to purchase additional shares of our common stock in full in this offering. The increase in net tangible book value per share to existing stockholders would be approximately $1.26 per share, or $1.36 per share if the underwriters exercise their option to purchase additional shares of our common stock in full, and the dilution to new investors purchasing shares in this offering would be approximately $5.23 per share, or approximately $5.13 per share if the underwriters exercise their option to purchase additional shares of our common stock in full.

FORWARD-LOOKING STATEMENTS

   Some of the statements under sections entitled “Prospectus Summary,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business” and elsewhere in this prospectus and those made from time to time by us through our senior management constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These statements relate to future events or our future financial performance and involve known and may involve unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by forward-looking statements including, but not limited to prospects for future market growth. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “could,” “expect,” “plan,” “anticipate,” “intend,” “believe,” “estimate,” “predict,” “potential,” “continue,” or the negative terms or other comparable terminology. In evaluating these statements, you should specifically consider various factors, including the risks outlined under “Risk Factors.”

   Although we believe that the expectations in the forward-looking statements contained in this prospectus are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. These forward-looking statements are based on our current expectations, and we disclaim any obligation to update these forward-looking statements for subsequent events or to explain why actual results differ unless otherwise required by law. You should not place undue reliance on these forward-looking statements.

USE OF PROCEEDS

   We expect to receive approximately $33.5 million from the sale of shares of common stock by us in this offering, or $36.8 million if the underwriters exercise their over-allotment option in full, based on the assumed offering price of $5.00 per share and after deducting the underwriting discounts and commissions and estimated offering expenses that we are to pay. We will not receive any of the proceeds from any sale of shares of common stock by the selling stockholders in this offering.

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   We intend to use our net proceeds from this offering for the following:

  •  approximately $3.3 million to repay the outstanding principal and accrued interest under our Loan and Security Agreement dated January 29, 2003 with Atlantic Investors, LLC, which bears interest at a rate of 8% per annum and is due and payable upon the earlier to occur of August 1, 2004 and five business days after our receipt of gross proceeds from a financing or a sale of assets of at least $13 million;
 
  •  approximately $16.7 million for the repayment of a portion of the outstanding principal under the promissory notes issued to Surebridge; and
 
  •  approximately $13.5 million for general corporate purposes, including working capital, and potential acquisitions of technologies, products and companies, although we have no current specific plans with respect to the $13.5 million.

   Borrowings under the Loan and Security Agreement with Atlantic Investors were used primarily to repay amounts due to Unicorn Worldwide Holdings Limited, for costs associated with our acquisition of Avasta and for working capital. We intend to seek acquisitions of businesses, products and technologies that are complementary to our business, and a portion of our net proceeds from this offering may also be used for such acquisitions. While we engage from time to time in discussions with respect to potential acquisitions, we have no current plans, commitments or agreements with respect to any such acquisitions, and there can be no assurances that any acquisitions will be made.

   The amounts and timing of our actual expenditures will depend on numerous factors, including the status of our product development efforts, sales and marketing activities, technological advances, and amount of cash generated or used by our operations. Our management will have considerable discretion in applying the net proceeds of this offering. Our net proceeds of this offering may be used for corporate purposes that do not enhance our results of operations or do not yield a favorable return. Pending the uses described above, we intend to invest our net proceeds in short-term, interest-bearing, investment-grade securities.

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PRICE RANGE OF COMMON STOCK

   Our common stock currently trades on the Nasdaq SmallCap Market under the symbol “NAVI.” Upon completion of this offering, we expect our common stock to be listed on the American Stock Exchange under the symbol “NVE.” For the period between October 22, 1999, the date of our initial public offering of our common stock, and June 7, 2002, our common stock was quoted on the Nasdaq National Market. On June 10, 2002, the listing of our common stock transferred from the Nasdaq National Market to the Nasdaq SmallCap Market because the market price of our common stock had failed to maintain compliance with the Nasdaq National Market’s minimum $1.00 per share continued listing requirement. The following table sets forth for the periods indicated below the high and low closing sale prices on the Nasdaq National Market and the Nasdaq SmallCap Market, as applicable. All share prices below have been adjusted to reflect the 1-for-15 reverse split of our common stock effected January 7, 2003.

                   
High Low


Year Ended July 31, 2002
               
 
First Quarter
  $ 12.30     $ 2.25  
 
Second Quarter
    9.15       3.90  
 
Third Quarter
    5.40       3.15  
 
Fourth Quarter
    3.90       1.80  
Year Ended July 31, 2003
               
 
First Quarter
    3.30       1.50  
 
Second Quarter
    4.35       1.78  
 
Third Quarter
    1.78       1.02  
 
Fourth Quarter
    3.60       1.26  
Year Ending July 31, 2004
               
 
First Quarter
    5.02       2.32  
 
Second Quarter
    9.97       4.30  
 
Third Quarter
    7.30       4.39  
 
Fourth Quarter (through June 28, 2004)
    5.28       3.83  

   On June 28, 2004, the last sale price for our common stock as reported by the Nasdaq SmallCap Market was $3.95 per share. As of June 17, 2004, we had 225 holders of record of our common stock.

DIVIDEND POLICY

   We have never declared or paid cash dividends on our common stock and do not anticipate declaring or paying any cash dividends on our common stock for the foreseeable future. We expect that we will retain all future earnings to fund the growth and development of our business. We are also restricted from paying any cash dividends on our common stock by the terms of our accounts receivable financing agreement with Silicon Valley Bank, as described in the “Liquidity and Capital Resources” section of the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section included later in this prospectus. Any future determination related to dividend policy will be made, subject to the restrictions of the financing agreement with Silicon Valley Bank, at the discretion of our Board of Directors.

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DILUTION

   Our net tangible book value as of April 30, 2004 was $(4,979,000), or $(0.20) per share of common stock. Net tangible book value per share represents the amount of our total tangible assets less our total liabilities, divided by the number of shares of common stock outstanding.

   After giving effect to the sale by us of 7,300,000 shares of common stock in this offering at an assumed offering price of $5.00 per share, and after deducting the underwriting discount and commissions and estimated offering expenses payable by us, our adjusted net tangible book value as of April 30, 2004 would have been approximately $28.5 million, or approximately $0.89 per share. This amount represents an immediate increase in net tangible book value of approximately $1.09 per share to our existing stockholders and an immediate dilution in net tangible book value of approximately $4.11 per share to new investors purchasing shares of common stock in this offering at the assumed offering price. We determine dilution by subtracting the adjusted net tangible book value per share after this offering from the amount of cash that a new investor paid for a share of common stock. The following table illustrates this dilution on a per share basis:

                   
Assumed offering price per share
          $ 5.00  
 
Net tangible book value per share as of April 30, 2004
  $ (0.20 )        
 
Increase per share attributable to new investors
    1.09          
     
         
Adjusted net tangible book value per share after this offering
            0.89  
             
 
Dilution in net tangible book value per share to new investors
          $ 4.11  
             
 

   If the underwriters exercise their option to purchase additional shares of our common stock in full in this offering, the net tangible book value per share after the offering would be approximately $0.97 per share, the increase in net tangible book value per share to existing stockholders would be approximately $1.17 per share and the dilution to new investors purchasing shares in this offering would be approximately $4.03 per share.

   Our net tangible book value as of April 30, 2004, on a pro forma basis giving effect to the Surebridge acquisition, was $(41,345,000), or $(1.49) per share of common stock. After giving effect to this offering, net tangible book value per share, on a pro forma basis giving effect to the Surebridge acquisition, as of April 30, 2004 would have been approximately $(0.23) per share, or approximately ($0.13) per share if the underwriters exercise their option to purchase additional shares of our common stock in full in this offering. The increase in net tangible book value per share to existing stockholders would be approximately $1.26 per share, or $1.36 per share if the underwriters exercise their option to purchase additional shares of our common stock in full, and the dilution to new investors purchasing shares in this offering would be approximately $5.23 per share, or approximately $5.13 per share if the underwriters exercise their option to purchase additional shares of our common stock in full.

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CAPITALIZATION

(In thousands)

   The following table sets forth our consolidated cash and cash equivalents and capitalization as of April 30, 2004:

  •  on an actual basis,
 
  •  on a pro forma basis to reflect the acquisition of substantially all of the assets and liabilities of Surebridge, and
 
  •  on a pro forma basis as adjusted to give effect to this offering and the application of the proceeds to us after deducting fees, commissions and other expenses that we will pay and the repayment of approximately $3.3 million of outstanding principal and accrued interest under our Loan and Security Agreement with Atlantic Investors, LLC and the repayment of approximately $16.7 million of outstanding principal under the promissory notes issued to Surebridge.

   You should read this table together with “Use of Proceeds,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our audited and unaudited consolidated financial statements and the related notes and the other financial information included elsewhere in this prospectus.

                                     
As of April 30, 2004

Pro Forma
Effect of As
Actual Pro Forma Offering Adjusted




(Unaudited)
Cash and cash equivalents
  $ 7,630     $ 9,355     $ 13,430     $ 22,785  
     
     
     
     
 
Accounts receivable financing line
  $ 15,786     $ 15,786     $     $ 15,786  
Current notes payable
    1,048       4,666             4,666  
Current note payable to Atlantic Investors
    3,000       3,000       (3,000 )      
Notes payable to Surebridge
          39,300       (16,730 )     22,570  
Note to the AppliedTheory Estate
    6,000       6,000             6,000  
Long-term note payable
    1,352       2,371             2,371  
     
     
     
     
 
   
Total debt
    27,186       71,123       (19,730 )     51,393  
     
     
     
     
 
Stockholders’ equity:
                               
 
Preferred stock, $0.01 par value; Authorized: 5,000 shares; Issued and outstanding: no shares at April 30, 2004 (actual, pro forma and pro forma as adjusted)
                       
 
Common stock, $0.01 par value; Authorized: 395,000 shares (actual, pro forma and pro forma as adjusted); Issued and outstanding: 24,829 (actual); 27,829 (pro forma) and 35,129 (pro forma as adjusted)
    249       279       73       352  
 
Deferred compensation
    (1,699 )     (1,699 )           (1,699 )
Accumulated other comprehensive income
    9       9             9  
Additional paid-in capital
    438,482       452,822       33,387       486,209  
Accumulated deficit
    (428,321 )     (428,321 )           (428,321 )
     
     
     
     
 
 
Total stockholders’ equity
    8,720       23,090       33,460       56,550  
     
     
     
     
 
   
Total capitalization
  $ 35,906     $ 94,213     $ 13,730     $ 107,943  
     
     
     
     
 

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UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL INFORMATION

   The following is the unaudited pro forma financial information included in this prospectus:

  •  Pro Forma Condensed Combined Balance Sheet as of April 30, 2004 (unaudited)
 
  •  Pro Forma Condensed Combined Statement of Operations for the three months ended April 30, 2004 (unaudited)
 
  •  Pro Forma Condensed Combined Statement of Operations for the nine months ended April 30, 2004 (unaudited)
 
  •  Pro Forma Condensed Combined Statement of Operations for the year ended July 31, 2003 (unaudited)

   The unaudited pro forma condensed combined balance sheet as of April 30, 2004 combines the unaudited condensed consolidated balance sheet of NaviSite as of April 30, 2004 with the condensed consolidated balance sheet of Surebridge as of March 31, 2004.

   The unaudited pro forma condensed combined statements of operations for the year ended July 31, 2003 (unaudited) combines the unaudited pro forma condensed consolidated statement of operations of NaviSite for the fiscal year ended July 31, 2003 with the unaudited condensed consolidated results of operations of Surebridge for the twelve months ended June 30, 2003. In addition, the unaudited pro forma condensed combined statements of operations for the three and nine months ended April 30, 2004 combine the unaudited condensed consolidated statement of operations of NaviSite for the three and nine months ended April 30, 2004 with the unaudited condensed consolidated statement of operations of Surebridge for the nine months ended March 31, 2004.

   The unaudited pro forma condensed combined statements of operations for the year ended July 31, 2003 also gives pro forma effect to NaviSite’s other recent acquisitions of ClearBlue Technologies, Inc., or CBT, Interliant, Inc., or Interliant, Conxion Corporation, or Conxion, and ClearBlue Technologies Management, Inc., or CBTM, as if they had occurred as of August 1, 2002.

   The following is a summary of the additional acquisitions noted above for which pro forma effect is given in the unaudited pro forma condensed combined statements of operations for the year ended July 31, 2003 for the portion of the fiscal year ended July 31, 2003 that each respective company was not owned by NaviSite:

  •  In August 2003, NaviSite acquired all of the outstanding shares of six wholly-owned subsidiaries of CBT with data centers in various U.S. locations and assumed the revenue and expense of four additional wholly-owned subsidiaries of CBT. Pursuant to the acquisition agreement, as amended, NaviSite had the right to acquire the four additional subsidiaries for no additional consideration at any time on or prior to August 8, 2005. In April 2004, NaviSite exercised its right to acquire the additional four subsidiaries and thereby acquired all of the outstanding shares of the additional four wholly-owned subsidiaries of CBT. This transaction was accounted for as a combination of entities under common control, similar to a pooling-of-interests, whereby the assets and liabilities of the ten wholly-owned subsidiaries of CBT (as described above) and NaviSite were combined at their historical amounts as of the date CBT had control of both entities (September 11, 2002). CBT’s results of operations and cash flows for the eleven months ended July 31, 2003 are included in NaviSite’s consolidated statements of operations and consolidated statements of cash flows for the year ended July 31, 2003. The subsidiaries of CBT that NaviSite acquired are now operated as wholly-owned subsidiaries of NaviSite.
 
  •  In May 2003, NaviSite acquired assets of Interliant related to managed messaging, application hosting and application development services. Interliant’s results of operations and cash flows for the two-and-one-half months ended July 31, 2003 are included in NaviSite’s consolidated statement of operations and consolidated statement of cash flows for the year ended July 31, 2003. The Interliant business is now operated as a wholly-owned subsidiary of NaviSite.

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  •  In April 2003, NaviSite acquired Conxion, a provider of application hosting, content and electronic software distribution and security services. Conxion’s results of operations and cash flows for the four months ended July 31, 2003 are included in NaviSite’s consolidated statement of operations and consolidated statement of cash flows for the year ended July 31, 2003. Conxion is operated as a wholly- owned subsidiary of NaviSite.
 
  •  In December 2002, NaviSite acquired all of the issued and outstanding stock of CBTM, a wholly-owned subsidiary of CBT, NaviSite’s then parent company which previously had acquired assets from the bankrupt estate AppliedTheory Corporation related to application management and application hosting services. As CBT had a controlling interest in both companies at the time of the combination, the transaction was accounted for as a combination of entities under common control, similar to a pooling-of-interests, whereby the assets and liabilities of CBTM and NaviSite were combined at their historical amounts as of the date CBT had control of both entities (September 11, 2002). CBTM’s results of operations and cash flows for the eleven months ended July 31, 2003 are included in NaviSite’s consolidated statements of operations and consolidated statements of cash flows for the year ended July 31, 2003. CBTM is operated as a wholly-owned subsidiary of NaviSite.

   The unaudited pro forma financial information is not necessarily indicative of the results of operations or financial position of NaviSite had the transactions assumed therein occurred, nor are they necessarily indicative of the results of operations or financial position, which may be expected to occur in the future. Furthermore, the unaudited pro forma financial information is based on assumptions that NaviSite believes are reasonable and should be read in conjunction with NaviSite’s Form 10-K for the fiscal year ended July 31, 2003 and Forms 10-Q for the fiscal quarters ended October 31, 2003, January 31, 2004 and April 30, 2004 previously filed.

