e10vq
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
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þ |
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended April 30, 2007
OR
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o |
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number: 000-27597
NAVISITE, INC.
(Exact name of registrant as specified in its charter)
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Delaware
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52-2137343 |
(State or other jurisdiction of
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(I.R.S. Employer |
incorporation or organization)
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Identification No.) |
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400 Minuteman Road |
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Andover, Massachusetts
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01810 |
(Address of principal executive offices)
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(Zip Code) |
(978) 682-8300
(Registrants telephone number, including area code)
None
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer,
or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in
Rule 12b-2 of the Exchange Act.
Large accelerated filer o Accelerated filer o Non-accelerated filer þ
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act).
Yes o No þ
As of June 1, 2007, there were 31,373,338 shares outstanding of the registrants common stock,
par value $.01 per share.
NAVISITE, INC.
TABLE OF CONTENTS
REPORT ON FORM 10-Q
FOR THE QUARTER ENDED APRIL 30, 2007
2
PART I: FINANCIAL INFORMATION
Item 1. Financial Statements
NAVISITE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands, except per share amounts)
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April 30, |
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July 31, |
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2007 |
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2006 |
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ASSETS |
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Current assets: |
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Cash and cash equivalents |
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$ |
4,624 |
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$ |
3,360 |
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Accounts receivable, less allowance for doubtful accounts of
$936 and $1,944 at April 30, 2007 and July 31, 2006,
respectively |
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15,737 |
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11,872 |
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Unbilled accounts receivable |
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1,095 |
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430 |
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Due from related party |
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30 |
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Prepaid expenses and other current assets |
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9,325 |
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8,804 |
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Total current assets |
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30,781 |
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24,496 |
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Property and equipment, net |
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14,757 |
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14,914 |
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Customer lists, less accumulated amortization of $21,149 and
$18,104 at April 30, 2007 and July 31, 2006, respectively |
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8,642 |
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11,687 |
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Goodwill |
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43,159 |
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43,159 |
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Other assets |
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6,467 |
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7,214 |
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Restricted cash |
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931 |
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939 |
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Total assets |
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$ |
104,737 |
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$ |
102,409 |
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LIABILITIES AND STOCKHOLDERS EQUITY (DEFICIT) |
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Current liabilities: |
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Notes payable, current portion |
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$ |
5,690 |
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$ |
2,115 |
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Notes payable to the AppliedTheory Estate |
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6,000 |
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6,000 |
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Capital lease obligations, current portion |
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2,053 |
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2,081 |
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Accounts payable |
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4,318 |
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5,338 |
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Accrued expenses and other current liabilities |
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13,298 |
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13,732 |
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Deferred revenue, deferred other income and customer deposits |
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4,603 |
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4,302 |
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Total current liabilities |
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35,962 |
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33,568 |
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Capital lease obligations, less current portion |
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871 |
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741 |
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Accrued lease abandonment costs, less current portion |
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845 |
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1,628 |
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Deferred tax liability |
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3,391 |
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2,512 |
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Other long-term liabilities |
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3,362 |
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3,258 |
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Notes payable, less current portion |
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60,300 |
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59,678 |
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Note payable to related party |
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3,000 |
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Total liabilities |
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104,731 |
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104,385 |
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Commitments and contingencies (Note 10) |
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Stockholders equity (deficit): |
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Preferred stock, $0.01 par value; Authorized 5,000 shares;
Issued and outstanding: no shares at April 30, 2007 and July
31, 2006 |
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Common stock, $0.01 par value; Authorized 395,000 shares;
Issued and outstanding: 31,351 at April 30, 2007 and 28,959 at
July 31, 2006 |
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314 |
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290 |
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Accumulated other comprehensive income |
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305 |
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203 |
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Additional paid-in capital |
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478,074 |
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467,400 |
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Accumulated deficit |
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(478,687 |
) |
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(469,869 |
) |
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Total stockholders equity (deficit) |
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6 |
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(1,976 |
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Total liabilities and stockholders equity (deficit) |
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$ |
104,737 |
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$ |
102,409 |
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See accompanying notes to condensed consolidated financial statements.
3
NAVISITE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands, except per share amounts)
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Three Months Ended |
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Nine Months Ended |
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April 30, |
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April 30, |
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April 30, |
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April 30, |
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2007 |
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2006 |
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2007 |
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2006 |
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Revenue |
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$ |
32,664 |
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$ |
27,850 |
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$ |
91,225 |
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$ |
79,524 |
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Revenue, related parties |
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84 |
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73 |
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260 |
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144 |
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Total revenue |
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32,748 |
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27,923 |
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91,485 |
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79,668 |
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Cost of revenue |
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21,914 |
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19,125 |
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61,703 |
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55,495 |
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Gross profit |
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10,834 |
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8,798 |
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29,782 |
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24,173 |
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Operating expenses: |
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Selling and marketing |
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4,274 |
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4,281 |
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12,129 |
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11,485 |
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General and administrative |
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5,508 |
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5,441 |
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16,662 |
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16,421 |
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Impairment, restructuring and other |
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136 |
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(287 |
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513 |
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Total operating expenses |
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9,782 |
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9,858 |
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28,504 |
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28,419 |
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Income (loss) from operations |
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1,052 |
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(1,060 |
) |
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1,278 |
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(4,246 |
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Other income (expense): |
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Interest income |
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79 |
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137 |
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163 |
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191 |
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Interest expense |
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(3,307 |
) |
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(2,377 |
) |
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(9,735 |
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(6,369 |
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Other income, net |
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110 |
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145 |
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356 |
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418 |
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Loss before income tax expense |
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(2,066 |
) |
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(3,155 |
) |
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(7,938 |
) |
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(10,006 |
) |
Income tax expense |
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(293 |
) |
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(293 |
) |
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(880 |
) |
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(880 |
) |
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Net loss |
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$ |
(2,359 |
) |
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$ |
(3,448 |
) |
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$ |
(8,818 |
) |
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$ |
(10,886 |
) |
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Basic and diluted net loss per common share |
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$ |
(0.08 |
) |
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$ |
(0.12 |
) |
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$ |
(0.29 |
) |
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$ |
(0.38 |
) |
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Basic and diluted weighted average number
of common shares outstanding |
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31,128 |
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28,554 |
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29,947 |
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28,505 |
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See accompanying notes to condensed consolidated financial statements.
4
NAVISITE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
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Nine Months Ended |
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April 30, |
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April 30, |
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2007 |
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2006 |
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Cash flows from operating activities: |
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Net loss |
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$ |
(8,818 |
) |
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$ |
(10,886 |
) |
Adjustments to reconcile net loss to net cash provided by (used
for) operating activities: |
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Depreciation and amortization |
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10,285 |
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9,477 |
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Mark to market for interest rate cap |
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164 |
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Costs (recoveries) associated with abandoned leases |
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(287 |
) |
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513 |
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Amortization of warrants |
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1,642 |
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158 |
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Stock based compensation |
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2,686 |
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3,112 |
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Provision for bad debts |
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50 |
|
Deferred income tax expense |
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|
880 |
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|
880 |
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Changes in operating assets and liabilities: |
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Accounts receivable |
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(3,865 |
) |
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(1,508 |
) |
Unbilled accounts receivable |
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(665 |
) |
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(147 |
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Due from related party |
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30 |
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|
58 |
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Prepaid expenses and other current assets, net |
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(509 |
) |
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(2,222 |
) |
Long term assets |
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583 |
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(873 |
) |
Accounts payable |
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(1,020 |
) |
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|
607 |
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Long-term liabilities |
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2,636 |
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|
778 |
|
Accrued expenses, deferred revenue and customer deposits |
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(574 |
) |
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(7,710 |
) |
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Net cash provided by (used for) operating activities |
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3,168 |
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(7,713 |
) |
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Cash flows from investing activities: |
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Purchase of property and equipment |
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(5,107 |
) |
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(4,327 |
) |
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Net cash used for investing activities |
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(5,107 |
) |
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(4,327 |
) |
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Cash flows from financing activities: |
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Restricted cash |
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(2 |
) |
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(6,400 |
) |
Proceeds from exercise of stock options and warrants |
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1,929 |
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|
527 |
|
Borrowings on notes payable |
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5,517 |
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|
70,436 |
|
Repayment of notes payable |
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(2,411 |
) |
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|
(22,460 |
) |
Payments on note payable to Waythere, Inc. (formerly Surebridge) |
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(34,611 |
) |
Payments on capital lease obligations |
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(1,830 |
) |
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|
(1,536 |
) |
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Net cash provided by financing activities |
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|
3,203 |
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|
5.956 |
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Net increase (decrease) in cash and cash equivalents |
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1,264 |
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(6,084 |
) |
Cash and cash equivalents, beginning of period |
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|
3,360 |
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|
|
6,816 |
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Cash and cash equivalents, end of period |
|
$ |
4,624 |
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|
$ |
732 |
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Supplemental disclosure of cash flow information: |
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Cash paid for interest |
|
$ |
6,617 |
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|
$ |
9,550 |
|
Equipment purchased under capital leases |
|
$ |
1,932 |
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|
$ |
1,578 |
|
See accompanying notes to condensed consolidated financial statements.
5
NAVISITE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(1) Description of Business
NaviSite, Inc. (NaviSite, the Company, we, us or our) provides information
technology (IT) hosting, outsourcing and professional services for mid- to large-sized
organizations. Leveraging our set of technologies and subject matter expertise, we deliver
cost-effective, flexible solutions that provide responsive and predictable levels of service for
our clients business. Over 950 companies across a variety of industries rely on NaviSite to
build, implement and manage their mission-critical systems and applications. NaviSite is a trusted
advisor committed to ensuring the long-term success of our customers business applications and
technology strategies. NaviSite has 14 state-of-the-art data centers across the U.S., U.K. and
India. Substantially all revenue is generated from customers in the United States.
(2) Summary of Significant Accounting Policies
(a) Basis of Presentation and Principles of Consolidation
The accompanying unaudited condensed consolidated financial statements include the accounts
and operations of NaviSite, Inc. and its wholly-owned subsidiaries and have been prepared pursuant
to the rules and regulations of the Securities and Exchange Commission regarding interim financial
reporting. Accordingly, they do not include all of the information and notes required by U.S.
generally accepted accounting principles for complete financial statements and thus should be read
in conjunction with the audited consolidated financial statements included in our Annual Report on
Form 10-K filed on October 26, 2006. In the opinion of management, the accompanying unaudited
condensed consolidated financial statements contain all adjustments, consisting only of those of a
normal recurring nature, necessary for a fair presentation of the Companys financial position,
results of operations and cash flows at the dates and for the periods indicated. The results of
operations for the three and nine months ended April 30, 2007 are not necessarily indicative of the
results expected for the remainder of the fiscal year ending July 31, 2007.
All significant intercompany accounts and transactions have been eliminated in consolidation.
The preparation of financial statements in conformity with U.S. generally accepted accounting
principles requires management to make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenue and expenses during the reported period.
Actual results could differ from those estimates. Significant estimates made by management include
the useful lives of fixed assets and intangible assets, recoverability of long-lived assets, the
collectability of receivables and other assumptions for sublease and lease abandonment reserves.
(b) Revenue Recognition
Revenue consists primarily of monthly fees for custom and packaged application management,
hosting, colocation and professional services. The Company also derives revenue from the sale of
software and related maintenance contracts. Reimbursable expenses charged to clients are included
in revenue and cost of revenue. Application management, hosting and colocation revenue (other than
installation fees) is billed and recognized over the term of the contract, generally one to three
years, based on actual usage. Payments received in advance of providing services are deferred until
the period such services are provided. Revenue from professional services is recognized on either a
time and material basis as the services are performed or under the percentage of completion method
for fixed-price contracts. When current contract estimates indicate that a loss is probable, a
provision is made for the total anticipated loss in the current period. Contract losses are
determined to be the amount by which the estimated service costs of the contract exceed the
estimated revenue that will be generated by the contract. Unbilled accounts receivable represents
revenue for services performed that have not been billed. Billings in excess of revenue recognized
are recorded as deferred revenue until the applicable revenue recognition criteria are met. Revenue
from the sale of software is recognized when persuasive evidence of an arrangement exists, the
product has been delivered, the fees are fixed and determinable and collection of the resulting
receivable is reasonably assured. In instances where the Company also provides application
management and hosting services in conjunction with the sale of software, software revenue is
deferred and recognized ratably over the expected customer relationship period.