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NAVISITE, INC. AND SUBSIDIARIES

PRO FORMA CONDENSED COMBINED BALANCE SHEET

(Unaudited)
(In thousands)
                                     
Consolidated Pro Forma Pro Forma
NaviSite Surebridge Adjustments Total
April 30, 2004 March 31, 2004 April 30, 2004 April 30, 2004




ASSETS
Current assets:
                               
 
Cash and cash equivalents
  $ 7,630     $ 1,725     $     $ 9,355  
 
Accounts receivable, net
    13,583       4,564             18,147  
 
Due from related party
    12       43             55  
 
Prepaid expenses and other current assets
    4,224       1,461             5,685  
     
     
     
     
 
   
Total current assets
    25,449       7,793             33,242  
Property and equipment, net
    15,388       7,782             23,170  
Intangible assets, net
    10,279       4,319             14,598  
Goodwill
    3,206       6,327       40,090 (a)     49,623  
Other assets
    5,913       162             6,075  
Restricted cash
    1,253       475             1,728  
     
     
     
     
 
   
Total assets
  $ 61,488     $ 26,858     $ 40,090     $ 128,436  
     
     
     
     
 
LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK
AND STOCKHOLDERS’ EQUITY (DEFICIT)
Current liabilities:
                               
 
Accounts receivable financing line
  $ 15,786     $     $     $ 15,786  
 
Current notes payable
    1,048       3,618             4,666  
 
Capital lease obligations, current portion
    2,418       139             2,557  
 
Current note payable to related party
    3,000                   3,000  
 
Accounts payable
    3,856       4,778             8,634  
 
Accrued expenses
    13,628       1,943       500 (b)     16,071  
 
Deferred revenue
    2,196       936             3,132  
 
Customer deposits
    135       250             385  
     
     
     
     
 
   
Total current liabilities
    42,067       11,664       500       54,231  
Capital lease obligations, less current portion
    830       24             854  
Accrued impairment, less current portion
    1,782                   1,782  
Note to AppliedTheory Estate
    6,000                   6,000  
Notes payable
    1,352       1,019       39,300 (b)     41,671  
Other long-term liabilities
    737       71             808  
     
     
     
     
 
   
Total liabilities
    52,768       12,778       39,800       105,346  
     
     
     
     
 
Redeemable convertible preferred stock
          62,144       (62,144 )(b)      
Stockholders’ equity (deficit):
                               
 
Treasury stock
          (465 )     465 (b)      
 
Common stock
    249       109       (79 )(b)     279  
 
Deferred compensation
    (1,699 )                 (1,699 )
 
Accumulated other comprehensive income
    9                   9  
 
Additional paid-in capital
    438,482       9,487       4,853 (b)     452,822  
 
Accumulated deficit
    (428,321 )     (57,195 )     57,195 (b)     (428,321 )
     
     
     
     
 
   
Total stockholders’ equity (deficit)
    8,720       (48,064 )     62,434       23,090  
     
     
     
     
 
   
Total liabilities, redeemable convertible preferred stock and stockholders’ equity (deficit)
  $ 61,488     $ 26,858     $ 40,090     $ 128,436  
     
     
     
     
 

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NAVISITE, INC. AND SUBSIDIARIES

PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS

(Unaudited)
(In thousands, except per share data)
                                     
Consolidated
NaviSite Surebridge Pro Forma
Three Months Ended Three Months Ended Pro Forma Three Months Ended
April 30, 2004 March 31, 2004 Adjustments April 30, 2004




Total revenue
  $ 20,185     $ 11,940     $     $ 32,125  
     
     
     
     
 
 
Cost of revenue:
                               
 
Cost of revenue
    14,217       7,777             21,994  
 
Impairment, restructuring and other
                       
     
     
     
     
 
   
Total cost of revenue
    14,217       7,777             21,994  
     
     
     
     
 
   
Gross profit
    5,968       4,163             10,131  
     
     
     
     
 
 
Operating expenses:
                               
 
Product development
    230                   230  
 
Selling and marketing
    1,848       1,961             3,809  
 
General and administrative
    6,097       2,534             8,631  
 
Impairment, restructuring and other
    206                   206  
     
     
     
     
 
   
Total operating expenses
    8,381       4,495             12,876  
     
     
     
     
 
   
Loss from operations
    (2,413 )     (332 )           (2,745 )
 
Other income (expense):
                               
 
Interest income
    18       2             20  
 
Interest expense
    (656 )     (89 )     (983 )(a)     (1,728 )
 
Other income (expense), net
    25                   25  
     
     
     
     
 
   
Net loss
  $ (3,026 )   $ (419 )   $ (983 )   $ (4,428 )
     
     
     
     
 
Basic and diluted net loss per share
  $ (0.12 )                   $ (0.16 )
     
                     
 
Weighted average basic and diluted shares used in computing net loss per share
    24,809               3,000 (b)     27,809  
     
             
     
 

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NAVISITE, INC. AND SUBSIDIARIES

PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS

(Unaudited)
(In thousands, except per share data)
                                     
Consolidated
NaviSite Surebridge Pro Forma
Nine Months Ended Nine Months Ended Pro Forma Nine Months Ended
April 30, 2004 March 31, 2004 Adjustments April 30, 2004




Total revenue
  $ 65,987     $ 33,079     $     $ 99,066  
     
     
     
     
 
Cost of revenue:
                               
 
Cost of revenue
    48,899       22,925             71,824  
 
Impairment, restructuring and other
    633                   633  
     
     
     
     
 
   
Total cost of revenue
    49,532       22,925             72,457  
     
     
     
     
 
   
Gross profit
    16,455       10,154             26,609  
     
     
     
     
 
Operating expenses:
                               
 
Product development
    890                   890  
 
Selling and marketing
    5,724       6,533             12,257  
 
General and administrative
    16,342       8,633             24,975  
 
Impairment, restructuring and other
    1,608                   1,608  
     
     
     
     
 
   
Total operating expenses
    24,564       15,166             39,730  
     
     
     
     
 
   
Loss from operations
    (8,109 )     (5,012 )           (13,121 )
Other income (expense):
                               
 
Interest income
    115       10             125  
 
Interest expense
    (1,935 )     (250 )     (2,948 )(c)     (5,133 )
 
Other income (expense), net
    111                   111  
     
     
     
     
 
   
Net loss
  $ (9,818 )   $ (5,252 )   $ (2,948 )   $ (18,018 )
     
     
     
     
 
Basic and diluted net loss per share
  $ (0.40 )                   $ (0.65 )
     
                     
 
Weighted average basic and diluted shares used in computing net loss per share
    24,685               3,000 (b)     27,685  
     
             
     
 

29


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NAVISITE, INC. AND SUBSIDIARIES

PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS

(Unaudited)
(In thousands, except per share data)
                                                                     
Consolidated
NaviSite Surebridge Pro Forma
Twelve Months Twelve Months CBT CBTM Conxion Interliant Year Ended
Ended Ended 8/1/02 - 8/1/02 - 8/1/02 - 8/1/02 - Pro Forma July 31,
July 31, 2003 June 30, 2003 8/31/02 8/31/02 3/31/03 5/15/03 Adjustments 2003








Total revenue
  $ 76,591     $ 34,343     $ 1,437     $ 2,536     $ 12,241     $ 20,654     $     $ 147,802  
Total cost of revenue
    70,781       22,386       1,263       1,850       19,057       11,517             126,854  
     
     
     
     
     
     
     
     
 
   
Gross profit (deficit)
    5,810       11,957       174       686       (6,816 )     9,137             20,948  
     
     
     
     
     
     
     
     
 
Operating expenses:
                                                               
 
Product development
    950                               958             1,908  
 
Selling and marketing
    5,960       6,702       9       157       4,104       1,853             18,785  
 
General and administrative
    20,207       9,728       237       500       1,590       16,479             48,741  
 
Impairment, restructuring and other
    8,882                         (4,135 )                 4,747  
     
     
     
     
     
     
     
     
 
   
Total operating expenses
    35,999       16,430       246       657       1,559       19,290             74,181  
     
     
     
     
     
     
     
     
 
   
(Loss) income from operations
    (30,189 )     (4,473 )     (72 )     29       (8,375 )     (10,153 )           (53,233 )
Other income (expense):
                                                               
 
Interest income
    851       102                   99       32             1,084  
 
Interest expense
    (43,403 )     (299 )           (140 )           (3,284 )     (3,930 )(c)     (51,056 )
 
Other income (expense), net
    (733 )     (111 )           (21 )     (209 )     6,149             5,075  
     
     
     
     
     
     
     
     
 
Loss before income tax expense
    (73,474 )     (4,781 )     (72 )     (132 )     (8,485 )     (7,256 )     (3,930 )     (98,130 )
Income tax expense
    (153 )     (237 )                                   (390 )
     
     
     
     
     
     
     
     
 
Net loss
  $ (73,627 )   $ (5,018 )   $ (72 )   $ (132 )   $ (8,485 )   $ (7,256 )   $ (3,930 )   $ (98,520 )
     
     
     
     
     
     
     
     
 
Basic and diluted net loss per share
  $ (6.32 )                                                   $ (6.72 )
     
                                                     
 
Weighted average basic and diluted shares used in computing net loss per share
    11,654                                               3,000 (b)     14,654  
     
                                             
     
 

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NAVISITE, INC. AND SUBSIDIARIES

NOTES TO THE PRO FORMA CONDENSED COMBINED FINANCIAL INFORMATION

(Unaudited)

Pro Forma Adjustments and Assumptions

 
     (a) Purchase Price Allocation

   The following represents the preliminary allocation of the estimated purchase price for NaviSite’s acquisition of Surebridge over the historical net book values of the acquired assets and assumed liabilities of Surebridge as of the date of the pro forma balance sheet, and is for illustrative purposes only. Assuming the transaction occurred on April 30, 2004, the estimated purchase price allocation for the acquisition of Surebridge would have been as follows (in thousands):

         
Working capital, including cash acquired
  $ (3,871 )
Property & equipment, net
    7,782  
Other non-current assets
    4,956  
Long-term debt
    (1,019 )
Non-current liabilities
    (95 )
Goodwill
    46,417  
     
 
Purchase price
  $ 54,170  
     
 

   The goodwill adjustment in the pro forma condensed combined balance sheet was determined as follows (in thousands):

         
Elimination of pre-existing Surebridge goodwill
  $ (6,327 )
Goodwill resulting from the acquisition (see above)
    46,417  
     
 
Goodwill adjustment
  $ 40,090  
     
 

   The purchase price allocation for the acquisition of Surebridge is preliminary and is subject to adjustment upon finalization of the purchase accounting as of the date of consummation of the acquisition. In addition, NaviSite has not completed its valuation of intangible assets to be acquired. As a result, the final allocation of the excess of the purchase price over the book value of the net assets acquired could differ materially. Upon completion of its valuation of the intangible assets to be acquired, certain identifiable intangible assets may be recorded and would be subject to amortization. Assuming a five-year life, every $1.0 million of identifiable intangible assets recorded would result in approximately $200,000 of annual amortization expense in the pro forma statements of operations.

 
     (b) Components of the Estimated Purchase Consideration

   The pro forma financial information reflects NaviSite’s acquisition of substantially all the assets and liabilities of Surebridge for consideration valued at approximately $54.2 million. The pro forma adjustments reconcile the historical balance sheet of NaviSite to the allocated purchase price above and include the purchase consideration. The description of the components of the estimated purchase price consideration is as follows (in thousands):

         
Two promissory notes payable
  $ 39,300  
Fair value of 3 million shares of NaviSite common stock
    14,370  
Estimated direct acquisition costs
    500  
     
 
Total estimated purchase price
  $ 54,170  
     
 

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NAVISITE, INC. AND SUBSIDIARIES

NOTES TO THE PRO FORMA CONDENSED COMBINED

FINANCIAL INFORMATION — (Continued)

   The fair value of the shares of NaviSite common stock noted in the table above was determined as follows (in thousands, except per share value):

         
Issuance of 3 million shares
    3,000  
Per share price of NaviSite common stock at closing
  $ 4.79  
     
 
Fair value of the common stock issued
  $ 14,370  
     
 

   The equity components of the common stock issued which is noted in the table above are as follows (in thousands):

         
Common stock (assumes $.01 par value)
  $ 30  
Additional paid-in capital
    14,340  
     
 
Fair value of the common stock issued
  $ 14,370  
     
 

   For pro forma purposes, all equity accounts of Surebridge were eliminated. The adjustments to both common stock and additional paid-in capital in the pro forma condensed combined balance sheet were determined as follows (in thousands):

         
Elimination of pre-existing Surebridge common stock
  $ (109 )
Common stock (at par value) resulting from Navisite shares issued
    30  
     
 
Common stock adjustment
  $ (79 )
     
 
Elimination of pre-existing Surebridge additional paid-in capital
  $ (9,487 )
Additional paid-capital resulting from NaviSite shares issued
    14,340  
     
 
Additional paid-in capital adjustment
  $ 4,853  
     
 
 
     (c) Interest Expense on the Promissory Notes

   Interest expense on the two promissory notes payable is calculated at 10% annually. The pro forma statements of operations assume interest will be paid in full. However, the promissory notes provide that no interest shall accrue or be payable on any principal paid within nine months. The interest expense recorded in the pro forma condensed combined statements of operations was calculated as follows (in thousands):

                         
Three Months Nine Months Year
Ended Ended Ended
April 30, April 30, July 31,
2004 2004 2003



Promissory notes principal
  $ 39,300     $ 39,300     $ 39,300  
Interest rate
    10 %     10 %     10 %
Interest expense recorded
  $ 983     $ 2,948     $ 3,930  

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Table of Contents

SELECTED CONSOLIDATED FINANCIAL DATA

(In thousands, except per share data)

   The following table provides selected consolidated financial data for the five years ended July 31, 2003 and the three and nine months ended April 30, 2004 and 2003 and for the three and nine months ended April 30, 2004 on a pro forma basis giving effect to the Surebridge acquisition. The statements of operations data for each of the three years ended July 31, 2003 and the balance sheet data as of July 31, 2003 and 2002 are derived from our audited consolidated financial statements, which are included elsewhere in this prospectus. The statements of operations data for each of the years ended July 31, 2000 and 1999 and the balance sheet data as of July 31, 2001, 2000 and 1999 shown below are derived from our audited consolidated financial statements, which are not included in this prospectus. The statements of operations data shown below for the three and nine months ended April 30, 2004 and 2003 and the balance sheet data as of April 30, 2004 are derived from our unaudited financial statements included elsewhere in this prospectus and, in the opinion of our management, include all adjustments, consisting principally of normal recurring adjustments, necessary for a fair presentation of such information when read in conjunction with our audited financial statements. In addition, the unaudited pro forma condensed combined statements of operations for the three and nine months ended April 30, 2004 combine the unaudited condensed consolidated statement of operations of NaviSite for the three and nine months ended April 30, 2004 with the unaudited condensed consolidated statement of operations of Surebridge for the three and nine months ended March 31, 2004. Our historical results are not necessarily indicative of the results of operations for future periods, and the results of operations for the three and nine months ended April 30, 2004 are not necessarily indicative of the results to be expected for the full year ending July 31, 2004. The following data is qualified in its entirety by and should be read together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes appearing elsewhere in this prospectus.

   On August 8, 2003, we completed the acquisition of certain assets and the assumption of certain liabilities of CBT in a business combination accounted for in a manner similar to a pooling-of-interest due to common control ownership. Accordingly, our consolidated financial statements have been restated for all periods prior to the business combination to include CBT’s financial results beginning on September 11, 2002, the date on which CBT acquired the controlling interest in us, after the elimination of intercompany balances.