6
NAVISITE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
If we determine that collection of a fee is not reasonably assured, we defer the fee and
recognize revenue at the time collection becomes reasonably assured, which is generally upon
receipt of cash.
(c) Cash and Cash Equivalents and Restricted Cash
The Company considers all highly liquid securities with original maturities of three months or
less to be cash equivalents. The Company had restricted cash of $7.3 million and $7.4 million as of
April 30, 2007 and July 31, 2006, respectively, including $6.4 million and $6.5 million as of April
30, 2007 and July 31, 2006, respectively, that is classified as short-term in the Condensed
Consolidated Balance Sheets and is included in Prepaid expenses and other current assets.
Restricted cash represents cash held in escrow related to our Note Payable to the AppliedTheory
Estate (see Note 8) and cash collateral requirements for standby letters of credit associated with
several of the Companys facility and equipment leases.
(d) Property and Equipment
Property and equipment are stated at cost. Depreciation is computed using the straight-line
method over the estimated useful lives of the assets, which range from three to five years.
Leasehold improvements and assets acquired under capital leases are amortized using the
straight-line method over the shorter of the lease term or the estimated useful life of the asset.
Assets acquired under capital leases in which title transfers to us at the end of the agreement are
amortized over the useful life of the asset. Expenditures for maintenance and repairs are charged
to expense as incurred.
Renewals and betterments, which materially extend the life of assets, are capitalized and
depreciated. Upon disposal, the asset cost and related accumulated depreciation are removed from
their respective accounts and any gain or loss is reflected within Other income (expense), net in
our Condensed Consolidated Statements of Operations.
(e) Long-lived Assets, Goodwill and Other Intangibles
The Company follows the provisions of Statement of Financial Accounting Standards (SFAS) No.
144, Accounting for the Impairment or Disposal of Long-Lived Assets. This statement requires that
long-lived assets and certain identifiable intangibles be reviewed for impairment whenever events
or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.
Recoverability of assets to be held and used is measured by a comparison of the carrying amount of
an asset to the undiscounted future net cash flows expected to be generated by the asset. If such
assets are considered to be impaired, the impairment to be recognized is measured by the amount by
which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed
of are reported at the lower of the carrying amount or fair value less cost to sell.
The Company reviews the valuation of goodwill in accordance with SFAS No. 142, Goodwill and
Other Intangible Assets. Under the provisions of SFAS No. 142, goodwill is required to be tested
for impairment annually in lieu of being amortized. This testing is done in the fourth fiscal
quarter of each year. Furthermore, goodwill is required to be tested for impairment on an interim
basis if an event or circumstance indicates that it is more likely than not that an impairment loss
has been incurred. An impairment loss shall be recognized to the extent that the carrying amount of
goodwill exceeds its fair value. Impairment losses are recognized in operations. The Companys
valuation methodology for assessing impairment requires management to make judgments and
assumptions based on historical experience and projections of future operating performance. If
these assumptions differ materially from future results, the Company may record additional
impairment charges in the future.
(f) Concentration of Credit Risk
Our financial instruments include cash, accounts receivable, obligations under capital leases,
debt agreements, derivative instruments, accounts payable, and accrued expenses. As of April 30,
2007, the carrying cost of these instruments approximated their fair value. The financial
instruments that potentially subject us to concentration of
7
NAVISITE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
credit risk consist primarily of accounts receivable. Concentration of credit risk with
respect to trade receivables is limited due to the large number of customers across many industries
that comprise our customer base. One third-party customer accounted for 8% and 10% of our total
revenue for the nine months ended April 30, 2007 and 2006, respectively. Accounts receivable
include approximately $1.7 million due from this third-party customer at April 30, 2007 and
approximately $0.9 million at July 31, 2006.
(g) Comprehensive Income
Comprehensive income is defined as the change in equity of a business enterprise during a
period of time from transactions and other events and circumstances from non-owner sources. The
Company reports accumulated other comprehensive income, primarily resulting from foreign currency
translation adjustments, in the Condensed Consolidated Balance Sheets.
(h) Income Taxes
We account for income taxes under the asset and liability method in accordance with SFAS No.
109, Accounting for Income Taxes. Deferred tax assets and liabilities are recognized for the
future tax consequences attributable to differences between the financial statement carrying
amounts of existing assets and liabilities and their respective tax bases and operating loss and
tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary differences are expected
to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax
rates is recognized in income in the period that includes the enactment date.
(i) Stock Based Compensation
In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of
Financial Accounting Standards No. 123R, Share-Based Payment, an amendment of FASB Statements Nos.
123 and 95 (SFAS 123R). SFAS 123R addresses the accounting for share-based payment transactions
in which a company receives employee services in exchange for either equity instruments of the
company or liabilities that are based on the fair value of the companys equity instruments or that
may be settled by the issuance of such equity instruments. The statement eliminates the ability to
account for share-based compensation transactions using the intrinsic value method and generally
requires that such transactions be accounted for using a fair value based method and recognized as
expense in the Condensed Consolidated Statement of Operations. In March 2005, the SEC issued Staff
Accounting Bulletin (SAB) No. 107 regarding its interpretation of SFAS 123R. This interpretation
provides the Staffs views regarding interpretations between SFAS 123R and certain SEC rules and
regulations and provides interpretations regarding the valuation of share-based payments for public
companies. The interpretive guidance is intended to assist companies in applying the provisions of
SFAS 123R and investors and users of financial statements in analyzing the information provided.
Following the guidance prescribed in SAB 107, on August 1, 2005, NaviSite adopted SFAS 123R
using the modified prospective method, and accordingly, we have not restated our condensed
consolidated financial statements from prior interim periods and fiscal years. Under SFAS 123R, we
are required to measure compensation cost for all stock based awards at fair value on the date of
grant and recognize compensation expense over the service period that the awards are expected to
vest. For US and UK grants, the Company generally grants options under its equity plan that vest as
to 25% of the original number of shares in the sixth month (180 days) following the date of the
grant and thereafter in equal monthly amounts over the three year period commencing on the sixth
month (180 days) following the date of grant. In February 2006, the Company issued its first option
grants to its India employees. The options vested as to 33.33% of the original number of shares in
the ninth month (270 days) following the date of the grant and thereafter in equal monthly amounts
over the three year period commencing on the ninth month (270 days) following the date of grant. In
October 2006, the Company eliminated this deviation from the US Plan and made the India Plan
consistent with the US Plan.
8
NAVISITE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The Company uses the Black-Scholes option pricing model to value compensation expense
associated with stock based awards under SFAS123R. The following table reflects the stock
compensation expense for the Company for the three and nine months ended April 30, 2007 and 2006.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Nine Months Ended |
|
|
April 30, |
|
April 30, |
|
|
(in thousands) |
|
(in thousands) |
|
|
2007 |
|
2006 |
|
2007 |
|
2006 |
Cost of revenue |
|
$ |
364 |
|
|
$ |
236 |
|
|
$ |
887 |
|
|
$ |
730 |
|
Selling and marketing |
|
$ |
171 |
|
|
$ |
93 |
|
|
$ |
372 |
|
|
$ |
258 |
|
General and administrative |
|
$ |
317 |
|
|
$ |
663 |
|
|
$ |
1,427 |
|
|
$ |
2,124 |
|
The fair value of each stock option grant was estimated on the date of grant assuming no
expected dividends and the weighted average assumptions detailed below. The expected volatility is
based upon the historical volatility of the Companys stock price. The expected life is the period
of time between the date the option is granted and the date the option is expected to be exercised.
The period of time takes into consideration the vesting period of the option, the average period of
time similar options have remained outstanding in the past, and other events that might influence
exercise behavior (such as stock price volatility).
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Nine Months Ended |
|
|
April 30, |
|
April 30, |
|
|
2007 |
|
2006 |
|
2007 |
|
2006 |
Risk free interest rate |
|
|
4.57 |
% |
|
|
4.74 |
% |
|
|
4.58 |
% |
|
|
4.48 |
% |
Expected volatility |
|
|
93.88 |
% |
|
|
106.07 |
% |
|
|
101.04 |
% |
|
|
105.83 |
% |
Expected life (years) |
|
|
2.50 |
|
|
|
2.62 |
|
|
|
3.10 |
|
|
|
2.37 |
|
Weighted average fair
value of options
granted |
|
$ |
3.35 |
|
|
$ |
1.31 |
|
|
$ |
3.07 |
|
|
$ |
1.04 |
|
The Company recorded $77,000 of expense in January 2007 due to a modification of options held
by the Chief Financial Officer, who resigned in January 2007. Pursuant to a lockup agreement,
NaviSite amended his option agreements to extend the time that vested options could be exercised
from 90 days from termination to 227 days from termination. Modifications to option agreements
under SFAS 123R require a remeasurement of the option based upon a comparison of the fair value of
the option immediately before the modification and immediately following the modification.
In addition, the Company estimates forfeitures when recognizing compensation expense and will
adjust the estimate of forfeitures when they are expected to differ. For the three months and nine
months ended April 30, 2007 we estimated that 5% of options granted will be forfeited before the
first vesting tranche. For the three months ended April 30, 2006, we estimated that 5% of options
granted would be forfeited before the first vesting tranche. Forfeitures after the first vesting
tranche are estimated to be immaterial. Prior to the quarter ended April 30, 2006, we estimated
that 15% of options granted would be forfeited before the first vesting tranche. This change in
accounting estimate was not material.
As of April 30, 2007, the total remaining unrecognized compensation cost relating to nonvested
awards is $6.6 million. The weighted average period over which the cost is expected to be
recognized is 2.8 years.
The following table reflects stock option activity under the Companys equity incentive plans
for the nine months ended April 30, 2007.
9
NAVISITE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted |
|
|
|
|
|
|
|
|
Weighted |
|
Average |
|
Aggregate |
|
|
Number |
|
Average |
|
Remaining |
|
Intrinsic |
|
|
of |
|
Exercise |
|
Contractual |
|
Value |
|
|
Shares |
|
Price |
|
Term |
|
(in thousands) |
|
|
|
Options outstanding at July 31, 2006 |
|
|
6,590,793 |
|
|
$ |
2.82 |
|
|
|
|
|
|
$ |
|
|
Granted |
|
|
1,952,435 |
|
|
$ |
4.85 |
|
|
|
|
|
|
$ |
|
|
Exercised |
|
|
(730,126 |
) |
|
$ |
2.64 |
|
|
|
|
|
|
$ |
|
|
Forfeited or expired |
|
|
(616,175 |
) |
|
$ |
2.86 |
|
|
|
|
|
|
$ |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options outstanding at April 30, 2007 |
|
|
7,196,927 |
|
|
$ |
3.39 |
|
|
|
8.15 |
|
|
$ |
22,119 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options exercisable at April 30, 2007 |
|
|
4,173,411 |
|
|
$ |
3.09 |
|
|
|
7.46 |
|
|
$ |
14,188 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The Company has a policy of issuing new shares to satisfy its stock option exercises.
In accordance with FASB Staff Position No. FAS 123R-3, Transition Election Related to
Accounting for Tax Effects of Share-Based Payment Awards, the Company elected to adopt the
alternative transition method for calculating the tax effects of stock-based compensation pursuant
to SFAS 123R. The alternative transition method includes simplified methods to establish the
beginning balance of the additional paid-in capital pool related to the tax effects of employee
stock-based compensation, and to determine the subsequent effect on the additional paid-in capital
pool and the statements of cash flows of the tax effects of employee stock-based compensation
awards that were outstanding upon the adoption of SFAS 123R.
(j) Net Loss Per Share
Basic net loss per share is computed by dividing net loss by the weighted average number of
common shares outstanding for the period. Diluted net loss per share is computed using the weighted
average number of common and diluted common equivalent shares outstanding during the period, using
either the if-converted method for convertible preferred stock and notes or the treasury stock
method for warrants and options, unless amounts are anti-dilutive.
For the three and nine months ended April 30, 2007 and 2006, net loss per basic and diluted
share is based on weighted average common shares and excludes any common stock equivalents, which
are anti-dilutive due to reported losses. For the three and nine months ended April 30, 2007, there
were 4,950,942 and 3,897,260 of dilutive shares, respectively, related to warrants and employee
stock options that were excluded as they have an anti-dilutive effect due to the net loss during
these periods. For the three and nine months ended April 30, 2006, there were 1,932,517 and 213,706
of dilutive shares, respectively, related to warrants and employee stock options that were
excluded as they have an anti-dilutive effect due to the net loss during these periods.
(k) Segment Reporting
We currently operate in one segment, managed IT services. The Companys chief operating
decision maker reviews financial information at a consolidated level.
(l) Foreign Currency
The functional currencies of our wholly-owned subsidiaries are the local currencies. The
financial statements of the subsidiaries are translated into U.S. dollars using period end exchange
rates for assets and liabilities and average exchange rates during corresponding periods for
revenue, cost of revenue and expenses. Translation gains and losses are recorded as a separate
component of stockholders equity (deficit), Accumulated other comprehensive income.
10
NAVISITE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(m) Derivative Financial Instruments
Derivative instruments are recorded in the balance sheet as either assets or liabilities,
measured at fair value. Changes in fair value are recognized currently in earnings. The Company
utilizes interest rate derivatives to protect against rising interest rates on a portion of its
floating rate debt and did not qualify to apply hedge accounting. The interest rate differentials
to be received under such derivatives are recognized as adjustments to interest expense and the
changes in the fair value of the instruments are recognized over the life of the agreements as
Other income (expense), net. The principal objectives of the derivative instruments are to minimize
the risks and reduce the expenses associated with financing activities. The Company does not use
derivative financial instruments for trading purposes.
(n) Recent Accounting Pronouncements
In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159 (FAS
159), The Fair Value Option for Financial Assets and Liabilities. FAS 159 permits entities to
choose to measure many financial instruments and certain other items at fair value. FAS 159 is
effective for the Companys fiscal year beginning August 1, 2008. Early adoption is permitted. The
Company has not determined the impact, if any, that adopting this standard may have on its
consolidated financial position or results of operations.
In September 2006, the SEC issued SAB 108 which provides interpretive guidance on how the
effects of the carryover or reversal of prior year misstatements should be considered in
quantifying a current year misstatement. SAB 108 is effective for fiscal years ending after
November 15, 2006. We do not believe that adoption of this SAB will have a material impact to our
consolidated financial position or results of operations.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (FAS 157). FAS
157 defines fair value, establishes a framework for measuring fair value in accordance with
generally accepted accounting principles, and expands disclosures about fair value measurements.
The provisions of FAS 157 are effective for fiscal years beginning after November 15, 2007. The
Company is currently evaluating the impact of the provisions of FAS 157.
In June 2006, the Emerging Issues Task Force (EITF) reached a consensus on EITF 06-3, How
Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the
Income Statement. EITF 06-3 provides that taxes imposed by a governmental authority on a revenue
producing transaction between a seller and a customer should be shown in the income statement on
either a gross or a net basis, based on the entitys accounting policy, which should be disclosed
pursuant to APB Opinion No. 22, Disclosure of Accounting Policies. If such taxes are significant,
and are presented on a gross basis, the amounts of those taxes should be disclosed. EITF 06-3 must
be applied to financial reports for interim and annual reporting periods beginning after December
15, 2006. We have determined that the amount of these taxes are not significant to our
consolidated revenues and have, therefore, not been disclosed.
In June 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in
Income Taxes (FIN 48). FIN 48 clarifies the accounting for uncertainty in income taxes
recognized in the Companys financial statements in accordance with FASB Statement No. 109,
Accounting for Income Taxes. The provisions of FIN 48 are effective for fiscal years beginning
after December 15, 2006. We are currently evaluating the impact the provisions of FIN 48 will have
on our consolidated financial position or results of operations.
In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial
Instruments an amendment of FASB Statements No. 133 and 140. SFAS No. 155 (1) permits fair value
re-measurement for any hybrid financial instrument that contains an embedded derivative that would
otherwise require bifurcation, (2) clarifies which interest-only strips and principal-only strips
are not subject to the requirements of FASB Statement No. 133, (3) establishes a requirement to
evaluate interests in securitized financial assets to identify interests that are freestanding
derivatives or that are hybrid financial instruments that contain an embedded derivative requiring
11
NAVISITE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
bifurcation, (4) clarifies that concentrations of credit risk in the form of subordination are
not embedded derivatives, and (5) amends FASB Statement No. 140 to eliminate the prohibition on a
qualifying special-purpose entity from holding a derivative financial instrument that pertains to a
beneficial interest in other than another derivative financial instrument. SFAS No. 155 is
effective for all financial instruments acquired, issued, or subject to a re-measurement event
occurring after the beginning of fiscal years beginning after September 15, 2006. We are currently
evaluating the effect, if any, that this pronouncement will have on our financial results.
(3) Impairment of Long-Lived Assets
During the nine months ended April 30, 2007, the Company recorded a recovery of a previously
impaired lease totaling $0.3 million. This recovery reflected a change in sub-lease assumptions
related to a lease impairment recorded in a prior reporting period. The amount has been included
in our statement of operations for the nine months ended April 30, 2007 as a component of operating
expenses (see Note 10).
(4) Property and Equipment
Property and equipment at April 30, 2007 and July 31, 2006 are summarized as follows:
|
|
|
|
|
|
|
|
|
|
|
April 30, |
|
|
July 31, |
|
|
|
2007 |
|
|
2006 |
|
|
|
(In thousands) |
|
Office furniture and equipment |
|
$ |
3,442 |
|
|
$ |
3,303 |
|
Computer equipment |
|
|
50,726 |
|
|
|
45,075 |
|
Software licenses |
|
|
12,105 |
|
|
|
11,216 |
|
Leasehold improvements |
|
|
10,486 |
|
|
|
9,958 |
|
|
|
|
|
|
|
|
|
|
|
76,759 |
|
|
|
69,552 |
|
Less: Accumulated depreciation and amortization |
|
|
(62,002 |
) |
|
|
(54,638 |
) |
|
|
|
|
|
|
|
Property and equipment, net |
|
$ |
14,757 |
|
|
$ |
14,914 |
|
|
|
|
|
|
|
|
The estimated useful lives of our property and equipment are as follows: office furniture and
equipment, 5 years; computer equipment, 3 years; software licenses, 3 years or life of the license;
and leasehold improvements, lesser of the lease term or the assets estimated useful life.
(5) Intangible Assets
The gross carrying amount and accumulated amortization as of April 30, 2007 and July 31, 2006
for intangible assets, generally customer lists, are as follows:
|
|
|
|
|
|
|
|
|
|
|
April 30, |
|
|
July 31, |
|
|
|
2007 |
|
|
2006 |
|
|
|
(In thousands) |
|
Gross carrying amount |
|
$ |
29,791 |
|
|
$ |
29,791 |
|
Less: Accumulated amortization |
|
|
(21,149 |
) |
|
|
(18,104 |
) |
|
|
|
|
|
|
|
Customer lists, net |
|
$ |
8,642 |
|
|
$ |
11,687 |
|
|
|
|
|
|
|
|
Intangible asset amortization expense for the three and nine months ended April 30, 2007 and
2006 aggregated $1.0 million and $3.0 million, and $1.2 million and $3.7 million, respectively.
Intangible assets are being amortized over estimated useful lives ranging from five to eight years.
The amount reflected in the table below for fiscal year 2007 includes year to date amortization.
Amortization expense related to intangible assets for the next five years is as follows:
12
NAVISITE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
|
|
|
|
|
Year Ending July 31, |
|
|
|
|
(In thousands) |
|
|
|
|
2007 |
|
$ |
3,932 |
|
2008 |
|
$ |
3,044 |
|
2009 |
|
$ |
1,868 |
|
2010 |
|
$ |
1,005 |
|
2011 |
|
$ |
988 |
|
(6) Investment in Debt Securities
In a privately negotiated transaction with Fir Tree Recovery Master Fund, LP and Fir Tree
Value Partners, LDC, pursuant to an Assignment Agreement dated October 11, 2002 and in a series of
open market transactions from certain other third-party holders, we acquired an aggregate principal
amount of approximately $36.3 million face value, 10% convertible senior notes (Interliant Notes)
due in 2006 of Interliant, Inc. (Interliant) for a total consideration of approximately $2.0
million. Interliant was a provider of managed services, which filed a petition under Chapter 11 of
Title 11 of the United States Bankruptcy Code in the Southern District of New York (White Plains)
on August 5, 2002, and we made this investment with the intention of participating in the
reorganization/sale of Interliant.
On May 16, 2003, the Bankruptcy Court confirmed us as the successful bidder for the purchase
of the Interliant Assets. We used $0.6 million of the first projected distribution to be made on
our Interliant Notes as partial payment for the assets acquired. As such, we reduced the carrying
value of the Interliant Notes by this amount. On September 30, 2004, the Third Amended Plan of
Liquidation of Interliant and its affiliated debtors became effective. As a result of unfavorable
facts and circumstances occurring in the fourth quarter of fiscal year 2005, as learned from
bankruptcy counsel, which negatively impacted the recoverability of our investment, the Company
recorded an impairment charge in the amount of $1.1 million, reducing the carrying value of the
Interliant Notes to approximately $0.2 million. On January 29, 2007, the final claim in the
bankruptcy case was settled and all remaining assets were distributed to the creditors of the
Estate. The Company received approximately $0.2 million in this final distribution and the
difference between the carrying value and the amount received is included in Other income, net in
the accompanying Condensed Consolidated Statements of Operations for the nine months ended April
30, 2007.