Consolidated Statements of Operations Data:

                                                                                           
Pro Forma(2) Pro Forma(2)
Three Months Nine Months Three Months Nine Months
Ended Ended Ended Ended
Year Ended July 31, April 30, April 30, April 30, April 30,





2003 2002 2001 2000 1999 2004 2003 2004 2003 2004 2004











(Unaudited)
(Unaudited) (Unaudited) (Unaudited)
Revenue
  $ 75,281     $ 40,968     $ 66,358     $ 24,870     $ 3,461     $ 20,173     $ 19,620     $ 65,975     $ 52,942     $ 31,886     $ 98,285  
Revenue, related parties
    1,310       18,453       36,368       24,893       7,058       12             12       1,310       239       781  
     
     
     
     
     
     
     
     
     
     
     
 
Total revenue
    76,591       59,421       102,726       49,763       10,519       20,185       19,620       65,987       54,252       32,125       99,066  
     
     
     
     
     
     
     
     
     
     
     
 
Cost of revenue
    70,781       67,000       127,155       68,496       20,338       14,217       17,312       48,899       50,821       21,994       71,824  
Impairment, restructuring and other
          68,317       1,930                               633                   633  
     
     
     
     
     
     
     
     
     
     
     
 
Total cost of revenue
    70,781       135,317       129,085       68,496       20,338       14,217       17,312       49,532       50,821       21,994       72,457  
     
     
     
     
     
     
     
     
     
     
     
 
Gross profit (deficit)
    5,810       (75,896 )     (26,359 )     (18,733 )     (9,819 )     5,968       2,308       16,455       3,431       10,131       26,609  
     
     
     
     
     
     
     
     
     
     
     
 
Operating expenses:
                                                                                       
 
Product development
    950       5,281       14,072       5,197       2,620       230       121       890       624       230       890  
 
Selling and marketing
    5,960       9,703       32,251       22,805       6,888       1,848       1,429       5,724       3,759       3,809       12,257  
 
General and administrative
    20,207       19,272       33,011       12,270       4,823       6,097       5,023       16,342       13,718       8,631       24,975  
 
Impairment, restructuring and other
    8,882       (2,633 )     8,011                   206       3,819       1,608       6,274       206       1,608  
     
     
     
     
     
     
     
     
     
     
     
 
Total operating expenses
    35,999       31,623       87,345       40,272       14,331       8,381       10,392       24,564       24,375       12,876       39,730  
     
     
     
     
     
     
     
     
     
     
     
 

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Pro Forma(2) Pro Forma(2)
Three Months Nine Months Three Months Nine Months
Ended Ended Ended Ended
Year Ended July 31, April 30, April 30, April 30, April 30,





2003 2002 2001 2000 1999 2004 2003 2004 2003 2004 2004











(Unaudited)
(Unaudited) (Unaudited) (Unaudited)
Loss from operations
    (30,189 )     (107,519 )     (113,704 )     (59,005 )     (24,150 )     (2,413 )     (8,084 )     (8,109 )     (20,944 )     (2,745 )     (13,121 )
Other income (expense):
                                                                                       
Interest income
    851       1,060       2,753       2,027       4       18       169       115       685       20       125  
Interest expense
    (43,403 )     (14,718 )     (8,042 )     (1,001 )     (347 )     (656 )     (2,470 )     (1,935 )     (20,170 )     (1,728 )     (5,133 )
Other income (expense), net
    (733 )     (516 )     292       9       (39 )     25       (919 )     111       (1,111 )     25       111  
     
     
     
     
     
     
     
     
     
     
     
 
Loss before cumulative effect of change in accounting principle and income tax expense
    (73,474 )     (121,693 )     (118,701 )     (57,970 )     (24,532 )     (3,026 )     (11,304 )     (9,818 )     (41,540 )     (4,428 )     (18,018 )
Income tax expense
    (153 )                                                            
     
     
     
     
     
     
     
     
     
     
     
 
Loss before cumulative effect of change in accounting principle
    (73,627 )     (121,693 )     (118,701 )     (57,970 )     (24,532 )     (3,026 )     (11,304 )     (9,818 )     (41,540 )     (4,428 )     (18,018 )
Cumulative effect of change in accounting principle
                (4,295 )                                                
     
     
     
     
     
     
     
     
     
     
     
 
Net loss
    (73,627 )     (121,693 )     (122,996 )     (57,970 )     (24,532 )     (3,026 )     (11,304 )     (9,818 )     (41,540 )     (4,428 )     (18,018 )
Accretion of dividends on Series C and D convertible redeemable preferred stock
                            (172 )                                    
     
     
     
     
     
     
     
     
     
     
     
 
Net loss applicable to common shareholders
  $ (73,627 )   $ (121,693 )   $ (122,996 )   $ (57,970 )   $ (24,704 )   $ (3,026 )   $ (11,304 )   $ (9,818 )   $ (41,540 )   $ (4,428 )   $ (18,018 )
     
     
     
     
     
     
     
     
     
     
     
 
Basic and diluted net loss per common share:
                                                                                       
Before cumulative effect of change in accounting principle
  $ (6.32 )   $ (22.30 )   $ (30.18 )   $ (20.57 )   $ (55.64 )   $ (0.12 )   $ (0.88 )   $ (0.40 )   $ (4.33 )   $ (0.16 )   $ (0.65 )
Cumulative effect of change in accounting principle
                (1.09 )                                                
     
     
     
     
     
     
     
     
     
     
     
 
Basic and diluted net loss per common share(1)
  $ (6.32 )   $ (22.30 )   $ (31.27 )   $ (20.57 )   $ (55.64 )   $ (0.12 )   $ (0.88 )   $ (0.40 )   $ (4.33 )   $ (0.16 )   $ (0.65 )
     
     
     
     
     
     
     
     
     
     
     
 
Basic and diluted weighted average number of common shares outstanding
    11,654       5,457       3,933       2,818       444       24,809       12,845       24,685       9,587       27,809       27,685  
     
     
     
     
     
     
     
     
     
     
     
 

Consolidated Balance Sheet Data:

                                                         
Pro Forma(3)
As of July 31, As of As of

April 30, April 30,
2003 2002 2001 2000 1999 2004 2004







(Unaudited) (Unaudited)
Cash and cash equivalents
  $ 3,862     $ 21,842     $ 22,214     $ 77,947     $ 3,352     $ 7,630     $ 9,355  
Working capital (deficit)
    (16,301 )     16,516       (9,683 )     48,159       (1,355 )     (16,618 )     (20,989 )
Total assets
    69,371       53,534       112,266       175,461       21,111       61,488       128,436  
Long-term obligations
    13,577       28,073       69,852       24,988       1,935       10,701       51,115  
Stockholders’ equity (deficit)
    16,879       8,544       (6,962 )     97,474       (4,369 )     8,720       23,090  


(1)  As discussed in the notes to our consolidated financial statements, in January 2003 we completed a 1-for-15 reverse stock split of our outstanding shares of common stock. All historical share and per share data have been adjusted for the reverse stock split.
 
(2)  The pro forma consolidated statement of operations data combines the unaudited condensed consolidated statement of operations of NaviSite for the three and nine months ended April 30, 2004 with the unaudited condensed consolidated statement of operations of Surebridge for the three and nine months ended March 31, 2004.
 
(3)  The pro forma consolidated balance sheet combines the unaudited condensed consolidated balance sheet of NaviSite as of April 30, 2004 with the unaudited condensed consolidated balance sheet of Surebridge as of March 31, 2004.

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

   The following discussion and analysis of our financial condition and results of operations should be read together with “Selected Consolidated Financial Data” and our consolidated financial statements and related notes included in this prospectus. This discussion and analysis contains forward-looking statements that involve risks and uncertainties. Words such as “may,” “will,” “should,” “could,” “expect,” “plan,” “anticipate,” “intend,” “believe,” “estimate,” “predict,” “potential,” “continue,” or similar words are intended to identify forward-looking statements, although not all forward-looking statements contain these words. Although we believe that our opinions and expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements, and our actual results may differ substantially from the views and expectations set forth below. We expressly disclaim any intent or obligation to update any forward-looking statements after the date hereof to conform such statements to actual results or to changes in our opinions or expectations.

   Readers are urged to carefully review and consider the various disclosures made by us which attempt to advise interested parties of the factors which affect our business including, but not limited to, those discussed in “Risk Factors,” “Forward-Looking Statements” and elsewhere in this prospectus.

Overview

   We provide our services to customers typically pursuant to agreements with a term of one to three years and monthly payment installments. As a result, these agreements provide us with a base of recurring revenue. Our revenue increases by adding new customers or additional services to existing customers. Our overall base of recurring revenue is affected by renewals or terminations of agreements with existing customers.

   A large portion of the costs to operate our data centers, such as rent, product development and general and administrative expenses, does not depend strictly on the number of customers or the amount of services we provide. As we add new customers or new services to existing customers, we generally incur limited additional expenses relating to telecommunications, utilities, hardware and software costs, and payroll expenses. We have substantial capacity to add customers to our data centers. Our relatively fixed cost base, sufficient capacity for expansion and limited incremental variable costs provide us with the opportunity to grow profitably. However, these same fixed costs present us with the risk that we may incur losses if we are unable to generate sufficient revenue.

   In recent years, we have grown through acquisitions of new businesses and have restructured our historical operations. Specifically, in December 2002, we acquired ClearBlue Technologies Management, Inc. (a wholly-owned subsidiary of our majority stockholder at the time of the acquisition), adding application management and development capabilities to our Managed Application Services; in February 2003, we acquired Avasta, adding capabilities to our Managed Application Services; in April 2003, we acquired Conxion, providing key services to our Managed Application Services and Managed Infrastructure Services; in May 2003, we acquired assets of Interliant, forming the core of our Managed Messaging Services; and in August 2003, we acquired assets of CBT (which was our majority stockholder at that time) related to colocation, bandwidth, security and disaster recovery services, enhancing our Managed Infrastructure Services. In June 2004, we acquired assets of Surebridge adding significant capabilities to our Managed Application and Professional Services. Prior to September 2002, substantially all of our services were managed application services, and we have added managed infrastructure and managed messaging services since that time. This transformation in our business will result in our recent results being more relevant to an understanding of our business than our historical results. We also expect to make additional acquisitions to take advantage of our available capacity, which will have significant effects on our financial results in the future.

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   Our acquisitions of CBTM and assets of CBT were accounted for in a manner similar to a pooling-of-interest due to common control ownership. The assets and the liabilities of CBT, CBTM and NaviSite were combined at their historical amounts beginning on September 11, 2002, the date on which CBT obtained a majority ownership of NaviSite. Our acquisitions of Avasta and Conxion and selected assets of Interliant were accounted for using the purchase method of accounting and as such, the results of operations and cash flows relating to these acquisitions were included in our Consolidated Statements of Operations and Consolidated Statements of Cash Flows for the fiscal year ended July 31, 2003 from their respective dates of acquisition of February 5, 2003, April 2, 2003 and May 16, 2003. The selected assets of Surebridge will be accounted for using the purchase method of accounting and are not yet included in our financial statements.

   In August 2003, we acquired assets of CBT related to colocation, bandwidth, security and disaster recovery services. Specifically, we acquired all of the outstanding shares of six wholly-owned subsidiaries of CBT with data centers in various U.S. locations and assumed the revenue and expense of four additional wholly-owned subsidiaries of CBT with data centers located in Dallas, Texas; New York, New York; San Francisco, California; and Santa Clara, California. Pursuant to the acquisition agreement, as amended, we had the right to acquire the four additional subsidiaries for no additional consideration at any time on or prior to August 8, 2005. In April 2004, we exercised our right to acquire the additional four subsidiaries and thereby acquired all of the outstanding shares of the additional four wholly-owned subsidiaries of CBT. In March 2004, we had initially rejected the Santa Clara data center subsidiary, pursuant to our right under the acquisition agreement; however, on April 12, 2004, prior to the expiration of the thirty-day notification period, we revoked this rejection. We will continue to consolidate, as part of our consolidated financial statements, the results of each of these four subsidiaries.

   The audit report on our fiscal year 2003 consolidated financial statements from KPMG LLP, our independent auditors, contains KPMG’s opinion that our recurring losses from operations since inception and accumulated deficit, as well as other factors, raise substantial doubt about our ability to continue as a going concern. During fiscal year 2003 and thereafter, we have undergone a significant transition, including all of the acquisitions that are described in this prospectus and a balance sheet restructuring. Included in this transition was a complete turnover of our senior management team and our Board of Directors. While we cannot assure you that we will continue as a going concern, we believe that we have developed and are implementing an operational plan that aligns our cost structure with our projected revenue growth.

Results of Operations

   The following table sets forth the percentage relationships of certain items from our Consolidated Statements of Operations as a percentage of total revenue.

                                                         
Three Months Nine Months
Year Ended July 31, Ended April 30, Ended April 30,



2003 2002 2001 2004 2003 2004 2003







(Unaudited) (Unaudited)
Revenue
    98.3 %     68.9 %     64.6 %     99.9 %     100.0 %     100.0 %     97.6 %
Revenue, related parties
    1.7       31.1       35.4       0.1       0.0       0.0       2.4  
     
     
     
     
     
     
     
 
Total revenue
    100.0       100.0       100.0       100.0       100.0       100.0       100.0  
     
     
     
     
     
     
     
 
Cost of revenue
    92.4       112.8       123.8       70.4       88.2       74.1       93.7  
Impairment, restructuring and other
    0.0       115.0       1.9       0.0       0.0       1.0       0.0  
     
     
     
     
     
     
     
 
Total cost of revenue
    92.4       227.8       125.7       70.4       88.2       75.1       93.7  
     
     
     
     
     
     
     
 
Gross profit (deficit)
    7.6       (127.8 )     (25.7 )     29.6       11.8       24.9       6.3  
     
     
     
     
     
     
     
 

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Three Months Nine Months
Year Ended July 31, Ended April 30, Ended April 30,



2003 2002 2001 2004 2003 2004 2003







(Unaudited) (Unaudited)
Operating expenses:
                                                       
 
Product development
    1.2       8.9       13.7       1.1       0.6       1.3       1.2  
 
Selling and marketing
    7.8       16.3       31.4       9.2       7.3       8.7       6.9  
 
General and administrative
    26.4       32.4       32.1       30.2       25.6       24.8       25.3  
 
Impairment, restructuring and other
    11.6       (4.4 )     7.8       1.0       19.5       2.4       11.6  
     
     
     
     
     
     
     
 
   
Total operating expenses
    47.0       53.2       85.0       41.5       53.0       37.2       45.0  
     
     
     
     
     
     
     
 
Loss from operations
    (39.4 )     (181.0 )     (110.7 )     (11.9 )     (41.2 )     (12.3 )     (38.7 )
Other income (expense):
                                                       
 
Interest income
    1.1       1.8       2.7       0.1       0.9       0.2       1.3  
 
Interest expense
    (56.7 )     (24.8 )     (7.8 )     (3.3 )     (12.6 )     (3.0 )     (37.2 )
 
Other income (expense), net
    (1.0 )     (0.9 )     0.3       0.1       4.7       0.2       (2.0 )
     
     
     
     
     
     
     
 
Loss before cumulative effect of change in accounting principle and income tax expense
    (96.0 )     (204.9 )     (115.5 )     (15.0 )     (57.6 )     (14.9 )     (76.6 )
Income tax expense
    (0.2 )     0.0       0.0       0.0       0.0       0.0       0.0  
     
     
     
     
     
     
     
 
Loss before cumulative effect of change in accounting principle
    (96.2 )     (204.9 )     (115.5 )     (15.0 )     (57.6 )     (14.9 )     (76.6 )
Cumulative effect of change in accounting principle
    0.0       0.0       (4.2 )     0.0       0.0       0.0       0.0  
     
     
     
     
     
     
     
 
Net loss
    (96.2 )%     (204.9 )%     (119.7 )%     (15.0 )%     (57.6 )%     (14.9 )%     (76.6 )%
     
     
     
     
     
     
     
 

Comparison of Three and Nine Months Ended April 30, 2004 and 2003

Revenue

   We derive our revenue primarily from outsourced managed hosting, co-location and application services comprised of a variety of service offerings, including providing related professional and consulting services, to mid-sized enterprises, divisions of large multi-national companies and government agencies. Revenue for the nine-month period ended April 30, 2003 contains eight months of revenue from CBTM and CBT.

   Total revenue for the three-month period ended April 30, 2004 increased 3% to approximately $20.2 million from approximately $19.6 million for the same period in fiscal year 2003. The overall growth in revenue of $0.6 million was mainly due to revenue resulting from our fiscal 2003 acquisitions, which contributed approximately $6.4 million in revenue during the quarter ended April 30, 2004. The increased revenue was partially offset by net lost customer revenue of $5.8 million.