(7) Accrued Expenses and Other Current Liabilities
Accrued expenses and other current liabilities consist of the following:
|
|
|
|
|
|
|
|
|
|
|
April 30, |
|
|
July 31, |
|
|
|
2007 |
|
|
2006 |
|
|
|
(In thousands) |
|
Accrued payroll, benefits and commissions |
|
$ |
4,594 |
|
|
$ |
4,331 |
|
Accrued accounts payable |
|
|
3,357 |
|
|
|
2,905 |
|
Accrued interest |
|
|
592 |
|
|
|
913 |
|
Accrued impairment |
|
|
853 |
|
|
|
1,360 |
|
Accrued sales/use, property and miscellaneous taxes |
|
|
924 |
|
|
|
1,070 |
|
Other accrued expenses and current liabilities |
|
|
2,978 |
|
|
|
3,153 |
|
|
|
|
|
|
|
|
|
|
$ |
13,298 |
|
|
$ |
13,732 |
|
|
|
|
|
|
|
|
(8) Long Term Debt
Long term debt consists of the following:
13
NAVISITE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
|
|
|
|
|
|
|
|
|
|
|
April 30, |
|
|
July 31, |
|
|
|
2007 |
|
|
2006 |
|
|
|
(In thousands) |
|
Term Loan, net of discount |
|
$ |
65,700 |
|
|
$ |
61,345 |
|
Notes payable to the AppliedTheory
Estate |
|
|
6,000 |
|
|
|
6,000 |
|
Notes payable to Atlantic Investors |
|
|
|
|
|
|
3,000 |
|
Notes payable to landlord |
|
|
|
|
|
|
319 |
|
Other notes payable |
|
|
290 |
|
|
|
129 |
|
|
|
|
|
|
|
|
Total |
|
|
71,990 |
|
|
|
70,793 |
|
Less current portion |
|
|
11,690 |
|
|
|
8,115 |
|
|
|
|
|
|
|
|
Long term debt |
|
$ |
60,300 |
|
|
$ |
62,678 |
|
|
|
|
|
|
|
|
(a) Term Loan and Revolving Credit Facility
On April 11, 2006, we entered into a senior secured Term Loan and senior secured Revolving
Credit Facility (the Credit Facility) with Silver Point Finance LLC, (the Lender) to repay
certain maturing debt and increase borrowing available for corporate purposes. The Term Loan
consists of a five year single-draw Term Loan in the aggregate amount of $70 million. Borrowings
under the Term Loan are guaranteed by the Company and all of its subsidiaries. During the first
twelve months of the loan, we are required to make quarterly interest only payments to the
Lender and commencing one year after closing date of the loan, we are also scheduled to make
quarterly repayments of the principal. The maturity date of the Term Loan is April 11, 2011. The
Lender is entitled to prepayment of the outstanding balance under the Term Loan, if any, upon
the occurrence of various events, including, among others, if the Company sells assets and does
not reinvest the proceeds in assets, receives cash proceeds from the incurrence of any
indebtedness, has excess cash, or closes an equity financing transaction, provided that the
first $10 million plus 50% of the remaining net proceeds from an equity financing shall not be
subject to the mandatory prepayment requirement. Generally, prepayments are subject to a
prepayment premium ranging from 8%-1% depending upon the timing of the prepayment (see Note 9
for discussion of the valuation of this prepayment premium). The unpaid amount of the Term Loan
and accrued interest and all other obligations shall become due and payable immediately upon
occurrence and continuation of any event of default. Under the Term Loan agreement, we must
comply with various financial and non-financial covenants. The financial covenants include among
others, minimum fixed charge coverage ratio, maximum consolidated leverage ratio, minimum
consolidated EBITDA and maximum annual capital expenditures. The primary non-financial covenants
limit our ability to pay dividends, make investments, engage in transactions with affiliates,
sell assets, conduct mergers or acquisitions, incur indebtedness or liens, alter capital
structure and sell stock.
Outstanding amounts of the Term Loan bear interest at either: (a) 7% per annum plus, the
greater of (i) Prime Rate, and (ii) the Federal Funds Effective Rate plus 3%, or (b) 8% plus
the floating rate of LIBOR. To the extent interest payable on the Term Loan (a) exceeds the
LIBOR Rate plus 5% in year one or (b) exceeds the LIBOR Rate plus 7% for the years thereafter,
such amounts exceeding the threshold will be capitalized and added to the outstanding principal
amount of the Term Loan and shall incur interest. The interest rate for the Term Loan was
13.32% as of April 30, 2007. Outstanding amounts under the Revolving Credit Facility bear
interest at either: (a) 7% per annum plus, the greater of (i) Prime Rate, and (ii) the Federal
Funds Effective Rate plus 3%, or (b) 8% plus the floating rate of LIBOR. Interest is payable in
arrears on the last day of the month for Base Rate loans, and the last day of the chosen
interest period (one, two or three months) for LIBOR Rate loans. We are required to maintain
Interest Rate Agreements constituting caps with respect to an aggregate notional principal
amount of a portion of the Loan, to limit the unadjusted LIBOR Rate Component of the interest
costs to the Company (see Note 9).
The amount borrowed was used to repay our accounts receivable financing line, convertible
notes and interest payable and to pay transaction fees and expenses relating to the loan. In
addition, we borrowed $6.4 million which is being held in an escrow account to pay the notes
payable to the AppliedTheory Estate.
In connection with the establishment of the Credit Facility, the Company issued warrants to
purchase an aggregate of 3,514,933 shares of common stock of the Company at an exercise price of
$0.01 per share. These warrants became exercisable 90 days following the closing date of the
Credit Facility and will expire on April
14
NAVISITE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
11, 2016. The warrants were fair valued using the
Black-Scholes option-pricing model and were recorded in our Condensed Consolidated Balance
Sheets at inception as a discount to the loan amount of $9.1 million and are being amortized
into interest expense over the five-year term of the Credit Facility.
In February 2007, the Company entered into Amendment No. 4 and Waiver to Credit and
Guaranty Agreement (the Amendment) with Silver Point. Under the Amendment, the Lenders
provided to the Company an additional term loan in the original principal amount of $3,762,753,
(the Supplemental Term Loan). The terms of the Supplemental Term Loan are identical to
the Term Loan. Amounts borrowed under the Supplemental Term Loan are to be used for working
capital and other general corporate purposes.
In February, 2007, in connection with the Amendment, the Company issued warrants to Silver
Point to purchase an aggregate of 415,203 shares of common stock at an exercise price of $0.01
per share. The warrants were fair valued using the Black-Scholes option-pricing model and are
recorded in our Condensed Consolidated Balance Sheets at inception as a discount to the loan
amount of $2.2 million and are being amortized into interest expense over the five-year term of
the Credit Facility.
As of April 30, 2007, we had $75.5 million outstanding under the Term Loan and Supplemental
Term Loan, collectively, and had accrued approximately $0.1 million in interest related to these
loans. At April 30, 2007, the unamortized discount to the loan amounts related to warrants (see
above) totaled $9.1 million. During the month of January 2007, Silverpoint exercised warrants
for the purchase of 287,500 share of common stock in connection with the public offering of the
Companys common stock. (see Note 12).
(b) Note Payable to Atlantic Investors, LLC
On January 29, 2003, we entered into a $10.0 million Loan and Security Agreement (Atlantic
Loan) with Atlantic Investors, LLC (Atlantic), a related party. The Atlantic Loan bears an
interest rate of 8% per annum. On April 11, 2006, the Company entered into an Amended and
Restated Loan Agreement with Atlantic, in connection with and as a condition precedent to the
Credit Facility with Silver Point, which amended and restated the existing loan agreement
between the Company and Atlantic dated January 29, 2003. Under the Atlantic amendment and
related transaction documents, Atlantic agreed to reduce the availability of the Atlantic Loan
to the amount outstanding as of April 11, 2006 of $3.0 million and approximately $0.7 million of
accrued interest, agreed that this indebtedness shall be an unsecured obligation of the Company,
agreed to subordinate this indebtedness to amounts owed by the Company to Silver Point and
agreed to extend the maturity date of the loan to the earlier of the date that is 90 days after
the earlier of: (a) April 11, 2011, and (b) the date all obligations under the Silver Point
Credit Facility have been paid in full.
The principal and accrued interest of the Atlantic Loan from time to time became
convertible into shares of the Companys common stock at $2.81 per share, (the market price of
our stock on April 11, 2006), 90 days following April 11, 2006.
In January 2007, Atlantic converted all of the remaining principal and accrued interest of
$3,863,610 into 1,374,950 shares of the Companys common stock. (See Note 12)
(c) Revolving Credit Facility with Atlantic Investors, LLC
On April 11, 2006, we entered into an unsecured subordinated Revolving Credit Agreement
with Atlantic Investors LLC, in connection with and as a condition precedent to the Silver Point
credit facility, whereby the Company established a subordinated revolving credit facility with
Atlantic (the Atlantic Facility) in the amount not to exceed $5 million. Credit advances under
the Atlantic Facility shall bear interest at either: (a) 7% per annum plus, the greater of (i)
Prime Rate, and (ii) the Federal Funds Effective Rate plus 3%, or (b) 8% plus
the floating rate of LIBOR. Interest may, at the Companys option, be paid in cash or
promissory notes. All outstanding amounts under the Atlantic Facility shall be paid in full by
the Company no later than the date that is 90 days after the earlier of: (a) April 11, 2011, and
(b) the date all obligations under the Credit Facility have been paid in full.
15
NAVISITE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
We plan to use the proceeds of the Atlantic Credit Facility, if necessary, for general
corporate and working capital purposes of the Company. As of April 30, 2007, there were no
borrowings outstanding under the Atlantic Credit Facility.
(d) Notes Payable to AppliedTheory Estate
As part of CBTMs acquisition of certain AppliedTheory assets, CBTM made and issued two
unsecured promissory notes totaling $6.0 million (Estate Liability) due to the AppliedTheory
Estate on June 13, 2006. The Estate Liability bears interest at 8% per annum, which is due and
payable annually. At April 30, 2007, we had approximately $0.5 million in accrued interest
related to these notes. The Company has reserved the borrowed $6.4 million from Silver Point as
part of Term loan and maintained in an escrow account to repay these notes. This $6.4 million is
included in Prepaid expenses and other current assets on our Condensed Consolidated Balance
Sheets. In July 2006, the Company reached agreement with the secured creditors of AppliedTheory
to settle certain claims against the estate of AppliedTheory and repay the outstanding notes
including accrued interest for approximately $5.0 million. The settlement agreement is
currently awaiting approval by the bankruptcy court.
(e) Notes Payable to Landlord
As part of an amendment to our 400 Minuteman Road lease, $2.2 million of our future
payments to the landlord of our 400 Minuteman Road facility was transferred into a note payable
(Landlord Note). The $2.2 million represented leasehold improvements made by the landlord, on
our behalf, to the 400 Minuteman location in order to facilitate the leasing of a portion of the
facility (First Lease Amendment), as well as common area maintenance and property taxes
associated with the space. The Landlord Note bore interest at an
annual rate of 11% and called
for 36 equal monthly payments of principal and interest. The final payment was due and paid in
November 2006.
In addition, during fiscal year 2004, we paid $120,000 and we entered into a separate
$150,000 note (Second Landlord Note) with the landlord for additional leasehold improvements
to facilitate a subleasing transaction involving a specific section of the 400 Minuteman Road
location. The Second Landlord Note bore interest at an annual rate of
11% and called for 36
equal monthly payments of principal and interest. The final payment was due and paid on March 1,
2007.
(9) Derivative Instruments
In May 2006, the Company purchased an interest rate cap on a notional amount of 70% of the
outstanding principal of the Term Loan (see Note 8) until expiration in April 2011. The Company
paid approximately $0.3 million to lock in a maximum LIBOR interest rate of 6.5% that could be
charged on the notional amount during the term of the agreement. As of April 30, 2007, the fair
value of the interest rate derivative was approximately $46,000 which is included in Other assets
in the Companys Condensed Consolidated Balance Sheets. The change in fair value for the three and
nine months ended April 30, 2007 was approximately $25,000 and $164,000, respectively. The change
in fair value was charged to Other income, net in the accompanying Condensed Consolidated
Statement of Operations.
The prepayment penalty of our Term Loan was determined to be an embedded derivative which was
required to be separately valued from the Term Loan. The Company calculated the fair value of this
embedded derivative to be approximately $867,000 upon the closing of the Term Loan which was
included in the Condensed Consolidated Balance Sheets as a discount to the Term Loan with an
offsetting amount included in Other long-term liabilities.
Amortization of the embedded derivative, calculated on a straight line basis, is included in
interest expense and will reduce the discount to the Term Loan over the term of the loan. The
value of the embedded derivative is required to be evaluated quarterly and any changes in the
valuation of the embedded derivative are recorded as an adjustment to
16
NAVISITE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
any interest expense
previously recorded and to the discount to the Term Loan with an offsetting adjustment to Other
long-term liabilities. Changes in fair value of the embedded derivative have not been material to
date.
(10) Commitments and Contingencies
(a) Leases
Abandoned Leased Facilities. During the third quarter of fiscal year 2007, no additional leases
were abandoned and no new lease abandonment charges were recorded. During the third quarter of
fiscal year 2006, we recorded lease impairment charges of approximately $0.1 million due to
revisions in sublease assumptions for previously abandoned facilities.
All impairment expense amounts recorded are included in the caption Impairment, restructuring
and other in the accompanying Condensed Consolidated Statements of Operations.
Details of activity in the lease exit accrual by facility for the nine months ended April 30,
2007 are as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchase |
|
|
|
|
|
|
|
|
|
Balance |
|
|
|
|
|
|
Accounting |
|
|
Payments, |
|
|
Balance |
|
|
|
July 31, |
|
|
Expense |
|
|
and Other |
|
|
less accretion |
|
|
April 30, |
|
Lease Abandonment Costs for: |
|
2006 |
|
|
(Recovery) |
|
|
Adjustments |
|
|
of interest |
|
|
2007 |
|
Andover, MA |
|
$ |
587 |
|
|
|
|
|
|
|
|
|
|
$ |
(139 |
) |
|
$ |
448 |
|
Chicago, IL |
|
|
786 |
|
|
|
(249 |
) |
|
|
|
|
|
|
(102 |
) |
|
|
435 |
|
Houston, TX |
|
|
880 |
|
|
|
|
|
|
|
|
|
|
|
(302 |
) |
|
|
578 |
|
Syracuse, NY |
|
|
417 |
|
|
|
|
|
|
|
|
|
|
|
(233 |
) |
|
|
184 |
|
Syracuse, NY |
|
|
76 |
|
|
|
|
|
|
|
|
|
|
|
(23 |
) |
|
|
53 |
|
San Jose, CA |
|
|
211 |
|
|
|
(38 |
) |
|
|
|
|
|
|
(173 |
) |
|
|
|
|
Atlanta, GA |
|
|
31 |
|
|
|
|
|
|
|
(18 |
) |
|
|
(13 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
2,988 |
|
|
$ |
(287 |
) |
|
$ |
(18 |
) |
|
$ |
(985 |
) |
|
$ |
1,698 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Minimum annual rental commitments under operating leases and other commitments are as follows
as of April 30, 2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less than |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
After |
|
Description |
|
Total |
|
|
1 Year |
|
|
Year 2 |
|
|
Year 3 |
|
|
Year 4 |
|
|
Year 5 |
|
|
Year 5 |
|
|
|
(In thousands) |
|
Short/Long-term
debt(a) |
|
$ |
81,766 |
|
|
$ |
11,690 |
|
|
$ |
8,600 |
|
|
$ |
11,200 |
|
|
$ |
50,276 |
|
|
$ |
|
|
|
$ |
|
|
Interest on debt(b) |
|
|
34,459 |
|
|
|
9,863 |
|
|
|
8,559 |
|
|
|
7,469 |
|
|
|
8,568 |
|
|
|
|
|
|
|
|
|
Capital leases |
|
|
3,265 |
|
|
|
2,275 |
|
|
|
603 |
|
|
|
304 |
|
|
|
51 |
|
|
|
32 |
|
|
|
|
|
Bandwidth commitments |
|
|
1,773 |
|
|
|
1,476 |
|
|
|
227 |
|
|
|
65 |
|
|
|
5 |
|
|
|
|
|
|
|
|
|
Maintenance for
hardware/software |
|
|
175 |
|
|
|
172 |
|
|
|
3 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Property leases(c)(d) |
|
|
64,951 |
|
|
|
10,201 |
|
|
|
9,234 |
|
|
|
7,244 |
|
|
|
4,846 |
|
|
|
5,029 |
|
|
|
28,397 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
186,389 |
|
|
$ |
35,677 |
|
|
$ |
27,226 |
|
|
$ |
26,282 |
|
|
$ |
63,746 |
|
|
$ |
5,061 |
|
|
$ |
28,397 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(a) |
|
Short/Long-term debt does not tie to the Condensed Consolidated Balance Sheets due to
recorded discounts for warrants and embedded derivative. |
|
(b) |
|
Interest on Term Loan assumes LIBOR is fixed at 5.32%. |
|
(c) |
|
Amounts exclude certain common area maintenance and other property charges that are not
included within the lease payment. |
17
NAVISITE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
|
|
|
(d) |
|
On February 9, 2005, the Company entered into an Assignment and Assumption Agreement with a
Las Vegas-based company, whereby this company purchased from us the right to use 29,000 square
feet in our Las Vegas data center, along with the infrastructure and equipment associated with
this space. In exchange, we received an initial payment of $600,000 and were to receive
$55,682 per month over two years. On May 31, 2006, we received full payment for the remaining
unpaid balance. This agreement shifts the responsibility for management of the data center and
its employees, along with the maintenance of the facilitys infrastructure, to this Las
Vegas-based company. Pursuant to this Agreement, we have subleased back 2,000 square feet of
space, allowing us to continue servicing our existing customer base in this market.
Commitments related to property leases include an amount related to the 2,000 square feet
sublease. |
With respect to the property lease commitments listed above, certain cash amounts are
restricted pursuant to terms of lease agreements with landlords. At April 30, 2007, restricted cash
of approximately $0.9 million related to these lease agreements and consisted of certificates of
deposit and a treasury note and are recorded at cost, which approximates fair value.
(b) Legal Matters
IPO Securities Litigation
On or about June 13, 2001, Stuart Werman and Lynn McFarlane filed a lawsuit against us,
BancBoston Robertson Stephens, an underwriter of our initial public offering in October 1999, Joel
B. Rosen, our then chief executive officer, and Kenneth W. Hale, our then chief financial officer.
The suit was filed in the United States District Court for the Southern District of New York, and
generally alleges that the defendants violated federal securities laws by not disclosing certain
actions allegedly taken by Robertson Stephens in connection with our initial public offering. The
suit seeks certification of a plaintiff class consisting of all persons who acquired shares of our
common stock between October 22, 1999 and December 6, 2000. Four other substantially similar
lawsuits were filed between June 15, 2001 and July 10, 2001 by Moses Mayer (filed June 15, 2001),
Barry Feldman (filed June 19, 2001), David Federico (filed June 21, 2001) and Binh Nguyen (filed
July 10, 2001). Robert E. Eisenberg, our president at the time of the initial public offering in
1999, was named as a defendant in the Nguyen lawsuit. The Federico lawsuit sought certification of
a plaintiff class consisting of all persons who acquired shares of our common stock between October
22, 1999 and June 12, 2001, and also named additional underwriter defendants, including J. P.
Morgan Chase, First Albany Companies, Inc., Bank of America Securities, LLC, Bear Stearns & Co.,
Inc., B. T. Alex. Brown, Inc., Chase Securities, Inc., CIBC World Markets, Credit Suisse First
Boston Corp., Dain Rauscher, Inc., Deutsche Bank Securities, Inc., The Goldman Sachs Group, Inc.,
J. P. Morgan & Co., J. P. Morgan Securities, Lehman Brothers, Inc., Merrill Lynch, Pierce, Fenner &
Smith, Inc., Morgan Stanley Dean Witter & Co., Robert Fleming, Inc. and Salomon Smith Barney, Inc.
Those five cases, along with lawsuits naming more than 300 other issuers and over 50
investment banks which have been sued in substantially similar lawsuits, have been assigned to the
Honorable Shira A. Scheindlin (the Court) for all pretrial purposes (the IPO Securities
Litigation). On September 6, 2001, the Court entered an order consolidating the five individual
cases involving us and designating Werman v. NaviSite, Inc., et al., Civil Action No. 01-CV-5374 as
the lead case. A consolidated, amended complaint was filed thereafter on April 19, 2002 (the Class
Action Litigation) on behalf of plaintiffs Arvid Brandstrom and Tony Tse against us and Messrs.
Rosen, Hale and Eisenberg (collectively, the NaviSite Defendants) and against underwriter
defendants Robertson Stephens (as successor-in-interest to BancBoston), BancBoston, J.P. Morgan (as
successor-in-interest to Hambrecht & Quist), Hambrecht & Quist and First Albany. Plaintiffs
uniformly allege that all defendants, including the NaviSite Defendants, violated the federal
securities laws (i.e., Sections 11 and 15 of the Securities Act, Sections 10(b) and 20(a) of the
Exchange Act and Rule 10b-5) by issuing and selling our common stock pursuant to the October 22,
1999 initial public offering, without disclosing to investors that some of the underwriters of the
offering, including the lead underwriters, had solicited and received extensive and undisclosed
agreements from certain investors to purchase aftermarket shares at pre-arranged, escalating prices
and also to receive additional
commissions and/or other compensation from those investors. The Class Action Litigation seeks
certification of a plaintiff class consisting of all persons who acquired shares of our common
stock between October 22, 1999 and December 6, 2000. At this time, plaintiffs have not specified
the amount of damages they are seeking in the Class Action Litigation.
18
NAVISITE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Between July and September 2002, the parties to the IPO Securities Litigation briefed motions
to dismiss filed by the underwriter defendants and the issuer defendants, including NaviSite. On
November 1, 2002, the Court held oral argument on the motions to dismiss. The plaintiffs have since
agreed to dismiss the claims against Messrs. Rosen, Hale and Eisenberg without prejudice, in return
for their agreement to toll any statute of limitations applicable to those claims. By stipulation
entered by the Court on November 18, 2002, Messrs. Rosen, Hale and Eisenberg were dismissed without
prejudice from the Class Action Litigation. On February 19, 2003, an opinion and order was issued
on defendants motion to dismiss the IPO Securities Litigation, essentially denying the motions to
dismiss of all 55 underwriter defendants and of 185 of the 301 issuer defendants, including
NaviSite.
On June 30, 2003, our Board of Directors considered and authorized us to negotiate a
settlement of the pending Class Action Litigation substantially consistent with a memorandum of
understanding negotiated among proposed class plaintiffs, the issuer defendants and the insurers
for such issuer defendants. Among other contingencies, any such settlement would be subject to
approval by the Court. Plaintiffs filed on June 14, 2004, a motion for preliminary approval of the
Stipulation And Agreement Of Settlement With Defendant Issuers And Individuals (the Preliminary
Approval Motion). On February 15, 2005, the Court approved the Preliminary Approval Motion in a
written opinion which detailed the terms of the settlement stipulation, its accompanying documents
and schedules, the proposed class notice and, with a modification to the bar order to be entered,
the proposed settlement order and judgment. A further conference was held on April 13, 2005, at
which time the Court considered additional submissions but did not make final determinations
regarding the exact form, substance and program for notifying the proposed settlement class. On
August 31, 2005, the Court entered a further Preliminary Order in Connection with Settlement
Proceedings (the Preliminary Approval Order), which granted preliminary approval to the issuers
settlement with the plaintiffs in the IPO Securities Litigation. The Court subsequently held a Fed.
R. Civ. P. 23 fairness hearing on April 24, 2006 in order to consider the written and oral
submissions addressing whether the Court should enter final approval of the settlement. On November
15, 2006, a second amendment to the settlement stipulation was filed (Amendment # 2). Amendment
#2 modifies how the Recovery Deficit, as defined in the settlement stipulation, is to be
calculated and also deletes certain provisions pursuant to which the insurers could have recouped
certain Notice Costs, Litigation Trust Costs and Defense Costs as defined in the settlement
stipulation. The matter was taken under advisement and remains pending with the Court.
On October 13, 2004, the Court granted a contested motion for class certification in a
sub-group of cases consolidated in the IPO Securities Litigation. On December 5, 2006, a panel of
the United States Court of Appeals for the Second Circuit (the Second Circuit) issued an opinion
vacating the Courts class certification decision because, among others, the plaintiffs-appellees
therein could not satisfy the predominance requirement for a Fed. R. Civ. P. 23(b)(3) class action.
On January 5, 2007, the plaintiffs-appellees filed a petition with the Second Circuit for rehearing
and rehearing en banc (the Petition). In response to a January 24, 2007 order by the Second
Circuit, on February 7, 2007, defendants-appellants filed a response to the Petition. The Petition
was denied by the Second Circuit on April 6, 2007. The Mandate issued on May 30, 2007, and the
matter has been remanded to the Court for further proceedings. The Court held a status conference
on May 30, 2007, at which plaintiffs orally indicated an intent to renew their class certification
motion as to redefined classes pursuant to Fed. R. Civ. P. 23(b)(3) and 23(c)(4). A further status
conference is scheduled for June 11, 2007.