   Total revenue for the nine-month period ended April 30, 2004 increased 22% to approximately $66 million from approximately $54.3 million for the same period in fiscal year 2003. The overall growth in revenue of $11.7 million was mainly due to revenue resulting from our fiscal 2003 acquisitions, which contributed approximately $27.6 million in revenue during the nine-month period ended April 30, 2004. The increased revenue was partially offset by net lost customer revenue of $15.9 million. Revenue from related parties principally consisted of sales of services to CMGI and its affiliates until September 11, 2002 when CMGI sold its equity and debt interests in NaviSite to CBT. The decrease of $1.3 million in related party revenue was primarily attributable to CMGI and its affiliates terminating their relationships with NaviSite upon the completion of their contracts although CMGI remains a third-party customer. We expect our total revenue for fiscal year 2004 to be up approximately 15% from fiscal year 2003 total revenue.

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Cost of Revenue

   Cost of revenue consists primarily of salaries and benefits for operations personnel, bandwidth fees and related Internet connectivity charges, equipment costs and related depreciation and costs to run our data centers, such as rent and utilities.

   Gross profit of $6.0 million for the three-month period ended April 30, 2004 represented 30% of total revenue as compared to gross profit of $2.3 million for the same period in fiscal year 2003 which represented 12% of total revenue. Total cost of revenue for the three-month period ended April 30, 2004 decreased 18% to approximately $14.2 million from approximately $17.3 million for the same period in fiscal year 2003. The decrease in total cost of revenue of $3.1 million resulted primarily from cost reductions relating to the integration of our acquisitions and the $1.4 million reduction of cost of revenue due to the gains recognized on the terminations of certain data center leases. The scaling of our fixed infrastructure costs over a larger revenue/customer base has also contributed to our improved gross profit.

   Gross profit of $16.5 million for the nine-month period ended April 30, 2004 represented 25% of total revenue as compared to gross profit of $3.4 million which represented 6% of total revenue for the same period in fiscal year 2003. Total cost of revenue for the nine-month period ended April 30, 2004 decreased 3% to approximately $49.5 million from approximately $50.8 million for the same period in fiscal year 2003. The decrease in the cost of revenue of $1.3 million resulted primarily from cost reductions relating to the integration of our acquisitions and the $1.4 million reduction of cost of revenue due to the gains recognized on the terminations of certain data center leases, partially offset by an impairment charge of $0.6 million in the nine-month period ended April 30, 2004, related to the abandonment of our data center space at the Vienna, VA data center. The scaling of our fixed infrastructure costs over a larger revenue/customer base has also contributed to our improved gross profit. We expect our gross profit to be approximately 24% for fiscal year 2004, as compared to approximately 8% for fiscal year 2003.

Operating Expenses

   Product Development. Product development expenses consist primarily of salaries and related costs. Product development expenses increased 90% to approximately $0.2 million for the three-month period ended April 30, 2004 from approximately $0.1 million from the same period in fiscal year 2003. The increase in product development expenses of approximately $0.1 million is primarily related to increased salary expense resulting from an increased headcount.

   Product development expenses increased 43% to approximately $0.9 million for the nine-month period ended April 30, 2004 from approximately $0.6 million from the same period in fiscal year 2003. The increase in product development expenses of approximately $0.3 million, is primarily related to increased salary expense resulting from an increased headcount. We expect product development expenses to remain constant as a percentage of revenue for fiscal year 2004.

   Selling and Marketing. Selling and marketing expenses consist primarily of salaries and related benefits, commissions and marketing expenses such as advertising, product literature, trade shows, marketing and direct mail programs. Selling and marketing expense increased 29% for the three-month period ended April 30, 2004 to approximately $1.8 million from approximately $1.4 million for the same period in fiscal year 2003. The increase of approximately $0.4 million resulted primarily from increased salary expense resulting from an increased headcount and increases in marketing program expenses. During the third quarter of fiscal 2004, we increased our quota bearing sales force from 16 to 25, excluding the sales force at Surebridge.

   Selling and marketing expense increased 52% for the nine-month period ended April 30, 2004 to approximately $5.7 million from approximately $3.8 million for the same period in fiscal year 2003. The increase of approximately $2.0 million resulted primarily from increased salary expense resulting from an increased headcount and increases in marketing program expenses. We expect selling and marketing

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expenses to slightly increase as a percentage of revenue during fiscal year 2004 as compared with fiscal year 2003 as we hire additional sales resources.

   General and Administrative. General and administrative expenses include the costs of financial, human resources, information technology and administrative personnel, professional services, bad debt and corporate overhead. During the three months ended April 30, 2004, general and administrative expenses increased 21% to approximately $6.1 million from approximately $5.0 million for the same period in fiscal year 2003. The increase of approximately $1.1 million was mainly the result of increased salary expense resulting from an increased headcount, increases in utilities costs and depreciation and provision for bad debt offset by reductions in legal and accounting fees, rent, and outside consultants.

   General and administrative expenses increased 19% to approximately $16.3 million for the nine-month period ended April 30, 2004 from approximately $13.7 million for the same period in fiscal year 2003. The increase of approximately $2.6 million was mainly the result of increased salary expense resulting from an increased headcount, depreciation, provision for bad debt, and utilities costs. Also included in the nine-month period ended April 30, 2003 are intercompany charges from CMGI for facilities and shared back office and business development support. These costs were eliminated upon the termination of the Facilities and Administrative Agreement between CMGI and us in September 2002. We expect general and administrative expenses to remain constant to slightly lower as a percentage of revenue during fiscal year 2004, as compared with fiscal year 2003.

Impairment, Restructuring and Other

   Costs associated with impairment, restructuring and abandonment of lease facilities were approximately $206,000 for the three-month period ended April 30, 2004, which resulted from the write-off of $300,000 in property and equipment, net of $94,000 in recovery of impairment charges triggered by the termination and settlement of the abandoned lease in San Francisco, CA, and has been included in operating expenses.

   The additional impairment charges recorded in the nine month period ended April 30, 2004 were due primarily to the abandonment of data center space at our Vienna, VA facility, recorded as an increase to cost of sales and the abandonment of administrative space at our San Francisco, CA office recorded as an increase to general and administrative expense. For our impairment costs, we recorded a charge equal to the amount of rent and other direct costs for the period and time the space is expected to remain unoccupied plus the present value of the amount by which the rent paid by us to the landlord exceeds any rent assumed to be paid to us by a subtenant under a sublease over the remainder of the lease term.

Interest Income

   Interest income decreased 89% to approximately $18,000 for the three-month period ended April 30, 2004 from approximately $169,000 for the same period in fiscal year 2003. The decrease is due primarily to lower cash balances during the three-month period ended April 30, 2004 as compared to the same period in fiscal year 2003 and the elimination of interest income from direct financing leases with our customers in fiscal year 2004.

   Interest income decreased 83% to approximately $0.1 million for the nine-month period ended April 30, 2004 from approximately $0.7 million for the same period in fiscal year 2003. The decrease is due primarily to lower cash balances during the nine-month period ended April 30, 2004 as compared to the same period in fiscal year 2003 and the elimination of interest income from direct financing leases with our customers in fiscal year 2004.

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Interest Expense

   Interest expense decreased 73% to approximately $0.7 million for the three-month period ended April 30, 2004 from $2.5 million for the same period in fiscal year 2003. The decrease is due primarily to the reduction of the expense related to the beneficial conversion feature and interest on our convertible debt, which was fully converted in fiscal year 2003.

   Interest expense decreased 90% to approximately $1.9 million for the nine-month period ended April 30, 2004 from $20.2 million for the same period in fiscal year 2003. The decrease is due primarily to the reduction of the expense related to the beneficial conversion feature and interest on our convertible debt, which was fully converted in fiscal year 2003.

Comparison of the Years 2003, 2002 and 2001

Revenue

   Total revenue for fiscal year 2003 increased 29% to approximately $76.6 million from approximately $59.4 million in fiscal year 2002. The overall growth in revenue was mainly due to revenue resulting from an increased number of customers gained pursuant to our acquisitions, which contributed $48.7 million in revenue during fiscal year 2003, offset by net lost customer revenue of $31.5 million. Revenue from non-related parties increased by 84% to approximately $75.3 million in fiscal year 2003 from approximately $41.0 million in fiscal year 2002 but was offset by a decline in revenue from related parties. Revenue from related parties decreased by 93% to approximately $1.3 million in fiscal year 2003 from approximately $18.5 million in 2002. Revenue from related parties principally consisted of sales of services to CMGI and its affiliates until September 2002 when CMGI sold its equity and debt interests in us to CBT, and then this related party revenue was recorded as revenue. The decrease in related party revenue for fiscal year 2003 as compared to fiscal year 2002 was primarily attributable to CMGI’s affiliates terminating their relationships with us upon the completion of their contracts.

   Total revenue for fiscal year 2002 decreased 42% to approximately $59.4 million from approximately $102.7 million in fiscal year 2001. Included in fiscal year 2002 revenue is approximately $2.9 million in non-recurring revenue from early contract termination settlements, primarily from related parties, including $2.4 million from the termination of a web hosting agreement with Engage, Inc. Excluding settlement revenue, total revenue for fiscal year 2002 decreased 45% to approximately $56.5 million from approximately $102.7 million in fiscal year 2001. The decrease in fiscal year 2002 revenue, net of settlement revenue, resulted from a $25.4 million, or 38%, decrease in unaffiliated revenue combined with a $17.9 million, or 49%, decrease in revenue from CMGI and its affiliates.

   In fiscal year 2003, one unrelated customer accounted for 21% of our revenue as compared to fiscal year 2002 where one CMGI affiliate accounted for approximately 11% of our revenue and fiscal year 2001 where four CMGI affiliates accounted for approximately 25%, 17%, 15% and 14% of our revenue, respectively.

Cost of Revenue

   Cost of revenue, excluding impairment charges, increased 6% to approximately $70.8 million in fiscal year 2003 from approximately $67.0 million in fiscal year 2002. The increase in cost of revenue of $3.8 million, net of impairment charges, resulted primarily from the addition of approximately $14.2 million in cost of revenue from the acquisitions of subsidiaries of CBT netted with a $10.4 million reduction in our cost of revenue. The $10.4 million reduction in our cost of revenue consisted primarily of reductions in depreciation of $11.1 million, equipment lease and related costs of $6.4 million due to restructuring that took place in fiscal year 2002 partially offset by increases in labor costs of $4.0 million, bandwidth costs of $1.6 million and software licenses of $1.4 million related to acquisitions made in fiscal year 2003.

   Cost of revenue, excluding impairment charges, decreased 47% to approximately $67.0 million in fiscal year 2002, from approximately $127.2 million in fiscal year 2001. The reduction in cost of

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revenue of $60.2 million, net of impairment charges, resulted primarily from a $34.7 million reduction in equipment lease and related costs, a $10.0 million reduction in labor costs due to head count reductions, a $9.1 million reduction in consulting fees, a $5.9 million reduction in bandwidth and bandwidth related costs, a $2.9 million reduction in rent costs related to the closing of our original data centers on July 31, 2001, and a $2.9 million reduction in other facility and equipment related costs offset by a $5.2 million increase in depreciation resulting from the purchase of equipment formerly held under operating leases. Included in cost of revenue for fiscal years 2002 and 2001 are impairment charges of $68.3 million and $1.9 million, respectively.

Impairment, Restructuring and Other

   In fiscal year 2002, we recorded a $68.3 million impairment charge related to leased and owned equipment and long-lived assets. The components of this charge are as follows:

  •  As a result of a physical inventory of our customer-dedicated equipment, we recorded an impairment charge of $1.5 million for obsolete equipment and for equipment no longer on hand and identified certain excess assets not in use.
 
  •  We modified the payment amounts and terms of operating leases with three equipment vendors such that the modified leases qualify as capital leases. One of the resulting capital leases is payable in 24 equal monthly payments of $38,000, starting in December 2001. The second capital lease has total payments of $2.6 million, of which $1.0 million was paid in the second quarter of fiscal year 2002 and $1.6 million was paid in fiscal year 2003. The third capital lease is payable in 28 monthly payments of $4,700 for the first four months and $20,400 for the remaining 24 months, starting in April 2002. The equipment under all resulting capital leases was capitalized at the fair market value of the equipment at the time of the modification, determined to be $1.1 million, which was lower than the present value of the future minimum lease payments based on our estimated incremental borrowing rate of 12%. Because the fair market value of the equipment was less than the consideration given, based on a third-party appraisal, we recorded an asset impairment charge of approximately $1.0 million. In addition, we returned some equipment held under operating leases with one of the above lessors and incurred and paid a breakage fee of $397,000.
 
  •  We recorded a net $1.9 million charge representing the future estimated remaining minimum lease payments related to certain idle equipment held under various operating leases. The equipment had previously been rented to former customers under operating leases, and upon the loss of the customer, the equipment became idle. Based on our then forecasts, the equipment would not be utilized before the related operating leases expired and/or the equipment became obsolete.
 
  •  We evaluated the current and forecasted utilization of our purchased software licenses. As a result of this evaluation, during the second quarter of fiscal year 2002, we recorded a $365,000 impairment for software licenses that would not be utilized before the licenses expired and/or became obsolete.
 
  •  We finalized agreements with various equipment lessors whereby we purchased equipment previously held under operating leases for approximately $42.0 million. The fair market value of the equipment at the time of purchase, based on third-party appraisal, was approximately $14.3 million. As the aggregate fair market value of the equipment, based on third-party appraisal, was less than the aggregate consideration given, we recorded an asset impairment charge of approximately $25.4 million, as a separate component of cost of revenue, in fiscal year 2002.
 
  •  A number of factors occurring during the fourth quarter of fiscal year 2002 impacted our long-lived assets including both our expected future cash flow generation and our expected utilization of the assets within revised operating plans. These factors included the further deterioration of market conditions within our industry, excess capacity in the industry and in our two data centers, our anticipated data center utilization and our revised business model.

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   Based on these factors and their impact on current and future projected cash flows, we performed an assessment of the carrying value of our long-lived assets pursuant to SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.” The conclusion of this assessment was that the decline in market conditions within our industry was significant and other than temporary. In this assessment, we reviewed our long-lived assets, which included property, equipment and goodwill. The carrying amount of goodwill, which totaled $186,000, was considered unrecoverable and was written-off as of July 31, 2002 and was included as a component of general and administrative expense.

   In accordance with SFAS No. 121, the measurement of the impairment loss of property and equipment was based on the fair value of the asset, as determined by third-party appraisal. Management determined that the best measure of fair value for the property and equipment was a combination of the market and cost approaches. The cost approach was utilized to determine the fair value of certain computer hardware, leasehold improvements, office furniture and equipment and construction in progress. The cost approach utilizes estimated replacement/reproduction cost, with allowances for physical depreciation and functional obsolescence (i.e. asset utilization). For certain equipment and leasehold improvements, the market approach was used. The market approach typically includes comparing recent sales of similar assets and adjusting these comparable transactions based on factors such as age, condition, and type of sale to determine fair value. Based on the appraised fair value of the property and equipment, we recorded an impairment charge of approximately $38.1 million during the fourth quarter of fiscal year 2002.

   Included in the fiscal year 2001 cost of revenue is a charge of approximately $1.9 million related to some of our equipment under operating leases, which had been deemed not to have a future economic benefit to us.

Operating Expenses

   Product Development. Product development expenses decreased 82% to approximately $950,000 in fiscal year 2003 from approximately $5.3 million in fiscal year 2002. The decrease in product development expenses is primarily related to reduced headcount and related costs resulting from the decrease in product development personnel in fiscal year 2003 from fiscal year 2002, combined with a reduction in allocated depreciation and equipment rental expense.

   Product development expenses decreased 63% to approximately $5.3 million in fiscal year 2002 from approximately $14.1 million in fiscal year 2001. The decrease in product development expenses is primarily related to reduced headcount and related costs resulting from the decrease in product development personnel in fiscal year 2002 from fiscal year 2001, combined with a reduction in outside consulting fees.

   Selling and Marketing. Selling and marketing expenses decreased 39% to approximately $6.0 million in fiscal year 2003 from approximately $9.7 million in fiscal year 2002. The decrease of approximately $3.7 million resulted primarily from a reduction in salary and related costs of approximately $2.6 million, a reduction of allocated rent of approximately $800,000 and a reduction in marketing program costs of approximately $300,000.

   Selling and marketing expenses decreased 70% to approximately $9.7 million in fiscal year 2002 from approximately $32.3 million in fiscal year 2001. The $22.5 million decrease resulted primarily from a $8.1 million reduction in headcount expenses related to a decrease in sales and marketing personnel, a $6.6 million reduction in marketing programs, advertising and product literature, a $5.2 million reduction in commission expense driven by decreased revenue levels, and a $765,000 reduction in consulting fees.

   General and Administrative. General and administrative expenses increased 4.9% to approximately $20.2 million in fiscal year 2003 from approximately $19.3 million in fiscal year 2002. The increase of approximately $935,000 was mainly the result of the addition of approximately $1.3 million in CBT

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general and administrative expenses offset by a net decrease in expenses of approximately $400,000. The $400,000 is primarily comprised of a reduction in bad debt expense of $2.5 million partially offset by increases in headcount related expenses of $1.2 million, increased accounting and legal fees of $800,000 and increased expense for amortization of intangibles related to the CBTM acquisition during the fiscal year.

   General and administrative expenses decreased 42% to approximately $19.3 million in fiscal year 2002 from approximately $33.0 million in fiscal year 2001. The $13.7 million decrease resulted primarily from a $8.3 million reduction in bad debt expense, a $5.1 million reduction in headcount expense related to a decrease in general and administrative personnel at July 31, 2002 to 26 from 52 at July 31, 2001, and a $1.7 million reduction in consulting fees. General and administrative expenses also included a $600,000 legal settlement paid to Level 3 to settle a contract dispute regarding colocation space cancelled by NaviSite.

Impairment, Restructuring and Other

   Costs associated with impairment, restructuring and abandonment of lease facilities increased to approximately $8.9 million in fiscal year 2003 compared to a reversal of a portion of a previous impairment and restructuring charge of approximately $2.6 million in fiscal year 2002. The increase is due primarily to abandonment of administrative space at our 400 Minuteman Road, Andover, MA facility and the abandonment of administrative space at our La Jolla, CA office and approximately $2.0 million impairment of intangible assets by CBT. We recorded a charge equal to the amount of rent and other direct costs for the period the space is expected to remain unoccupied plus the present value of the amount by which the rent paid by us to the landlord exceeds any rent paid to us by a subtenant under a sublease over the remainder of the lease term.

   In July 2001, we announced a plan, approved by our Board of Directors, to restructure our operations and consolidate our data centers, which resulted in a charge of approximately $8.0 million, of which approximately $5.2 million was accrued for as of July 31, 2001. Of the total restructuring charge, approximately $1.8 million was related to employee termination benefits. We terminated 126 employees on July 31, 2001. The restructuring charge also included approximately $6.2 million of costs related to the closing of our two original data centers. The components of the facility closing costs included approximately $3.8 million of estimated lease obligations associated with restoring the facilities to their original condition, and other contractual obligations, to be paid over the term of the respective agreements through 2002, and approximately $2.4 million of write-offs of leasehold improvements, which were recorded as of July 31, 2001. During fiscal year 2002, we were able to favorably renegotiate the facility closing costs. The accrual for the two original data centers was reduced by approximately $1.6 million and the bandwidth termination costs were reduced by approximately $1.0 million. In addition, $63,000 in severance and employee costs were forfeited by former employees. As a result, we reversed approximately $2.6 million in restructuring accrual during fiscal year 2002. As of July 31, 2002, we had completed the restructuring plan and made all related payments.

Interest Income

   Interest income decreased 20% to approximately $851,000 in fiscal year 2003 from approximately $1.1 million in fiscal year 2002. The decrease is due primarily to the reduced levels of average cash on hand.

   Interest income decreased 62% to approximately $1.1 million in fiscal year 2002, from approximately $2.8 million in fiscal year 2001. The decrease is due primarily to the reduced levels of average cash on hand.

Interest Expense

   Interest expense increased 195% to approximately $43.4 million in fiscal year 2003 from approximately $14.7 million in fiscal year 2002. The increase of $28.7 million is due mainly to the non-

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cash write-off of the unamortized beneficial conversion feature related to the conversion of the $65 million of convertible notes during fiscal year 2003.

   Interest expense increased 83% to approximately $14.7 million in fiscal year 2002 from approximately $8.0 million in fiscal year 2001. The increase is due to the interest payable on the $65 million of convertible notes and related beneficial conversion feature amortization.

Other Income (Expense), net

   Other income (expense) increased 42% to approximately ($733,000) in fiscal year 2003 from ($516,000) in fiscal year 2002. This increase is mainly due to increased fees related to the accounts receivable financing agreement with Silicon Valley Bank.

   Other income (expense) decreased 277% to ($516,000) in fiscal year 2002 from $292,000 in fiscal year 2001. The decrease is due to the loss on the sale of assets offset by the gain realized on the sale of certain of our Streaming Media assets.

Fiscal Year 2001 Change in Accounting Principle

   During fiscal year 2001, we adopted SEC Staff Accounting Bulletin No. 101 — Revenue Recognition in Financial Statements, or SAB 101. Under SAB 101, installation fees are recognized over the life of the related customer contracts. Prior to fiscal year 2001, we recognized installation fees at the time the installation occurred. The cumulative effect of the change in accounting principle on all prior years resulted in a $4.3 million increase in net loss for the year ended July 31, 2001 and is reflected as a cumulative effect of change in accounting principle. Revenue for the year ended July 31, 2001 includes $1.5 million that was included in the cumulative effect adjustment. The $1.5 million of fiscal year 2001 revenue was primarily attributable to the recognition of the previously deferred revenue on customers lost during fiscal year 2001.

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Quarterly Results of Operations

(In thousands, except for per share data)

   We have prepared the following table on a basis consistent with the audited consolidated financial statements included in this prospectus and, in the opinion of management, this chart includes all adjustments necessary for the fair presentation of such data.

                                                                                             
Three Months Ended

April 30, Jan. 31, Oct. 31, July 31, April 30, Jan. 31, Oct. 31, July 31, April 30, Jan. 31, Oct. 31,
2004 2004 2003 2003(1) 2003(1) 2003(1) 2002 2002 2002 2002 2001











(Unaudited)
Revenue
  $ 20,173     $ 22,329     $ 23,473     $ 22,341     $ 19,620     $ 18,761     $ 14,561     $ 6,625     $ 9,113     $ 11,747     $ 13,483  
Revenue, related parties
    12                                     1,310       3,126       5,604       3,927       5,796  
     
     
     
     
     
     
     
     
     
     
     
 
Total revenue
    20,185       22,329       23,473       22,341       19,620       18,761       15,871       9,751       14,717       15,674       19,279  
     
     
     
     
     
     
     
     
     
     
     
 
Cost of revenue
    14,217       16,758       17,924       19,960       17,312       17,014       16,495       11,166       14,150       20,307       21,377  
Impairment, restructuring and other
                633 (7)                             37,717 (3)     (3,985 )(4)     7,226 (3)     27,359 (5)
     
     
     
     
     
     
     
     
     
     
     
 
Total cost of revenue
    14,217       16,758       18,557       19,960       17,312       17,014       16,495       48,883       10,165       27,533       48,736  
     
     
     
     
     
     
     
     
     
     
     
 
Gross profit (deficit)
    5,968       5,571       4,916       2,381       2,308       1,747       (624 )     (39,132 )     4,552       (11,859 )     (29,457 )
     
     
     
     
     
     
     
     
     
     
     
 
Operating expenses:
                                                                                       
 
Product development
    230       312       348       326       121       121       382       356       1,003       1,945       1,977  
 
Selling and marketing
    1,848       1,904       1,972       2,201       1,429       1,043       1,287       1,834       2,731       2,502       2,636  
 
General and administrative
    6,097       5,287       4,958       6,489       5,023       5,018       3,677       2,729       2,622       7,086       6,835  
 
Impairment, restructuring and other
    206       946 (7)     456 (7)     2,608 (6)     3,819 (7)     2,308 (7)     147       (138 )     (2,495 )(8)            
     
     
     
     
     
     
     
     
     
     
     
 
   
Total operating expenses
    8,381       8,449       7,734       11,624       10,392       8,490       5,493       4,781       3,861       11,533       11,448  
     
     
     
     
     
     
     
     
     
     
     
 
Income (loss) from operations
    (2,413 )     (2,878 )     (2,818 )     (9,243 )     (8,084 )     (6,743 )     (6,117 )     (43,913 )     691       (23,392 )     (40,905 )
Other income (expense):
                                                                                       
 
Interest income
    18       33       64       167       169       211       305       339       389       168       164  
 
Interest expense
    (656 )     (670 )     (609 )     (23,232 )(9)     (2,470 )     (13,760 )(9)     (3,940 )     (3,770 )     (3,763 )     (3,576 )     (3,609 )
 
Other income (expense), net
    25       76       10       376       (919 )     61       (253 )     (1,186 )     639       21       10  
     
     
     
     
     
     
     
     
     
     
     
 
Loss before income tax expense
    (3,026 )     (3,439 )     (3,353 )     (31,932 )     (11,304 )     (20,231 )     (10,005 )     (48,530 )     (2,044 )     (26,779 )     (44,340 )
Income tax expense
                      153                                            
     
     
     
     
     
     
     
     
     
     
     
 
Net loss
  $ (3,026 )   $ (3,439 )   $ (3,353 )   $ (32,085 )   $ (11,304 )   $ (20,231 )   $ (10,005 )   $ (48,530 )   $ (2,044 )   $ (26,779 )   $ (44,340 )
     
     
     
     
     
     
     
     
     
     
     
 
Basic and diluted net loss per common share(2):
  $ (0.12 )   $ (0.14 )   $ (0.14 )   $ (1.80 )   $ (0.88 )   $ (2.07 )   $ (1.60 )   $ (7.97 )   $ (0.35 )   $ (4.70 )   $ (10.72 )
     
     
     
     
     
     
     
     
     
     
     
 
Basic and diluted weighted average number of common shares outstanding(2)
    24,809       24,741       24,506       17,788       12,845       9,751       6,270       6,092       5,917       5,698       4,138  
     
     
     
     
     
     
     
     
     
     
     
 

(1)  The three-month periods ended July 31, April 30 and January 31, 2003 have been restated herein to reflect our acquisition of assets of CBT as if the acquisition had taken place on September 11, 2002. This acquisition transpired when both companies were under common control, and therefore, the acquisition is accounted for in a manner similar to a pooling-of-interest.
 
(2)  As discussed in the notes to our consolidated financial statements, in January 2003 we completed a 1-for-15 reverse stock split of our outstanding shares of common stock. All historical share and per share data have been adjusted for the reverse stock split.
 
(3)  Impairment related to valuation of our fixed assets.
 
(4)  Reversal of impaired lease accrual due to change in estimate.
 
(5)  Impairment of assets purchased during buyout of certain operating leases.
 
(6)  Impairment of leased facility and write-off of intangible assets at CBT.
 
(7)  Impairment of leased facility.
 
(8)  Reversal of fiscal year 2001 restructuring charge due to change in estimate.
 
(9)  Increase in interest expense related to non-cash expense from conversion of our convertible debt.

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   The following is a reconciliation from the quarterly reported results previously filed on our annual report on Form 10-K and our quarterly reports on Form 10-Q to the results presented herein.

                                                                             
Three Months Ended

July 31, 2003 April 30, 2003 January 31, 2003



As reported CBT Results Combined(1) As reported CBT Results Combined(1) As reported CBT Results Combined(1)









(Unaudited)
Revenue
  $ 18,627     $ 3,713     $ 22,341     $ 15,877     $ 3,743     $ 19,620     $ 14,803     $ 3,958     $ 18,761  
Revenue, related parties
          81                                            
     
     
     
     
     
     
     
     
     
 
Total revenue
    18,627       3,794       22,341       15,877       3,743       19,620       14,803       3,958       18,761  
     
     
     
     
     
     
     
     
     
 
Cost of revenue
    16,339       3,741       19,960       13,633       3,622       17,312       13,006       3,989       17,014  
Impairment, restructuring and other
                                                     
     
     
     
     
     
     
     
     
     
 
Total cost of revenue
    16,339       3,741       19,960       13,633       3,622       17,312       13,006       3,989       17,014  
     
     
     
     
     
     
     
     
     
 
Gross profit (deficit)
    2,288       53       2,381       2,244       121       2,308       1,797       (31 )     1,747  
     
     
     
     
     
     
     
     
     
 
Operating expenses:
                                                                       
 
Product development
    326             326       121             121       121             121  
 
Selling and marketing
    2,197             2,201       1,367             1,429       996       26       1,043  
 
General and administrative
    5,836       797       6,489       4,729       323       5,023       4,716       311       5,018  
 
Impairment, restructuring and other
    776       1,831       2,608       3,819             3,819       2,308             2,308  
     
     
     
     
     
     
     
     
     
 
   
Total operating expenses
    9,135       2,628       11,624       10,036       323       10,392       8,141       337       8,490  
     
     
     
     
     
     
     
     
     
 
Loss from operations
    (6,847 )     (2,575 )     (9,243 )     (7,792 )     (202 )     (8,084 )     (6,344 )     (368 )     (6,743 )
Other income (expense):
                                                                       
 
Interest income
    155       12       167       157       12       169       200       11       211  
 
Interest expense
    (23,216 )     (16 )     (23,232 )     (2,448 )     (22 )     (2,470 )     (13,721 )     (39 )     (13,760 )
 
Other income (expense), net
    377             376       (909 )           (919 )     64             61  
     
     
     
     
     
     
     
     
     
 
Loss before income tax expense
    (29,531 )     (2,579 )     (31,932 )     (10,992 )     (212 )     (11,304 )     (19,801 )     (396 )     (20,231 )
Income tax expense
          153       153                                      
     
     
     
     
     
     
     
     
     
 
Net loss
  $ (29,531 )   $ (2,732 )   $ (32,085 )   $ (10,992 )   $ (212 )   $ (11,304 )   $ (19,801 )   $ (396 )   $ (20,231 )
     
     
     
     
     
     
     
     
     
 

(1)  The combined amounts include the elimination of intercompany activity consisting of $81,000 of revenue in the three-month period ended July 31, 2003 and general and administrative expense of $144,000, $29,000 and $9,000 for the three-month periods ended July 31, April 30 and January 31, 2003, respectively.

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Contractual Obligations and Commercial Commitments

   We are obligated under various capital and operating leases for facilities and equipment. Minimum annual rental commitments under operating leases and other commitments are as follows as of April 30, 2004:

                                                         
Less than After 5
Description Total 1 Year Year 2 Year 3 Year 4 Year 5 Years








(in thousands)
Short/Long-term debt
  $ 27,400     $ 20,048     $ 815     $ 6,537     $     $     $  
Interest on debt
    1,819       859       480       480                    
Capital leases
    3,248       2,418       830                          
Operating leases
    535       523       12                          
Bandwidth commitments
    7,981       3,095       2,768       1,875       243              
Maintenance for hardware/software
    1,019       1,019                                
Property leases
    57,808       12,599       11,184       8,804       8,655       7,014       9,552  
     
     
     
     
     
     
     
 
    $ 99,810     $ 40,561     $ 16,089     $ 17,696     $ 8,898     $ 7,014     $ 9,552  
     
     
     
     
     
     
     
 

Liquidity and Capital Resources

   As of April 30, 2004, our principal sources of liquidity include cash and cash equivalents and our financing agreement with Silicon Valley Bank. We had a working capital deficit of $16.6 million, including cash and cash equivalents of $7.6 million at April 30, 2004, as compared to a working capital deficit of $16.3 million, including cash and cash equivalents of $3.9 million at July 31, 2003.