The ultimate effect, if any, that the Second Circuits ruling may have on the pending issuers
settlement is not known at this time but may result in withdrawal of the settlement or denial of
the motion for final approval. If the proposed issuers settlement is completed and then approved
by the Court without further modifications to its material terms, we and the participating insurers
acting on our behalf may be responsible for providing funding of approximately $3.4 million towards
the total amount plaintiffs are guaranteed by the proposed issuers settlement to recover in the
IPO Securities Litigation. The amount of the guarantee allocable to us could be reduced or
eliminated in its entirety in the event that plaintiffs are able to recover some or all of the
total amount of such overall guarantee
from settlements with or judgments obtained against the non-settling defendants. Even if no
additional recovery is obtained from any of the non-settling defendants, the settlement amount
allocable to us is expected to be fully covered by our existing insurance policies and is not
expected to have a material effect on our business, financial condition, results of operations or
cash flows.
19
NAVISITE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
We believe that the allegations against us are without merit and, if the settlement is not
approved by the Court and finalized, we intend to vigorously defend against the plaintiffs claims.
Due to the inherent uncertainty of litigation, we are not able to predict the possible outcome of
the suits and their ultimate effect, if any, on our business, financial condition, results of
operations or cash flows.
(11) Income Tax Expense
The Company recorded $0.3 million and $0.9 million of deferred income tax expense during
the three and nine months ended April 30, 2007. No deferred tax benefit was recorded for the losses
incurred due to a valuation allowance recognized against deferred tax assets. The deferred tax
expense resulted from tax goodwill amortization related to the Surebridge acquisition and the
acquisition of AppliedTheory Corporation by ClearBlue Technologies Management, Inc. The acquired
goodwill and intangible assets for both acquisitions are amortizable for tax purposes over fifteen
years. For financial statement purposes, goodwill is not amortized for either acquisition but is
tested for impairment annually. Tax amortization of goodwill results in a taxable temporary
difference, which will not reverse until the goodwill is impaired or written off. The resulting
taxable temporary difference may not be offset by deductible temporary differences currently
available, such as net operating loss carryforwards which expire within a definite period.
(12) Stockholders Equity
(a) Unregistered Sales of Equity Securities
On January 2, 2007, the Company, pursuant to the terms of the Amended and Restated Loan
Agreement (the Amended Loan Agreement) dated as of April 11, 2006, received notice from Atlantic
of its election to convert the full amount of the Companys outstanding repayment obligations under
the Amended Loan Agreement into 1,374,950 shares of the Companys common stock. Under the Amended
Loan Agreement, if the Company did not pay in full the Companys outstanding repayment obligations
by July 10, 2006, Atlantic had the right, but not the obligation, to convert such outstanding
amounts into shares of the Companys common stock by dividing (i) the dollar value of the
outstanding obligations by (ii) $2.81 (the market price per share of our common stock on April 11,
2006), rounded to the nearest whole share.
The shares issuable upon conversion of the outstanding repayment obligations under the Amended
Loan Agreement were not registered under the Securities Act of 1933, as amended (the Securities
Act). The Company relied on the exemption from registration provided by Section 4(2) of the
Securities Act as a sale by the Company not involving a public offering. No underwriters were
involved with the issuance of the shares issuable upon conversion of the outstanding repayment
obligations under the Amended Loan Agreement.
(b) Public Offering
On January 19, 2007, 9,952,500 shares of the Companys common stock, par value $0.01, were
sold in a public offering by certain shareholders, at a per share price of $4.50. The Company
received no proceeds from the sale of shares by these selling shareholders.
20
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of
Section 21E of the Securities Exchange Act of 1934, as amended, and Section 27A of the Securities
Act of 1933, as amended, that involve risks and uncertainties. All statements other than statements
of historical information provided herein are forward-looking statements and may contain
information about financial results, economic conditions, trends and known uncertainties. Our
actual results could differ materially from those discussed in the forward-looking statements as a
result of a number of factors, which include those discussed in this section and elsewhere in this
report under Item 1.A. Risk Factors and in our annual report on Form 10-K under Item 1.A. Risk
Factors and the risks discussed in our other filings with the Securities and Exchange Commission.
Readers are cautioned not to place undue reliance on these forward-looking statements, which
reflect managements analysis, judgment, belief or expectation only as of the date hereof. We
undertake no obligation to publicly revise these forward-looking statements to reflect events or
circumstances that arise after the date hereof.
Overview
NaviSite, Inc. provides application management, hosting and professional services for mid- to
large-sized organizations. Leveraging our set of technologies and subject matter expertise, we
deliver cost-effective, flexible solutions that provide responsive and predictable levels of
service for our customers businesses. We provide services throughout the information technology
lifecycle. We are dedicated to delivering quality services and meeting rigorous standards,
including SAS 70, Microsoft Gold, and Oracle Certified Partner certifications.
We believe that by leveraging economies of scale utilizing our global delivery approach,
industry best practices and process automation, our services enable our customers to achieve
significant cost savings. In addition, we are able to leverage our application services platform,
NaviViewTM, to enable software to be delivered on-demand over the Internet, providing an
alternative delivery model to the traditional licensed software model. As the platform provider
for an increasing number of independent software vendors (ISVs), we enable solutions and services
to a wider and growing customer base.
Our services include:
Application Management
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Application management services Defined services provided for specific
packaged applications that are incremental to managed services. Services can
include monitoring, diagnostics and problem resolution. Frequently sold as a
follow-on to a professional services project. |
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Software as a Service Enablement of Software as a Service to the ISV
community. |
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Development Services Services include eBusiness/Web solutions, enterprise
integration, business intelligence, content management and user interface design. |
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Custom Services Services include custom application management and remote
infrastructure management. |
Hosting Services
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Managed services Support provided for hardware and software located
in a data center. Services include business continuity and disaster recovery,
connectivity, content distribution, database administration and performance tuning,
desktop support, hardware management, monitoring, network management, security
management, server and operating system management and storage management. |
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Content Delivery Includes the delivery of software electronically
using NaviSite technology to manage version control and accelerated content
distribution. |
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Colocation Physical space offered in a data center. In addition to
providing the physical space, NaviSite offers environmental support, specified
power with back-up power generation and network connectivity options. |
Professional Services
21
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For leading enterprise software applications such as Oracle,
PeopleSoft, JD Edwards and Siebel Systems, NaviSite Professional Services helps
organizations plan, implement and maintain these applications. |
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Optimize scalable, business-driven software solutions. Specific
services include planning, implementation, maintenance, optimization, and
compliance services. |
We provide these services to a range of vertical industries, including financial services,
healthcare and pharmaceutical, manufacturing and distribution, publishing, media and
communications, business services, public sector and software, through our direct sales force and
sales channel relationships.
Our managed application services are facilitated by our proprietary NaviViewTM
collaborative application management platform. Our NaviViewTM platform enables us to
provide highly efficient, effective and customized management of enterprise applications and
information technology. Comprised of a suite of third-party and proprietary products,
NaviViewTM provides tools designed specifically to meet the needs of customers who
outsource their IT needs. This platform supports utility and virtualization services and tools for
the Web 2.0 integration. We also use this platform for electronic software distribution for
software vendors and to enable software to be delivered on-demand over the Internet, providing an
alternative delivery model to the traditional licensed software model.
We believe that the combination of NaviViewTM 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. NaviViewTM is
application and operating platform neutral as its on-demand provisioning capability is not
dependent on the individual software application. Designed to enable enterprise software
applications to be provisioned and used as an on-demand solution, the
NaviViewTM technology allows us to offer new solutions to our software vendors
and new products to our current customers.
We currently operate in 13 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 1,000 hosted customers. Our hosted customers typically
enter into service agreements for a term of one to three years, which provide for monthly payment
installments, providing us with a base of recurring revenue. Our revenue increases by adding new
customers or providing additional services to existing customers. Our overall base of recurring
revenue is affected by new customers, renewals and terminations of agreements with existing
customers.
In past years, we have grown through business acquisitions and have restructured our
operations. Specifically, in December 2002, we completed a common control merger with CBTM; in
February 2003, we acquired Avasta; in April 2003, we acquired Conxion; in May 2003, we acquired
assets of Interliant; in August 2003 and April 2004, we completed a common control merger with
certain subsidiaries of CBT; and in June 2004, we acquired substantially all of the assets and
liabilities of Surebridge (now known as Waythere, Inc.). In January 2005, we formed NaviSite India
Private Limited, a New Delhi-based operation which is intended to expand our international
capability. NaviSite India will provide a range of software services, including design and
development of custom and E-commerce solutions, application management, problem resolution management and the deployment and
management of IT networks, customer specific infrastructure and data center infrastructure. We
expect to make additional acquisitions to take advantage of our available capacity, which will have
significant effects on our financial results in the future.
22
Results of Operations for the Three and Nine Months Ended April 30, 2007 and 2006
The following table sets forth the percentage relationships of certain items from our Condensed
Consolidated
Statements of Operations as a percentage of total revenue.
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Three Months Ended |
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Nine Months Ended |
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April 30, |
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April 30, |
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2007 |
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2006 |
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2007 |
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2006 |
Revenue |
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99.7 |
% |
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99.7 |
% |
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99.7 |
% |
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99.8 |
% |
Revenue, related parties |
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0.3 |
% |
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0.3 |
% |
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0.3 |
% |
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0.2 |
% |
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Total revenue |
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100.0 |
% |
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100.0 |
% |
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100.0 |
% |
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100.0 |
% |
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Cost of revenue |
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66.9 |
% |
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68.5 |
% |
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67.4 |
% |
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69.7 |
% |
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Gross profit |
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33.1 |
% |
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31.5 |
% |
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32.6 |
% |
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30.3 |
% |
Operating expenses: |
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Selling and marketing |
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13.1 |
% |
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15.3 |
% |
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13.3 |
% |
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14.4 |
% |
General and administrative |
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16.8 |
% |
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19.5 |
% |
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18.2 |
% |
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20.6 |
% |
Impairment, restructuring and other |
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0.0 |
% |
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0.5 |
% |
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(0.3 |
)% |
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0.6 |
% |
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Total operating expenses |
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29.9 |
% |
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35.3 |
% |
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31.2 |
% |
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35.7 |
% |
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Income (loss) from operations |
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3.2 |
% |
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(3.8 |
)% |
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1.4 |
% |
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(5.3 |
)% |
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Other income (expense): |
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Interest income |
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0.2 |
% |
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0.5 |
% |
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0.1 |
% |
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0.2 |
% |
Interest expense |
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(10.0 |
)% |
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(8.5 |
)% |
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(10.6 |
)% |
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(8.0 |
)% |
Other income, net |
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0.3 |
% |
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0.5 |
% |
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0.4 |
% |
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0.5 |
% |
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Loss before income tax expense |
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(6.3 |
)% |
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(11.3 |
)% |
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(8.7 |
)% |
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(12.6 |
)% |
Income tax expense |
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(0.9 |
)% |
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(1.0 |
)% |
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(1.0 |
)% |
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(1.1 |
)% |
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Net loss |
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(7.2 |
)% |
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(12.3 |
)% |
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(9.7 |
)% |
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(13.7 |
)% |
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|
Comparison of the Three and Nine Months Ended April 30, 2007 and 2006
Revenue
We derive our revenue from managed IT services, including hosting, colocation and application
services comprised of a variety of service offerings and professional services, to mid-market
companies and organizations, including mid-sized companies, divisions of large multi-national
companies and government agencies.
Revenue for the three months ended April 30, 2007 increased 17.2% to approximately $32.7
million from approximately $27.9 million for the three months ended April 30, 2006. The overall
growth of $4.8 million in revenue was mainly due to the increased sales to new and existing
customers. Revenue from related parties during the three months ended April 30, 2007 and 2006
totaled $84,000 and $73,000, respectively.
Revenue for the nine months ended April 30, 2007 increased 14.7% to approximately $91.2
million from approximately $79.5 million for the nine months ended April 30, 2006. The overall
growth of $11.7 million in revenue was mainly due to the increased sales to new and existing
customers. Revenue from related parties during the nine months ended April 30, 2007 and 2006
totaled $260,000 and $144,000, respectively.