   The total net change in cash and cash equivalents for the nine months ended April 30, 2004 was an increase of $3.8 million. The primary uses of cash during this nine-month period included $2.7 million of cash used for operating activities, $1.8 million for purchases of property and equipment and $10.4 million in repayments on notes payable, capital lease obligations and borrowings under our former accounts receivable financing line. Our primary sources of cash during this nine-month period were a $1.7 million decrease in restricted cash, $0.4 million in proceeds associated with the exercise of stock options under the employee stock option plans, $16.0 million in net proceeds from our modified financing agreement and $0.6 million in proceeds from sale-leaseback and note payable transactions. Net cash used for operating activities of $2.7 million for the nine months ended April 30, 2004, resulted primarily from our $9.8 million net loss, partially offset by $14.3 million in non-cash charges, and $7.2 million used by net changes in operating assets and liabilities. At April 30, 2004, we had an accumulated deficit of $428.3 million, and have reported losses from operations since incorporation. At July 31, 2003, we had an accumulated deficit of $415.7 million.

   Prior to May 2003, our primary sources of cash to fund our operations were sales of equity and convertible debt securities. Since May 2003, our primary source of cash to fund our operations and meet our contractual obligations and commitments has been our accounts receivable financing agreement with Silicon Valley Bank. On January 30, 2004, we amended this agreement to, among other things, allow for future borrowing to be based on monthly recurring revenue, increase the maximum borrowings level from $10.0 million to $12.8 million, and extend the term until January 29, 2006. On April 29, 2004, we amended this agreement, among other things, to increase the maximum borrowing level from $12.8 million to $20.4 million, and extend the term until April 29, 2006. Under the amended agreement, borrowings are based on monthly recurring revenue. We are required to prepare and deliver a written request for an advance of up to three times the value of total monthly recurring revenue, calculated to be monthly revenue (including revenue from New York State Department of Labor) less professional services revenue. The bank may then provide an advance of 85% of such value (or such other percentage as the bank may determine). The interest rate under the amended agreement is variable and is currently calculated at the bank’s published “prime rate” plus four percent. Following the completion of this offering, and provided we continue to meet certain ratios under the amended

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agreement, the interest rate shall be reduced to the bank’s prime rate plus one percent. In no event, however, will the bank’s prime rate be less than 4.25%. On April 30, 2004, we had an outstanding balance under the amended agreement of $16.0 million. On June 11, 2004, we borrowed approximately $3.9 million under the Silicon Valley Bank amended agreement to repay a Surebridge loan with Silicon Valley Bank that we assumed as part of the Surebridge acquisition. Our outstanding balance under this amended agreement as of June 11, 2004, was $15.2 million.

   We anticipate incurring additional losses throughout our current fiscal year. We have taken several actions we believe will allow us to continue as a going concern through July 31, 2004, including the closing and integration of strategic acquisitions, the changes to our senior management and bringing costs more in line with projected revenue. We believe that this offering will allow us to raise the necessary funds to meet our anticipated needs for working capital and capital equipment for at least 12 months following the proposed offering. However, there can be no assurance that we will complete this offering. In the event we are unable to complete this offering, we will need to find alternative sources of financing, in order to remain a going concern. Potential sources include our financing agreement with Silicon Valley Bank and public or private sales of equity or debt securities. We may also consider sales of assets to raise additional cash. If we use a significant portion of the net proceeds from an offering to acquire a company, technology or product, we will need to raise additional debt or equity capital.

   During fiscal 2003, we acquired four companies, downsized our workforce and restructured our business and balance sheet to improve operating cash flow. Our operating forecast incorporates material trends, such as our acquisitions, reductions in workforce, loss of related party revenue and closings of facilities. Our forecast also incorporates the future cash flow benefits expected from our continued efforts to increase efficiencies and reduce redundancies. Nonetheless, our forecast includes the need to raise additional funds through this offering or alternate sources of financing. Our cash flow estimates are based upon attaining certain levels of sales, maintaining budgeted levels of operating expenses, collections of accounts receivable and maintaining our current borrowing line with Silicon Valley Bank among other assumptions, including the improvement in the overall macroeconomic environment. However there can be no assurance that we will be able to meet such assumptions. Our sales estimate includes revenue from new and existing customers which may not be realized and we may be required to further reduce expenses if budgeted sales are not attained. We may be unsuccessful in reducing expenses in proportion to any shortfall in projected sales and our estimate of collections of accounts receivable may be hindered by our customers’ ability to pay. In addition, we are currently involved in various pending and potential legal proceedings. While we believe that the allegations against us in each of these matters are without merit, and that we have a meritorious defense in each, we are not able to predict the final outcomes of any of these matters and the effect, if any, on our financial condition. If we are ultimately unsuccessful in any of these matters, we could be required to pay substantial amounts of cash and/ or shares of our common stock to the other parties. The amount and timing of any such payments could adversely affect our financial condition.

Critical Accounting Policies

   We prepare our consolidated financial statements in accordance with accounting principles generally accepted in the United States of America. As such, management is required to make certain estimates, judgments and assumptions that it believes are reasonable based on the information available. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses for the periods presented. The significant accounting policies which management believes are the most critical to aid in fully understanding and evaluating our reported financial results include revenue recognition, allowance for doubtful accounts and impairment of long-lived assets. Management reviews the estimates on a regular basis and makes adjustments based on historical experiences, current conditions and future expectations. The reviews are performed regularly and adjustments are made as required by current available information. We believe these estimates are reasonable, but actual results could differ from these estimates.

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   Revenue Recognition. We provide outsourced hosting, colocation and managed application services and related professional and consulting services. Revenue consists of monthly fees for Web site and information technology infrastructure and application management, application rentals and hosting. Revenues related to monthly fees for information technology infrastructure and applications are recognized over the term of the customer contract based on actual usage and services. Revenue from professional services is recognized on a time-and-materials basis as the services are performed or under the percentage-of-completion method for revenue related to fixed-price contracts. Revenue and profits on long-term Internet solutions contracts, performed over extended periods, are recognized under the percentage-of-completion method of accounting, principally based on direct labor dollars. Revenues and profits on long-term contracts are based on our estimates to complete and are reviewed periodically, with adjustments recorded in the period in which the revisions are made. Any anticipated losses on contracts are charged to operations as soon as they are determinable. Fees charged for the installation of customer equipment are generally received in advance and are deferred and recognized as revenue over the life of the related customer contract, typically 12 to 36 months. In the event a customer terminates the agreement prior to its stated maturity, all deferred revenue related to installation services is automatically recognized upon the effective date of the termination, and we generally charge cancellation or termination fees that are also recognized upon the effective date of the termination. Generally, cancellation fees are calculated as the customer’s remaining base monthly fees obligation times the number of months remaining in the contract term.

   Existing customers are subject to ongoing credit evaluations based on payment history and other factors. If it is determined subsequent to our initial evaluation and at any time during the arrangement that collectability is not reasonably assured, revenue is recognized as cash is received. Due to the nature of our service arrangements, we provide written notice of termination of services, typically 10 days in advance of disconnecting a customer. Revenue for services rendered during this notification period is generally recognized on a cash basis as collectability is not considered probable at the time the services are provided.

   Allowance for Doubtful Accounts. We perform periodic credit evaluations of our customers’ financial conditions and generally do not require collateral or other security against trade receivables. We make estimates of the uncollectability of our accounts receivables and maintain an allowance for doubtful accounts for potential credit losses. We specifically analyze accounts receivable and consider historical bad debts, customer and industry concentrations, customer credit-worthiness, current economic trends and changes in our customer payment patterns when evaluating the adequacy of the allowance for doubtful accounts. We specifically reserve for 100% of the balance of customer accounts deemed uncollectible. For all other customer accounts, we reserve for 20% of the balance over 90 days old and 2% of all other customer balances. This method historically approximated actual write-off experience. Changes in economic conditions or the financial viability of our customers may result in additional provisions for doubtful accounts in excess of our current estimate.

   Impairment of Long-lived Assets. We review our long-lived assets, primarily property and equipment, for impairment whenever events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable. Factors we consider important that could trigger an interim impairment review include:

  •  significant underperformance relative to expected historical or projected future operating results;
 
  •  significant changes in the manner of our use of the acquired assets or the strategy of our overall business;
 
  •  significant negative industry or economic trends;
 
  •  significant declines in our stock price for a sustained period; and
 
  •  our market capitalization relative to net book value.

   Recoverability is measured by a comparison of the carrying amount of an asset to future undiscounted cash flows expected to be generated by the asset. If the assets were considered to be

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impaired, the impairment to be recognized would be measured by the amount by which the carrying value of the assets exceeds their fair value. Fair value is determined based on discounted cash flows or appraised values, depending on the nature of the asset. Assets to be disposed of are valued at the lower of the carrying amount or their fair value less disposal costs. Property and equipment is primarily comprised of leasehold improvements, computer and office equipment and software licenses. If our costs are more or less than our estimates, then we record an additional loss or gain in the future period when the actual costs are known. For example, in fiscal year 2002, we reversed approximately $2.6 million in prior restructuring accrued as a result of the incurrence of less costs than estimated.

New Accounting Pronouncements

   In January 2003, Financial Accounting Standards Board (“FASB”) Interpretation No. (“FIN”) 46, “Consolidation of Variable Interest Entities,” was issued. FIN 46 requires certain variable interest entities (“VIE”) to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective for all new VIEs created or acquired after January 31, 2003. During December 2003, the FASB issued a new revision to FIN 46 (“FIN 46R”). Under the revised provisions, public entities are required to apply for guidance if the entity has interests in VIEs commonly referred to as special-purpose entities for the periods ending after December 15, 2003. The adoption of FIN 46 and 46R did not have a material effect on our consolidated financial statements.

   In May 2003, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 150, “Accounting For Certain Financial Instruments with Characteristics of Both Liabilities and Equity,” which establishes standards for how an issuer of financial instruments classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances) if, at inception, the monetary value of the obligation is based solely or predominantly on a fixed monetary amount known at inception, variations in something other than the fair value of the issuer’s equity shares or variations inversely related to changes in the fair value of the issuer’s equity shares. This Statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. On November 7, 2003, the FASB deferred the classification and measurement provisions of SFAS No. 150 as they apply to certain mandatory redeemable non-controlling interests. This deferral is expected to remain in effect while these provisions are further evaluated by the FASB. We have not entered into or modified any financial instruments covered by this statement after May 31, 2003 and the application of this standard is not expected to have a material impact on our financial position or results of operations.

   In December 2003, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin (“SAB”) No. 104, “Revenue Recognition,” which supersedes SAB 101, “Revenue Recognition in Financial Statements.” SAB 104’s primary purpose is to rescind accounting guidance contained in SAB 101 related to multiple element revenue arrangements, superseded as a result of the issuance of Emerging Issues Task Force (“EITF”) 00-21, “Accounting for Revenue Arrangements with Multiple Deliverables.” The issuance of SAB 104 reflects the concepts contained in EITF 00-21; the other revenue recognition concepts contained in SAB 101 remain largely unchanged. The application of SAB 104 did not have a material impact on our financial position or results of operations.

Quantitative and Qualitative Disclosures About Market Risk

   We do not enter into financial instruments for trading purposes. We do not use derivative financial instruments or derivative commodity instruments in our investment portfolio or enter into hedging transactions. Our exposure to market risk associated with risk-sensitive instruments entered into for purposes other than trading purposes is not material to NaviSite. We currently have no significant foreign operations and therefore face no material foreign currency exchange rate risk.

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BUSINESS

Our Business

   We provide a broad range of hosting and managed application services for middle-market organizations, which include mid-sized companies, divisions of large multi-national companies and government agencies. Our service offerings allow our customers to outsource the hosting and management of their information technology infrastructure and applications, such as commerce systems, enterprise software applications and e-mail. We offer services that are designed to focus on the needs of middle-market organizations, where we believe the need for outsourcing is most acute. We believe that by using our services, our customers are able to focus on, and apply resources to, their core business operations by avoiding the significant ongoing investments required to replicate our infrastructure, performance, reliability and expertise. Our services include:

     
Managed Application Services
(A-Services)
  Application Hosting
Application Management
Application Development
Managed Infrastructure Services
(I-Services)
  Content and Electronic Software Distribution
Colocation
Bandwidth
Security
Disaster Recovery
Managed Messaging Services
(M-Services)
  Managed Messaging

   Following our Surebridge acquisition, we support a broad portfolio of outsourced application services including financial management, supply chain management, human resources management and customer relationship management. We provide these services to a range of vertical industries through our direct sales force and channel relationships. The applications we provide include PeopleSoft, Siebel Systems, Progress Software and Microsoft Business Solutions suite.

   Our service offerings are facilitated by our proprietary Collaborative Application Management platform, or CAM. Our CAM platform enables us, with our customers, to provide highly efficient, effective and customized management of their outsourced enterprise applications and information technology. Comprised of a suite of third-party and proprietary products, CAM provides tools designed specifically to meet the needs of customers who outsource or want to provide on-demand application services.

   We believe that the combination of CAM with our physical infrastructure and technical staff gives us a unique ability to provision on-demand application services for software providers for use by their customers. Because this on-demand provisioning capability is not dependent on the individual software application, CAM is application and operating platform neutral. Designed to enable enterprise software applications to be provisioned and used as an on-demand solution, the CAM technology allows us to offer new solutions to our software vendors and new products to our current customers.

   We currently operate 16 data centers in the United States and one data center in the United Kingdom. We believe that our data centers and infrastructure have the capacity necessary to expand our business for the foreseeable future. Our services combine our developed infrastructure with established processes and procedures for delivering hosting and application management services. Our high availability infrastructure, high performance monitoring systems, and proactive and collaborative problem resolution and change management processes are designed to identify and address potentially crippling problems before they are able to disrupt our customers’ operations.

   We currently service approximately 1,100 customers, including approximately 191 customers through our sales channel relationships. Our customers typically enter into service agreements for a term of one

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to three years, which provide for monthly payment installments, providing us with a base of recurring revenue.

   In September 2002, ClearBlue Technologies, Inc., or CBT, acquired all of our equity and debt interests then held by CMGI, Inc. and Hewlett-Packard Financial Services Company, thus becoming our majority stockholder. At the time of the CBT acquisition, our business was focused primarily on outsourced management and hosting of web operations and applications. We have since successfully grown our revenues, service offerings and customer base through a number of acquisitions, including:

  •  In December 2002, we acquired all of the issued and outstanding stock of ClearBlue Technologies Management, Inc., or CBTM, a subsidiary of CBT which previously had acquired assets from the bankrupt estate of AppliedTheory Corporation related to application management and application hosting services. This acquisition added application management and development capabilities to our Managed Application Services.
 
  •  In February 2003, we acquired Avasta, Inc., a provider of application management services, adding automated application and device monitoring software capabilities to our Managed Application Services.
 
  •  In April 2003, we acquired Conxion Corporation, a provider of application hosting, content and electronic software distribution and security services. This acquisition added proprietary content delivery software and related network agreements to our Managed Application Services and Managed Infrastructure Services.
 
  •  In May 2003, we acquired assets of Interliant, Inc. related to managed messaging, application hosting and application development services. This acquisition added messaging-specific skills and IBM Lotus Domino expertise, and formed the core of our Managed Messaging Services.
 
  •  In August 2003, we acquired assets of CBT related to colocation, bandwidth, security and disaster recovery services, enhancing our Managed Infrastructure Services and adding physical plant assets. Specifically, we acquired all of the outstanding shares of six wholly-owned subsidiaries of CBT with data centers located in Chicago, Illinois; Las Vegas, Nevada; Los Angeles, California; Milwaukee, Wisconsin; Oakbrook, Illinois; and Vienna, Virginia and assumed the revenue and expense of four additional wholly-owned subsidiaries of CBT with data centers located in Dallas, Texas; New York, New York; San Francisco, California; and Santa Clara, California. Pursuant to the acquisition agreement, as amended on February 6, 2004, we had the right to acquire from CBT ownership of those additional subsidiaries for no additional consideration at any time on or prior to August 8, 2005, provided that any necessary third-party consents are first obtained. In April 2004, we exercised our right to acquire the additional subsidiaries and thereby acquired all of the outstanding shares of the four wholly-owned subsidiaries of CBT with data centers located in Dallas, Texas; New York, New York; San Francisco, California; and Santa Clara, California.
 