One unrelated customer accounted for 8% and 10% of our total revenue during the first nine
months of fiscal year 2007 and 2006, respectively.
23
Cost of Revenue and Gross Profit
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.
Cost of revenue for the three months ended April 30, 2007, increased approximately 14.7% to
$21.9 million from approximately $19.1 million for the three months ended April 30, 2006. As a
percentage of revenue, cost of revenue decreased from 68.5% of revenue for the three months ended
April 30, 2006 to 67.0% of revenue for the three months ended April 30, 2007. The overall increase
in cost of revenue of $2.8 million resulted primarily from increased salary and related expenses of
approximately $1.7 million due to increased headcount, increases in depreciation charges of
approximately $0.5 million, and an increase in billable expenses of approximately $0.4 million.
Cost of revenue for the nine months ended April 30, 2007, increased approximately 11.2% to
$61.7 million from approximately $55.5 million for the nine months ended April 30, 2006. As a
percentage of revenue, total cost of revenue decreased from 69.8% of revenue for the nine months
ended April 30, 2006 to 67.7% of revenue for the nine months ended April 30, 2007. The overall
increase in cost of revenue of approximately $6.2 million resulted primarily from increased salary
and related expenses of approximately $3.4 million due to increased headcount, increases in
depreciation and amortization related charges of approximately $ 0.9 million, an increase in
billable expenses of approximately $1.2 million and increased hardware and software maintenance
costs and other expenses of approximately $0.5 million.
Gross profit of $10.8 million for the three months ended April 30, 2007 increased
approximately $2.0 million, or 22.7%, from a gross profit of approximately $8.8 million for the
three months ended April 30, 2006. Gross profit for the third fiscal quarter of 2007 represented
33.0% of total revenue, as compared to 31.5% of total revenue for the third fiscal quarter of 2006. Due to
the fixed cost nature of our infrastructure, increased revenue resulted in incremental improvements
in our gross profit.
Gross profit of $29.8 million for the nine months ended April 30, 2007 increased approximately
$5.6 million, or 23.1%, from a gross profit of approximately $24.2 million for the nine months
ended April 30, 2006. Gross profit for the first nine months of fiscal year 2007 represented 32.6%
of total revenue, as compared to 30.2% of total revenue for the comparable period last year. Due to the fixed cost nature
of our infrastructure, increased revenue resulted in incremental improvements in our gross profit.
Operating Expenses
Selling and Marketing. Selling and marketing expense consists primarily of salaries and
related benefits, commissions and marketing expenses such as travel, advertising, product
literature, trade show, and marketing and direct mail programs.
Selling and marketing expense remained constant at approximately $4.3 million, or 13.0% of
total revenue, during the three months ended April 30, 2007 compared to 15.3% of total revenue,
during the three months ended April 30, 2006.
Selling and marketing expense increased 5.2% to approximately $12.1 million, or 13.3% of total
revenue, during the nine months ended April 30, 2007 from approximately $11.5 million, or 14.4% of
total revenue, during the nine months ended April 30, 2006. The increase of approximately $0.6
million resulted primarily from increased salary and related expenses due to increased headcount
and increased spending on advertising.
General and Administrative. General and administrative expense includes the costs of
financial, human resources, IT and administrative personnel, professional services, bad debt and
corporate overhead.
General and administrative expense increased 1.9% to approximately $5.5 million, or 16.8% of
total revenue, during the three months ended April 30, 2007 from approximately $5.4 million , or
19.5% of total revenue during the three months ended April 30, 2006. The increase of approximately
$0.1 million was primarily the result of increases in facilities related expenses.
24
General and administrative expense increased 1.8% to approximately $16.7 million, or 18.2% of
total revenue, during the nine months ended April 30, 2007 from approximately $16.4 million, or
20.6% of total revenue, during the nine months ended April 30, 2006. The increase of approximately
$0.3 million was primarily the result of increases in facilities related expenses.
Operating Expenses Impairment
No impairment charges were recorded during the three months ended April 30, 2007.
Costs associated with the abandonment of leased facilities and the impairment of property and
equipment included in impairment, restructuring and other expense within operating expenses were
approximately $0.1 million during the three months ended April 30, 2006, as a result of revised
assumptions associated with our impaired facilities.
We recorded a reduction in expense of $0.3 million during the nine months ended April 30,
2007, primarily due to revised assumptions due to securing a sublease of an impaired facility, as
compared to a charge of $0.5 million recorded during the nine months ended April 30, 2006,
associated with the abandonment of leased facilities and the impairment of property and equipment
included in impairment, restructuring and other expense.
Interest Income
During the three and nine months ended April 30, 2007, interest income decreased to
approximately $79,000 and $163,000, respectively, from $137,000 and $191,000, respectively, during
the comparable periods last year. The decrease of $58,000 and $29,000 for the three and nine month
periods is mainly due to a settlement awarded by the court in favor of the Company in the third
quarter of 2006.
Interest Expense
During the three and nine months ended April 30, 2007, interest expense increased 37.5% and
51.6%, respectively, from the comparable prior year periods to approximately $3.3 million and $9.7
million, respectively. The increase of $0.9 million and $3.3 million for the three and nine month
periods is primarily due to increased rates of interest related to amounts drawn in April 2006 on
our Term Loan and the addition of capital leases.
Other Income, Net
Other income, net was
approximately $110,000 during the three months ended April 30,
2007, as compared to other income, net of approximately $145,000 during the three months
ended April 30, 2006. The other income recorded during the third fiscal quarter of 2007
is primarily attributable to sublease income.
Other income, net was
approximately $356,000 during the nine months ended April 30,
2007, as compared to other income, net of approximately $418,000 during the nine months
ended April 30, 2006. The other income recorded during the first nine months of 2007 is
primarily attributable to sublease income, settlements and changes in the fair value of our
interest rate cap which is marked to market for each reporting period.
Income Tax Expense
The Company recorded $0.3 million and $0.9 million of deferred income tax expense during
the three and nine months ended April 30, 2007 and 2006, respectively. No income tax benefit was
recorded for the losses incurred due to a valuation allowance recognized against deferred tax
assets. The deferred tax expense resulted from tax goodwill amortization related to the Surebridge
acquisition and the acquisition of AppliedTheory Corporation by ClearBlue Technologies Management,
Inc. The acquired goodwill and intangible assets for both acquisitions are amortizable
25
for tax purposes over fifteen years. For financial statement purposes, goodwill is not
amortized for either acquisition but is tested for impairment annually. Tax amortization of
goodwill results in a taxable temporary difference, which will not reverse until the goodwill is
impaired or written off. The resulting taxable temporary difference may not be offset by deductible
temporary differences currently available, such as net operating loss carryforwards which expire
within a definite period.
Liquidity and Capital Resources
As of April 30, 2007, our principal sources of liquidity included cash and cash equivalents, a
revolving credit facility of $3.0 million provided by Silver Point Finance and a revolving credit
facility with Atlantic Investors LLC, to borrow a maximum amount of $5.0 million. We had a working
capital deficit of $5.2 million, including cash and cash equivalents of approximately $4.6 million
at April 30, 2007, as compared to a working capital deficit of $9.1 million, including cash and
cash equivalents of $3.4 million, at July 31, 2006.
The total net change in cash and cash equivalents for the nine months ended April 30, 2007 was
an increase of $1.3 million. The primary uses of cash during the nine months ended April 30, 2007
included $5.1 million for purchases of property and equipment and approximately $4.2 million in
repayments on notes payable and capital lease obligations. Our primary sources of cash during the
nine months ended April 30, 2007 were $3.2 million of cash provided by operating activities, $1.9
million in proceeds from exercise of stock options and warrants and $5.5 million in borrowings on
notes payable. Net cash provided by operating activities of $3.2 million during the nine months
ended April 30, 2007, resulting primarily from approximately $15.4 million of non-cash charges,
which was partially offset by funding our $8.8 million net loss and $3.4 million of net changes in
operating assets and liabilities.
Our revolving credit facility with Silver Point allows for maximum borrowing of $3.0 million
and expires on April 11, 2011. Outstanding amounts will bear interest at either: (a) 7% per annum
plus, the greater of (i) Prime Rate, and (ii) the Federal Funds Effective Rate plus 3%, or (b) 8%
plus the floating rate of LIBOR. Interest is payable in arrears on the last day of the month for
Base Rate loans, and the last day of the chosen interest period (one, two or three months) for
LIBOR Rate loans. During the second quarter of fiscal year 2007, we borrowed and repaid $1.0
million under the revolving credit facility. No amounts were outstanding at April 30, 2007 under
the revolving credit facility.
Our revolving credit facility with Atlantic Investors LLC allows for maximum borrowing of $5.0
million. All outstanding amounts under the Atlantic facility shall be paid in full no later than
the date that is 90 days after the earlier of: (a) April 11, 2011, and (b) the date all obligations
under the Silver Point Credit Facility have been paid in full. Credit advances under the Atlantic
facility shall bear interest at either: (a) 7% per annum plus the greater of (i) Prime Rate, and
(ii) the Federal Funds Effective Rate plus 3%, or (b) 8% plus the floating rate of LIBOR. Interest
may, at our option, be paid in cash or promissory notes. As of April 30, 2007, we had not started
borrowing from our facility with Atlantic Investors LLC.
Given the Companys cash resources as of April 30, 2007 and committed lines of credit, the
Company believes that it has sufficient liquidity to support its operations over the fiscal year
and for the foreseeable future.
Recent Accounting Pronouncements
In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159 (FAS
159), The Fair Value Option for Financial Assets and Liabilities. FAS 159 permits entities to
choose to measure many financial instruments and certain other items at fair value. FAS 159 is
effective for the Companys fiscal year beginning August 1, 2008. Early adoption is permitted. The
Company has not determined the impact, if any, that adopting this standard may have on its
consolidated financial position or results of operations.
In September 2006, the SEC issued SAB 108 which provides interpretive guidance on how the
effects of the carryover or reversal of prior year misstatements should be considered in
quantifying a current year misstatement. SAB 108 is effective for fiscal years ending after
November 15, 2006. We do not believe that adoption of this SAB will have a material impact to our
consolidated financial position or results of operations.
26
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (FAS 157). FAS
157 defines fair value, establishes a framework for measuring fair value in accordance with
generally accepted accounting principles, and expands disclosures about fair value measurements.
The provisions of FAS 157 are effective for fiscal years beginning after November 15, 2007. The
Company is currently evaluating the impact of the provisions of FAS 157.
In June 2006, the Emerging Issues Task Force (EITF) reached a consensus on EITF 06-3, How
Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the
Income Statement. EITF 06-3 provides that taxes imposed by a governmental authority on a revenue
producing transaction between a seller and a customer should be shown in the income statement on
either a gross or a net basis, based on the entitys accounting policy, which should be disclosed
pursuant to APB Opinion No. 22, Disclosure of Accounting Policies. If such taxes are significant,
and are presented on a gross basis, the amounts of those taxes should be disclosed. EITF 06-3 must
be applied to financial reports for interim and annual reporting periods beginning after December
15, 2006. We have determined that the amount of these taxes are not significant to our
consolidated revenues and have, therefore, not been disclosed.
In June 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in
Income Taxes (FIN 48). FIN 48 clarifies the accounting for uncertainty in income taxes
recognized in the Companys financial statements in accordance with FASB Statement No. 109,
Accounting for Income Taxes. The provisions of FIN 48 are effective for fiscal years beginning
after December 15, 2006. We are currently evaluating the impact the provisions of FIN 48 will have
on our consolidated financial position or results of operations.