  •  In June 2004, we acquired substantially all of the assets and liabilities of Surebridge, a privately held provider of managed application services for mid-market companies. This acquisition broadens our Managed Application Services, particularly in the areas of financial management, supply chain management, human resources management and customer relationship management.

We believe we have demonstrated a disciplined acquisition strategy and effective integration expertise.

   The audit report from KPMG LLP, our independent auditors, relating to our fiscal year 2003 financial statements contains KPMG’s opinion that our recurring losses from operations since inception and accumulated deficit, as well as other factors, raise substantial doubt about our ability to continue as a going concern.

   Over the past 18 months, we have had significant reductions-in-force due to redundancies and restructurings resulting from the consolidation of acquired companies. We have also had a number of departures of several members of senior management due primarily to the change of control of NaviSite on September 11, 2002. Specifically, the following members of senior management have departed since

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such date: Patricia Gilligan, formerly President and Chief Executive Officer; Kevin H. Lo, formerly Chief Financial Officer; Robert C.B. Poon, formerly Vice President of Service Delivery; Joe Suyemoto, formerly General Counsel; and Richard DeWaele, formerly Vice President and General Counsel.

Our Industry

   The dramatic growth in Internet usage and the enhanced functionality, accessibility and security of Internet-enabled applications have made conducting business on the Internet increasingly attractive. Many businesses are using Internet-enabled information technology infrastructure and applications to enhance their core business operations, increase efficiencies and remain competitive. Internet-enabled information technology infrastructure and applications extend beyond Web sites to software such as financial, email, enterprise resource planning, supply chain management and customer relationship management applications. Organizations have become increasingly dependent on these applications and they have evolved into important components of their businesses.

   As enterprises seek to remain competitive and improve profitability, we believe they will continue to implement increasingly sophisticated Internet-enabled applications. Some of the potential benefits of these applications include the ability to:

  •  increase operating efficiencies and reduce costs;
 
  •  build and enhance customer relationships by providing Internet-enabled customer service and technical support;
 
  •  manage vendor and supplier relationships through Internet-enabled technologies such as online training and online sales and marketing; and
 
  •  communicate and conduct business more rapidly and cost-effectively with customers, suppliers and employees worldwide.

   These benefits have driven increased use of Internet-enabled information technology infrastructure and applications which in turn has created a strong demand for specialized information technology support and applications expertise. An increasing number of businesses are choosing to outsource the hosting and management of these applications. Gartner estimates that the mid-sized business market, defined as companies with 100 to 999 employees, for outsourced information technology management will grow from approximately $12.6 billion to approximately $15.7 billion by 2006.

   The trend towards outsourced hosting and management of information technology infrastructure and applications by middle-market organizations is driven by a number of factors, including:

  •  developments by major hardware and software vendors that facilitate outsourcing;
 
  •  the need to improve the reliability, availability and overall performance of Internet-enabled applications as they increase in importance and complexity;
 
  •  the need to focus on core business operations;
 
  •  challenges and costs of hiring, training and retaining application engineers and information technology employees with the requisite range of information technology expertise; and
 
  •  increasing complexity of managing the operations of Internet-enabled applications.

   Independent market research firms indicate that the markets for our services are large and expected to grow rapidly over the next few years:

  •  According to Gartner, the North American Web-hosting market will grow from $5.8 billion in 2002 to $20.0 billion by 2007. Gartner further estimates that managed services accounted for 72% of the market in 2002, and will grow to account for 85% of the market by 2007.
 
  •  Gartner also estimates that the North American content distribution network and software delivery services market will grow from $173 million in 2002 to $814 million by 2007.

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  •  According to The Radicati Group, the hosted and managed business email market will grow from approximately $2.3 billion in 2003 to approximately $3.1 billion in 2007. The Radicati Group further estimates that approximately 64% of the 581 million actively used email accounts worldwide are hosted accounts.

   Notwithstanding increasing demand for these services, we believe the number of providers has decreased over the past three years, primarily as a result of industry consolidation and bankruptcies. We believe this consolidation trend will continue and will benefit a small number of service providers that have the resources and infrastructure to cost effectively provide the scalability, performance, reliability and business continuity that customers expect.

Our Strategy

   Our goal is to become the leading provider of outsourced managed hosting and managed application services for middle-market organizations. Key elements of our strategy are to:

   Deepen Existing Customer Relationships and Expand Our Customer Base. Most of our customers currently utilize only one of our service offerings. We plan to increase revenues with minimal additional costs by cross-selling our services to existing customers. We also plan to increase our customer base through direct sales and by expanding our channel relationships with key systems integrators and independent software vendors. For systems integrators, our flexibility and cost-effectiveness bolster their application development and management service. For independent software vendors, we provide the ability to offer their software as a managed service.

   Improve Operating Margins Through Efficiencies. We have made significant improvements to our overall cost structure during the last twelve months. We intend to continue to improve operating margins as we improve the efficiency of our operations. As we grow, we will take advantage of our infrastructure capacity, our CAM platform and our automated processes. Due to the fixed cost nature of our infrastructure, increased customer revenue results in incremental improvements in our operating margins.

   Grow Through Disciplined Acquisitions. We intend to derive much of our future growth through acquisitions of technologies, products and companies that improve our services and strengthen our position in our target markets. By utilizing our expertise in acquiring and effectively integrating complementary companies, we can eliminate duplicative operations, reduce costs and improve our operating margins. We will acquire companies that provide valuable technical capabilities and entry into target markets, and allow us to take advantage of our existing technical and physical infrastructure.

   Emphasize and Invest in New High-Growth Service Areas. We plan to target emerging high growth service areas and increase the number of services we provide to our customers. These services include electronic software distribution and message archiving, as well as offering third-party enterprise software applications. As organizations become increasingly dependent on complex applications to run their businesses, we intend to provide technological innovation that will allow us to become an increasingly valuable provider to our customers.

Our Services

   We offer our customers a broad range of managed application, infrastructure and messaging services that can be deployed quickly and cost effectively. Our management expertise allows us to meet an expanding set of needs as our customers’ applications become more complex. Our experience and capabilities save our customers the time and cost of developing expertise in-house and we increasingly serve as the sole manager of our customers’ outsourced applications.

   All of our service offerings can be customized to meet our customers’ particular needs. Our proprietary CAM platform enables us to offer valuable flexibility without the significant costs associated with traditional customization.

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   Our services include:

Managed Application Services (A-Services)

   Application Hosting Services — We provide fully managed application hosting services. We manage data centers, Internet connectivity, servers and networking, security (including firewalls, virtual private networks and intrusion detection), storage, load balancers, database clusters, operating systems, and Web and application servers.

   Application Management Services — We provide application management services for leading databases and complex software such as financial, enterprise resource planning, supply chain management and customer relationship management applications from software providers including PeopleSoft, Microsoft, Oracle and Siebel. Application management services are available in one of our data centers or via remote management on a customer’s premises.

   Application Development Services — We customize our customers’ Web sites to enable them to share Web-based information. Our development systems and software tools allow our customers to update and access the back-end systems that control and populate the data that updates their Web sites.

Managed Infrastructure Services (I-Services)

   Content and Electronic Software Distribution Services — Our content and electronic software distribution services allow customers to accelerate the distribution of Internet-based data to users while reducing costs typically associated with this function. Currently, our two primary areas of focus within this business are our caching and acceleration services and our electronic software distribution services.

  •  Our caching and acceleration services are specifically designed to bring Web content and information closer to the end user, which results in a decrease in overall bandwidth usage for the customer as well as an increase in overall performance regardless of the user’s Internet connection.
 
  •  Our electronic software distribution services allow software manufacturers to securely and reliably distribute patches, updates, and even large new versions of their software products to users. This service decreases their software distribution costs and increases their ability to distribute updates quickly and accurately by permitting them to largely bypass traditional distribution processes such as shipping a CD.

   Colocation Services — Our data centers provide our colocation customers with a secure place to gain rapid access to the Internet, without having to build their own physical infrastructure. Our data centers include multiple levels of security with camera surveillance, redundant uninterruptible power supply, heating, ventilation and air conditioning, monitored customer access 24 hours a day, seven days a week, and advanced fire suppression.

   Bandwidth Services — Our data centers provide Internet connectivity via a wide range of network providers and offer competitive bandwidth pricing.

   Security Services — We offer industry standard security services, including managed firewalls, intrusion detection, denial of service attack prevention and exposure analysis. For our security services, we utilize software and hardware from vendors including Netscreen, Checkpoint and Cisco.

   Disaster Recovery Services — Features of our disaster recovery program include back-up equipment, redundant data centers for physical separation, tape back-up and off-site archiving, storage on-demand, load balancing, fully replicated data content, remote access, and professional consulting services.

Managed Messaging Services (M-Services)

   Our M-Services include the monitoring and management of messaging applications, such as Microsoft Exchange and Lotus Domino, allowing customers to outsource their critical messaging applications. Customers can host their applications in one of our data centers or keep their servers in their own facility, which we monitor and manage remotely. In addition, our customers can choose to utilize

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dedicated servers or shared servers. We provide expert services to assist our customers with the migration from legacy or proprietary messaging systems to Microsoft Exchange or Lotus Domino. We also have expertise to customize messaging and collaborative applications for our customers. We offer user provisioning, spam filtering, virus protection and enhanced monitoring and reporting.

   We are developing managed messaging services focused on allowing our customers to outsource other workplace communication applications, including online collaboration, business-class instant messaging, shared desktop and other solutions.

Collaborative Application Management (CAM) Platform

   Our proprietary CAM platform is a critical element of each of our service offerings. Our CAM platform allows us to work with our customers’ information technology teams, systems integrators and other third parties to provide our services to customers. Our CAM platform and its user interface help ensure full transparency to the customer and seamless operation of outsourced applications and infrastructure, including: (1) hardware, operating system, database and application monitoring; (2) event management; (3) problem resolution management; and (4) integrated change and configuration management tools. Our CAM platform includes:

   Event Detection System — Our proprietary technology allows our operations personnel to efficiently process alerts across heterogeneous computing environments. This system collects and aggregates data from all of the relevant systems management software packages utilized by an information technology organization.

   Synthetic Transaction Monitoring — Our proprietary synthetic transaction methods emulate the end-user experience and monitor for application latency or malfunctions that affect user productivity.

   Automated Remediation — Our CAM platform allows us to proactively monitor, identify and fix common problems associated with the applications we manage on behalf of our customers. These automated fixes help ensure availability and reliability by remediating known issues in real time, and keeping applications up and running while underlying problems or potential problems are diagnosed.

   Component Information Manager — This central repository provides a unified view of disparate network, database, application and hardware information.

   Escalation Manager — This workflow automation technology allows us to streamline routine tasks and escalate critical issues in a fraction of the time that manual procedures require. Escalation manager initiates specific orders and tasks based on pre-defined conditions, ensuring clear, consistent communications with our customers.

Our Infrastructure

   Our infrastructure has been designed specifically to meet the demanding technical requirements of providing our services to our customers. We securely provide our services across Windows, Unix and Linux platforms. We believe our infrastructure, together with our trained and experienced staff, enable us to offer market-leading levels of service backed by high service level guarantees.

   Network Operations Centers — We monitor the operations of our infrastructure and customer applications from our own state-of-the-art network operations centers. Network and system management and monitoring tools continuously monitor our network and server performance. Our network operations center performs first-level problem identification, validation and resolution. Our primary network operations center in Andover, Massachusetts is staffed 24 hours a day, seven days a week with network, security, Windows, Unix and Linux personnel. We have technical support personnel located in our facilities in San Jose, California; Syracuse, New York; and Houston, Texas, who provide initial and escalated support, 24 hours a day, seven days a week for our customers. Our engineers and support personnel are promptly alerted to problems, and we have established procedures for rapidly resolving any technical issues that arise.

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   Data Centers — We currently have 16 data centers located in the United States and one data center located in the United Kingdom. Our data centers incorporate technically sophisticated components which are designed to be fault-tolerant. The components used in our data centers include redundant core routers, redundant core switching hubs and secure virtual local area networks. We utilize the equipment and tools necessary for our data center operations, including our infrastructure hardware, networking and software products, from industry leaders such as BMC, Cisco, Dell, EMC, Hewlett-Packard, Microsoft, Oracle and Sun Microsystems.

   Internet Connectivity — We have redundant high-capacity Internet connections to Level 3, Internap, WilTel and XO Communications. We have deployed direct private transit and peering Internet connections to utilize the provider’s peering capabilities and to enhance routes via their networks to improve global performance. Our private transit system enables us to provide fast, reliable access for our customers’ information technology infrastructure and applications.

Sales and Marketing

   Direct Sales — Our direct sales professionals are organized geographically into groups located in Massachusetts, New York, California, Virginia and the United Kingdom. Our sales teams meet with customers to understand and identify their individual business requirements, then translate those requirements into tailored services. Our sales teams are also supported by customer relationship managers who are assigned to specific accounts in order to identify and take advantage of cross-selling opportunities. To date, most of our sales have been realized through our direct sales force.

   Channel Relationships — We also sell our services through third parties, including IBM, Progress Software application providers, SingTel and Accenture, pursuant to reseller or referral contracts with such third parties. These contracts are generally one to three years in length and provide the reseller a discount of approximately 25% from our list price or require us to pay a referral fee, typically ranging from approximately 4% to 10% of the amounts we receive from the customer. Typically, these third parties resell our services to their customers under their private label brand or under the NaviSite brand. In addition, we jointly market and sell our services with the products of Progress Software. For systems integrators, our flexibility and cost-effectiveness bolsters their application development and management services. For independent software vendors, we provide the opportunity to offer their software as a managed service.

   Marketing — Our marketing organization is responsible for defining our overall market strategy. We focus on identifying key market opportunities and customer segments which will best match our service portfolio and creating marketing programs which target those segments. We are actively building general awareness of our company and our strategy through public relations, marketing communications and product marketing. The marketing organization supports direct sales.

Customers

   Our customers include mid-sized companies, divisions of large multi-national companies and government agencies. Our customers operate in a wide variety of industries, such as technology, manufacturing, retail, business services and government agencies.

   We increased our customer base to approximately 700 customers as of July 31, 2003 from 145 customers as of July 31, 2002, principally through acquisitions, an increase in our product offering portfolio and increased market demand. We currently have approximately 1,100 customers, including approximately 191 customers through our sales channel relationships.

   We derived approximately 2%, 31% and 35% of our revenue from CMGI and CMGI affiliates for the fiscal years ended July 31, 2003, 2002 and 2001, respectively.

   We derived approximately 21%, 0% and 0% of our revenue from the New York State Department of Labor for the fiscal years ended July 31, 2003, 2002 and 2001, respectively. The contract with the New York State Department of Labor is scheduled to expire in June 2005, but the New York State

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Department of Labor has the right to terminate the contract at any time by providing us with 60 days notice. On November 25, 2003, we announced that the New York State Department of Labor added $52 million to its existing contract with us to provide application hosting and application development services in support of the America’s Job Bank Web site and related programs. This amendment to the existing five-year, $83 million hosting and services contract also decreased the hourly rates for various services that we provide under the contract by an average of approximately 21%. America’s Job Bank is a 20-year-old labor exchange network developed and funded by the U.S. Department of Labor and state employment service offices to link employers and job seekers. The New York State Department of Labor has the ability to purchase additional services to meet the projected contract needs until the expiration of the contract in 2005.

   Other than CMGI, CMGI affiliates and the New York State Department of Labor, no other customer represented 10% or more of our revenue for the fiscal years ended July 31, 2003, 2002 and 2001. Substantially all of our revenues are derived from, and substantially all of our plant, property and equipment are located in, the United States.

Competition

   We compete in the managed hosting and application services market, the managed infrastructure services market and the managed messaging services market. These markets are fragmented, highly competitive and likely to be characterized by industry consolidation.

   We believe that participants in these markets must grow rapidly and achieve a significant presence to compete effectively. We believe that the primary competitive factors determining success in our markets include:

  •  quality of service delivered;
 
  •  ability to consistently measure, track and report operational metrics;
 
  •  application hosting, infrastructure and messaging management expertise;
 
  •  fast, redundant and reliable Internet connectivity;
 
  •  a robust infrastructure providing availability, speed, scalability and security;
 
  •  comprehensive and diverse service offerings and timely addition of value-add services;
 
  •  brand recognition;
 
  •  strategic relationships;
 
  •  competitive pricing; and
 
  •  adequate capital to permit continued investment in infrastructure, customer service and support, and sales and marketing.

   We believe that we compete effectively based on our breadth of service offerings, the strength of our CAM platform, our existing infrastructure capacity and our pricing.

   Our current and prospective competitors include:

  •  hosting and related services providers, including Digex Incorporated (a subsidiary of Worldcom, Inc.), Data Return, LLC, Globix Corp., Computer Sciences Corporation and local and regional hosting providers;
 
  •  systems integrators and information technology outsourcing firms, such as SevenSpace Inc., Totality Corp. and BearingPoint, Inc.;
 
  •  application services providers, such as Corio, Inc., USinternetworking, Inc. (USi) and Blue Star Systems, Inc.;

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  •  content and electronic software distribution providers, such as Akamai, Inc., Speedera Networks, Inc., Digital River, Inc., Intraware, Inc. and element 5 AG;
 
  •  colocation providers, including Cable & Wireless PLC (which acquired the Exodus and Digital Island businesses), Verio, Inc. (a subsidiary of NTT Communications Corporation), Rackspace, Ltd., Inflow, Inc., Interland, Inc., XO Communications, Inc. and Switch & Data Facilities Company, Inc.; and
 
  •  messaging providers, including Critical Path, Inc., Connectria Corp., Internoded, Inc., USA.net, Inc. and Apptix, ASA.

Employees

   As of June 17, 2004, we had 589 employees. Of these employees, 389 were principally engaged in operations, 109 were principally engaged in sales and marketing and 91 were principally engaged in general and administration. None of our employees is party to a collective bargaining agreement and we believe our relationship with our employees is good. We also retain consultants and independent contractors on a regular basis to assist in the completion of projects.

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Facilities

   Our executive offices are located at 400 Minuteman Road, Andover, Massachusetts. We lease offices and data centers in various cities across the United States and have an office and data center in the United Kingdom. The table below sets forth a list of our leased offices and data centers:

                     
Square Footage
Leased
Location Type (Approximate) Lease Expiration




Andover, MA
  Office     16,500       March 2006  
Andover, MA
  Data Center and Office     90,000       January 2012  
San Jose, CA
  Data Center and Office     66,350       November 2006  
La Jolla, CA(1)
  Office     16,810       December 2006  
Los Angeles, CA
  Data Center     34,711       February 2009  
Syracuse, NY
  Data Center     21,246       November 2008  
Syracuse, NY
  Office     44,002       December 2007  
Syracuse, NY
  Office     5,016       May 2009  
New York, NY
  Office     1,500       October 2004  
Chicago, IL(1)
  Office     4,453       February 2008  
Chicago, IL
  Data Center     6,800       January 2009  
Oak Brook, IL
  Data Center     16,780       September 2009  
Vienna, VA(1)
  Office     22,270       July 2005  
Vienna, VA
  Data Center and Office     23,715       February 2010  
Houston, TX
  Data Center and Office     14,772       October 2005  
Las Vegas, NV
  Data Center     28,560       February 2010  
Milwaukee, WI
  Data Center     5,200       March 2010  
Santa Clara, CA
  Data Center     25,000       March 2006  
New York, NY
  Data Center     33,286       May 2008  
San Francisco, CA
  Data Center     23,342       November 2009  
Dallas, TX
  Data Center     27,370       January 2010  
Atlanta, GA
  Office     10,577       September 2006  
Atlanta, GA
  Office     21,670       May 2005  
Boston, MA
  Data Center and Office     4,651       December 2005  
Bedford, NH
  Data Center and Office     46,673       September 2004  
Lexington, MA
  Office     21,056       April 2006  
London, England
  Data Center     4,022       March 2010  
Amsterdam, The Netherlands(1)
  Office     3,017       January 2005  


  (1)  We have abandoned our administrative space at this office.

   We believe that these offices and data centers are adequate to meet our foreseeable requirements and that suitable additional or substitute space will be available on commercially reasonable terms, if needed.

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MANAGEMENT

   The following table sets forth information regarding individuals who currently serve as our directors or executive officers.

             
Name Age Position



Andrew Ruhan
    41     Chairman of the Board of Directors
Arthur P. Becker
    53     Chief Executive Officer, President and Director
John J. Gavin, Jr. 
    48     Chief Financial Officer
Gabriel Ruhan
    38     Chief Operating Officer and Director
Kenneth Drake
    37     General Counsel and Secretary
James H. Dennedy
    38     Director
Larry W. Schwartz
    40     Director
Thomas R. Evans
    49     Director

   Andrew Ruhan has served as our Chairman of the Board of Directors since September 2002. Mr. Ruhan is a private investor in the United Kingdom. In addition, since 2000, Mr. Ruhan has served as Chief Executive Officer of ClearBlue Technologies, Inc., a managed service provider based in San Francisco, California. From 1998 to 2002, Mr. Ruhan was the co-founder and Chief Executive Officer of GlobalSwitch Group, a data center company in the United Kingdom. Prior to 1998, Mr. Ruhan was a private investor. Mr. Ruhan holds a 10% equity interest in Unicorn Worldwide Holdings Limited, a managing member of Atlantic Investors. Mr. Andrew Ruhan is the brother of Mr. Gabriel Ruhan.

   Arthur P. Becker has served as a member of our Board of Directors since September 2002 and has been our Chief Executive Officer and President since February 2003. Since 2000, Mr. Becker has served as Vice Chairman and a director of ClearBlue Technologies, Inc. Mr. Becker is also a co-founder of Atlantic Investors, LLC, a holder of approximately 61% of the outstanding shares of our common stock prior to this offering. For the past five years, Mr. Becker has been a private investor and since 1999 he has been a managing member of Madison Technology LLC, which is a managing member of Atlantic Investors, LLC.

   John J. Gavin, Jr. has served as our Chief Financial Officer since May 2004. From January 2002 to April 2004, Mr. Gavin was a private investor. From February 2000 through December 2001, Mr. Gavin served as the Senior Vice President and Chief Financial Officer of Cambridge Technology Partners, which was acquired by Novell, Inc. Prior to his work at Cambridge Technology Partners, Mr. Gavin spent twelve years at Data General Corporation rising through the financial organization to Vice President and Chief Financial Officer. Mr. Gavin also spent ten years at Price Waterhouse LLP in various accounting and audit positions including serving as Senior Manager in charge of multi-national audits. Since October 2001, Mr. Gavin has served on the Board of Directors of Ascential Software Corporation, an enterprise software company providing data integration and management solutions. Mr. Gavin is a certified public accountant.

   Gabriel Ruhan has served as a member of our Board of Directors since October 2002 and has been our Chief Operating Officer since April 2003. From December 2002 until April 2003, Mr. Ruhan served as our Executive Vice President for Business Development. Mr. Ruhan is a director of ClearBlue Technologies, Inc. From 1998 to 2002, Mr. Ruhan was Corporate Development Director of GlobalSwitch Group, a data center company in the United Kingdom. Prior to 1998, Mr. Ruhan was a private investor. Mr. Gabriel Ruhan is the brother of Mr. Andrew Ruhan.

   Kenneth Drake has served as our General Counsel since September 2003 and as our Secretary since October 2003. From July 2001 to September 2003, Mr. Drake served as a senior corporate associate with the law firm of Heller Ehrman White and McAuliffe LLP. From March 2000 to November 2000, Mr. Drake served as General Counsel and Secretary of Phlair, Inc., an application software company. Mr. Drake served as a legal consultant from February 1999 to February 2000 and from January 2001 to

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June 2001. From September 1992 to January 1999, Mr. Drake served as a corporate associate with the law firm Sonnenschein Nath & Rosenthal.

   James H. Dennedy has served as a member of our Board of Directors since January 2003. Mr. Dennedy is the President of Strategic Software Holdings, LLC, an investment firm making equity investments and buyouts on behalf of itself and its investors in the enterprise software industry. From April 2001 to March 2002, Mr. Dennedy served as President and Chief Operating Officer of divine Managed Services. From January 2000 to March 2001, Mr. Dennedy served as Global Vice President at marchFirst, Inc. Mr. Dennedy also serves on the Board of Directors of Abridean, Inc., an enterprise software company providing software provisioning and identity management solutions.

   Larry W. Schwartz has served as a member of our Board of Directors since April 2003. Since January 2004, Mr. Schwartz has been the principal of The Wenham Group, a provider of strategic advisory services founded by Mr. Schwartz. From May 2000 to December 2003, Mr. Schwartz served as the Senior Vice President and Chief Restructuring Officer for Genuity Inc. Mr. Schwartz also served as a member of Genuity’s senior management committee. Prior to joining Genuity, Mr. Schwartz was a partner with the law firm of Choate Hall & Stewart from September 1995 to April 2000, where he specialized in mergers, acquisitions, buyouts and venture capital transactions involving communications and media companies.

   Thomas R. Evans has served as a member of our Board of Directors since October 2003. Since September 2002, Mr. Evans has been a private investor and consultant. From August 1999 to August 2002, Mr. Evans served as Chairman of the Board and Chief Executive Officer for Official Payments Corp., an online payment service for government taxes and fees. From March 1998 to June 1999, Mr. Evans was the President and Chief Executive Officer of the website development and hosting community, GeoCities, Inc., which was acquired by Yahoo! Inc.

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DESCRIPTION OF CAPITAL STOCK

General

   Our authorized capital stock consists of 395,000,000 shares of common stock, $0.01 par value, and 5,000,000 shares of preferred stock, $0.01 par value. The following summary of the terms of our common stock and preferred stock is subject to, and qualified in its entirety by, the provisions in our certificate of incorporation and bylaws, which are included as exhibits to the registration statement of which this prospectus is a part.

Common Stock

   As of June 17, 2004, there were 27,918,049 shares of our common stock outstanding. Upon completion of this offering, there will be 35,218,049 shares of our common stock outstanding. Shares of our common stock have the following rights, preferences and privileges:

   Voting Rights. Each outstanding share of our common stock is entitled to one vote on all matters submitted to a vote of our stockholders, including the election of directors. There are no cumulative voting rights, and therefore the holders of a plurality of the shares of our common stock voting for the election of directors may elect all of the members of our Board of Directors standing for election.

   Dividends. Holders of our common stock are entitled to receive dividends at the same rate if and when dividends are declared by our Board of Directors out of assets legally available for the payment of dividends, subject to preferential rights of any outstanding shares of preferred stock.

   Liquidation. In the event of a liquidation, dissolution or winding up of our affairs, whether voluntary or involuntary, after payment of our debts and other liabilities and making provision for the holders of any outstanding shares of our preferred stock, our remaining assets will be distributed ratably among the holders of shares of our common stock.

   Rights and Preferences. Our common stock has no preemptive, redemption, conversion or subscription rights. The rights, powers, preferences and privileges of holders of our common stock are subject to, and may be adversely affected by, the rights of the holders of shares of any series of our preferred stock that we may designate and issue in the future.

   Fully Paid and Nonassessable. All outstanding shares of our common stock are, and the shares of our common stock to be issued pursuant to this offering will be, fully paid and nonassessable.

Preferred Stock

   Pursuant to the terms of our certificate of incorporation, our Board of Directors is authorized, subject to any limitations prescribed by Delaware law, without further stockholder approval, to issue from time to time up to an aggregate of 5,000,000 shares of our preferred stock, in one or more classes or series, and to fix the voting powers, full or limited, or no voting powers, and the distinctive designations, preferences and relative, participating, optional or other special rights and the qualifications, limitations or restrictions of these rights, of the shares of each such class or series. Our Board of Directors is authorized to issue shares of our preferred stock with voting, conversion and other rights and preferences that could adversely affect the voting power or other rights of the holders of our common stock.

   We have no current plans to issue any shares of our preferred stock. However, the issuance of shares of our preferred stock or of rights to purchase shares of our preferred stock could have the effect of making it more difficult for a third party to acquire, or of discouraging a third party from attempting to acquire, a majority of our outstanding common stock.

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Delaware Business Combination Statute

   Our certificate of incorporation contains a provision expressly electing not to be governed by Section 203 of the Delaware General Corporation Law. In general, Section 203 restricts some business combinations involving interested stockholders or their affiliates. An interested stockholder is defined as any person or entity that is the beneficial owner of at least 15% of a corporation’s voting stock or is an affiliate or associate of the corporation or the owner of 15% or more of the outstanding voting stock of the corporation at any time in the past three years. Because of this election, Section 203 will not apply to us.

Other Rights of Stockholders

   Under our certificate of incorporation and our by-laws, only our Board of Directors, our chairman of the board, our chief executive officer, our president or the holders of at least 40% of our outstanding shares of common stock may call a special meeting of stockholders. In addition, under our by-laws, stockholders are required to provide advance notice for nominations for the election of directors or for proposing matters that can be acted on by stockholders at stockholders’ meetings.

Transfer Agent and Registrar

   EquiServe Limited Partnership serves as transfer agent and registrar for our common stock.

SHARES ELIGIBLE FOR FUTURE SALE

   Upon completion of this offering, we will have outstanding 35,218,049 shares of our common stock. The 9,000,000 shares of common stock being sold by us and the selling stockholders in this offering and all of our currently outstanding shares of common stock, other than those shares held by our “affiliates,” as such term is defined under Rule 144 of the Securities Act, approximately 147,483 shares transferred by CBT to its stockholders during the past 12 months and 426,134 shares transferred by Atlantic Investors to a member during the past 12 months, will be freely tradable without restriction or registration under the Securities Act.

   Shares held by our affiliates, which generally include our directors and executive officers and persons owning 10% or more of our common stock, are subject to restrictions on resale in accordance with Rule 144 under the Securities Act. As of June 17, 2004, we estimate that approximately 24,922,209 shares of our common stock were held by our affiliates. In general, under Rule 144 as currently in effect, an affiliate would be entitled to sell within any three-month period a number of shares that does not exceed the greater of one percent of our then outstanding shares of common stock or the average weekly trading volume of our common stock during the four calendar weeks preceding notice of the sale. Sales under Rule 144 are subject to certain manner of sale provisions, notice requirements and the availability of current public information about us.

   Our officers and directors, Atlantic Investors, LLC and the selling stockholders in this offering (including their affiliates) have agreed that they will not sell or otherwise transfer any common stock owned by them without the prior written consent of Thomas Weisel Partners LLC for a period of 90 days from the date of this prospectus. Upon expiration of this 90-day period, approximately 20,283,792 shares previously covered by the lock-up agreements will be eligible for resale in the public market, subject to compliance with the volume limitations and other restrictions of Rule 144. In addition, Surebridge, Inc. has agreed with us that it will not sell or otherwise transfer any common stock owned by it until June 10, 2005.

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PRINCIPAL AND SELLING STOCKHOLDERS

   The following table sets forth information with respect to the beneficial ownership of our common stock as of June 17, 2004 (unless otherwise indicated) and upon completion of this offering by the following:

  •  each person known by us to beneficially own more than 5% of the outstanding shares of our common stock;
 
  •  each of our directors;
 
  •  each of our named executive officers;
 
  •  all of our current executive officers and directors as a group; and
 
  •  each of the selling stockholders.

   For purposes of the following tables, beneficial ownership is determined in accordance with the rules promulgated by the Securities and Exchange Commission and the information is not necessarily indicative of beneficial ownership for any other purpose. Except as otherwise noted in the footnotes to the respective tables, we believe that each person or entity named in the tables has sole voting and investment power with respect to all shares of our common stock shown as beneficially owned by them (or shares such power with his or her spouse). Under such rules, shares of our common stock issuable under options that are currently exercisable or exercisable within 60 days after June 17, 2004, or presently exercisable options, are deemed outstanding and are included in the number of shares beneficially owned by a person named in the table and are used to compute the percentage ownership of that person. These shares are not, however, de