In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial
Instruments an amendment of FASB Statements No. 133 and 140. SFAS No. 155 (1) permits fair value
re-measurement for any hybrid financial instrument that contains an embedded derivative that would
otherwise require bifurcation, (2) clarifies which interest-only strips and principal-only strips
are not subject to the requirements of FASB Statement No. 133, (3) establishes a requirement to
evaluate interests in securitized financial assets to identify interests that are freestanding
derivatives or that are hybrid financial instruments that contain an imbedded derivative requiring
bifurcation, (4) clarifies that concentrations of credit risk in the form of subordination are not
embedded derivatives, and (5) amends FASB Statement No. 140 to eliminate the prohibition on a
qualifying special-purpose entity from holding a derivative financial instrument that pertains to a
beneficial interest in other than another derivative financial instrument. SFAS No. 155 is
effective August 1, 2007 and we are currently evaluating the effect, if any, that this
pronouncement will have on our financial results.
Contractual Obligations and Commercial Commitments
We are obligated under various capital and operating leases for facilities and equipment.
Future minimum annual rental commitments under capital and operating leases and other commitments,
as of April 30, 2007, are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less than |
|
|
|
|
|
|
|
|
|
|
After |
|
Description |
|
Total |
|
|
1 Year |
|
|
1-3 Years |
|
|
4-5 Year s |
|
|
Year 5 |
|
|
|
(In thousands) |
|
Short/Long-term debt(a) |
|
$ |
81,766 |
|
|
$ |
11,690 |
|
|
$ |
19,800 |
|
|
$ |
50,276 |
|
|
$ |
|
|
Interest on debt(b) |
|
|
34,459 |
|
|
|
9,863 |
|
|
|
16,028 |
|
|
|
8,568 |
|
|
|
|
|
Capital leases |
|
|
3,265 |
|
|
|
2,275 |
|
|
|
907 |
|
|
|
83 |
|
|
|
|
|
Bandwidth commitments |
|
|
1,773 |
|
|
|
1,476 |
|
|
|
292 |
|
|
|
5 |
|
|
|
|
|
Maintenance for hardware/software |
|
|
175 |
|
|
|
172 |
|
|
|
3 |
|
|
|
|
|
|
|
|
|
Property leases(c)(d) |
|
|
64,951 |
|
|
|
10,201 |
|
|
|
16,478 |
|
|
|
9,875 |
|
|
|
28,397 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
186,389 |
|
|
$ |
35,677 |
|
|
$ |
53,508 |
|
|
$ |
68,807 |
|
|
$ |
28,397 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(a) |
|
Short/Long-term debt does not tie to the Condensed Consolidated Balance Sheets due to
recorded discounts for warrants and embedded derivative. |
|
(b) |
|
Interest on Term Loan assumes LIBOR is fixed at 5.32%. |
|
(c) |
|
Amounts exclude certain common area maintenance and other property charges that are not
included within the lease payment. |
|
(d) |
|
On February 9, 2005, the Company entered into an Assignment and Assumption Agreement
with a Las Vegas-based company, whereby this company purchased from us the right to use
29,000 square feet in our Las Vegas data center, along with the infrastructure and
equipment associated with this space. In exchange, we received an initial payment of
$600,000 and were to receive |
27
|
|
|
|
|
$55,682 per month over two years. On May 31, 2006, we received full payment for the
remaining unpaid balance. This agreement shifts the responsibility for management of the
data center and its employees, along with the maintenance of the facilitys infrastructure,
to this Las Vegas-based company. Pursuant to this Agreement, we have subleased back 2,000
square feet of space, allowing us to continue servicing our existing customer base in this
market. Commitments related to property leases include an amount related to the 2,000
square feet sublease. |
Off-Balance Sheet Financing Arrangements
The Company does not have any off-balance sheet financing arrangements other than operating
leases, which are recorded in accordance with generally accepted accounting principles.
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.
Revenue Recognition. Revenue consists primarily of monthly fees for application management,
hosting, colocation and professional services. We also derive revenue from the sale of software and
related maintenance contracts. Reimbursable expenses charged to customers are included in revenue
and cost of revenue. Application management, hosting and colocation revenue is billed and
recognized over the term of the contract, generally one to three years. Installation fees
associated with application management, hosting and colocation revenue are billed at the time the
installation service is provided and recognized over the term of the related contract. Payments
received in advance of providing services are deferred until the period such services are provided.
Revenue from professional services is recognized on either a time and material basis as the
services are performed or under the percentage of completion method for fixed price contracts. When
current contract estimates indicate that a loss is probable, a provision is made for the total
anticipated loss in the current period. Contract losses are determined to be the amount by which
the estimated service costs of the contract exceed the estimated revenue that will be generated by
the contract. Unbilled accounts receivable represents revenue for services performed that have not
been billed. Billings in excess of revenue recognized are recorded as deferred revenue until the
applicable revenue recognition criteria are met. Revenue from the sale of software is recognized
when persuasive evidence of an arrangement exists, the product has been delivered, the fees are
fixed and determinable and collection of the resulting receivable is reasonably assured. In
instances where we also provide application management and hosting services in conjunction with the
sale of software, software revenue is deferred and recognized ratably over the expected customer
relationship period. If we determine that collection of a fee is not reasonably assured, we defer
the fee and recognize revenue at the time collection becomes reasonably assured, which is generally
upon receipt of cash.
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 collectability 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
28
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. 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, subject to amortization and
depreciation, including customer lists and 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
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. Intangible assets consist of customer lists.
We review the valuation of our goodwill in the fourth quarter of each fiscal year. If an event
or circumstance indicates that it is more likely than not an impairment loss has been incurred, we
review the valuation of goodwill on an interim basis. An impairment loss is recognized to the
extent that the carrying amount of goodwill exceeds its implied fair value. Impairment losses are
recognized in operations.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
We do not enter into financial instruments for trading purposes. We have not used derivative
financial instruments or derivative commodity instruments in our investment portfolio or entered
into hedging transactions. However, under our senior secured term loan facility with Silver Point
Finance, we are required to have interest rate protection which shall effectively limit the
unadjusted LIBOR component of the interest costs of our loan with respect to not less than 70% of
the principal amount at a rate not more than 6.5% per annum. Our exposure to market risk associated
with risk-sensitive instruments entered into for purposes other than trading purposes is not
material to us. We currently have no significant foreign operations and therefore face no material
foreign currency exchange rate risk. Our interest rate risk at April 30, 2007 was limited mainly to
LIBOR on our outstanding loan with our senior secured term loan facility with Silver Point Finance.
At April 30, 2007, other than the interest rate protection, we had no open derivative positions with respect to our borrowing arrangements. A
hypothetical 100 basis point increase in the LIBOR rate would have resulted in an approximate $0.2
million increase in our interest expense under our senior secured term loan facility with Silver
Point Finance for the fiscal quarter ended April 30, 2007.
Item 4. Controls and Procedures
Disclosure Controls and Procedures. Our management, with the participation of our Chief
Executive Officer and Chief Financial Officer, have evaluated the effectiveness of our disclosure
controls and procedures (as defined in Rule 13a-15(e) of the Exchange Act) as of the end of the
period covered by this report. Based on that evaluation, our Chief Executive Officer and Chief
Financial Officer have concluded that our disclosure controls and procedures as of the end of the
period covered by this report were effective in ensuring that information required to be disclosed
by us in reports that we file or submit under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in the Securities and Exchange
Commissions rules and forms and that such
29
information is accumulated and communicated to our
management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to
allow timely decisions regarding required disclosure.
Internal Control Over Financial Reporting. There was no change in our internal control over
financial reporting (as defined in Rule 13a-15(f) of the Exchange Act) that occurred during the
fiscal quarter to which this report relates that has materially affected, or is reasonably likely
to materially affect, our internal control over financial reporting.
PART II: OTHER INFORMATION
Item 1. Legal Proceedings
IPO Securities Litigation
On or about June 13, 2001, Stuart Werman and Lynn McFarlane filed a lawsuit against us,
BancBoston Robertson Stephens, an underwriter of our initial public offering in October 1999, Joel
B. Rosen, our then chief executive officer, and Kenneth W. Hale, our then chief financial officer.
The suit was filed in the United States District Court for the Southern District of New York, and
generally alleges that the defendants violated federal securities laws by not disclosing certain
actions allegedly taken by Robertson Stephens in connection with our initial public offering. The
suit seeks certification of a plaintiff class consisting of all persons who acquired shares of our
common stock between October 22, 1999 and December 6, 2000. Four other substantially similar
lawsuits were filed between June 15, 2001 and July 10, 2001 by Moses Mayer (filed June 15, 2001),
Barry Feldman (filed June 19, 2001), David Federico (filed June 21, 2001) and Binh Nguyen (filed
July 10, 2001). Robert E. Eisenberg, our president at the time of the initial public offering in
1999, was named as a defendant in the Nguyen lawsuit. The Federico lawsuit sought certification of
a plaintiff class consisting of all persons who acquired shares of our common stock between October
22, 1999 and June 12, 2001, and also named additional underwriter defendants, including J. P.
Morgan Chase, First Albany Companies, Inc., Bank of America Securities, LLC, Bear Stearns & Co.,
Inc., B. T. Alex. Brown, Inc., Chase Securities, Inc., CIBC World Markets, Credit Suisse First
Boston Corp., Dain Rauscher, Inc., Deutsche Bank Securities, Inc., The Goldman Sachs Group, Inc.,
J. P. Morgan & Co., J. P. Morgan Securities, Lehman Brothers, Inc., Merrill Lynch, Pierce, Fenner &
Smith, Inc., Morgan Stanley Dean Witter & Co., Robert Fleming, Inc. and Salomon Smith Barney, Inc.
Those five cases, along with lawsuits naming more than 300 other issuers and over 50
investment banks which have been sued in substantially similar lawsuits, have been assigned to the
Honorable Shira A. Scheindlin (the Court) for all pretrial purposes (the IPO Securities
Litigation). On September 6, 2001, the Court entered an order consolidating the five individual
cases involving us and designating Werman v. NaviSite, Inc., et al., Civil Action No. 01-CV-5374 as
the lead case. A consolidated, amended complaint was filed thereafter on April 19, 2002 (the Class
Action Litigation) on behalf of plaintiffs Arvid Brandstrom and Tony Tse against us and Messrs.
Rosen, Hale and Eisenberg (collectively, the NaviSite Defendants) and against underwriter
defendants Robertson Stephens (as successor-in-interest to BancBoston), BancBoston, J.P. Morgan (as
successor-in-interest to Hambrecht & Quist), Hambrecht & Quist and First Albany. Plaintiffs
uniformly allege that all defendants, including the NaviSite Defendants, violated the federal
securities laws (i.e., Sections 11 and 15 of the Securities Act, Sections 10(b) and 20(a) of the
Exchange Act and Rule 10b-5) by issuing and selling our common stock pursuant to the October 22,
1999 initial public offering, without disclosing to investors that some of the underwriters of the
offering, including the lead underwriters, had solicited and received extensive and undisclosed
agreements from certain investors to purchase aftermarket shares at pre-arranged, escalating prices
and also to receive additional commissions and/or other compensation from those investors. The
Class Action Litigation seeks certification of a plaintiff class consisting of all persons who
acquired shares of our common stock between October 22, 1999 and December 6, 2000. At this time,
plaintiffs have not specified the amount of damages they are seeking in the Class Action
Litigation.
Between July and September 2002, the parties to the IPO Securities Litigation briefed motions
to dismiss filed by the underwriter defendants and the issuer defendants, including NaviSite. On
November 1, 2002, the Court held oral
argument on the motions to dismiss. The plaintiffs have since agreed to dismiss the claims against
Messrs. Rosen, Hale and Eisenberg without prejudice, in return for their agreement to toll any
statute of limitations applicable to
30
those claims. By stipulation entered by the Court on November
18, 2002, Messrs. Rosen, Hale and Eisenberg were dismissed without prejudice from the Class Action
Litigation. On February 19, 2003, an opinion and order was issued on defendants motion to dismiss
the IPO Securities Litigation, essentially denying the motions to dismiss of all 55 underwriter
defendants and of 185 of the 301 issuer defendants, including NaviSite.
On June 30, 2003, our Board of Directors considered and authorized us to negotiate a
settlement of the pending Class Action Litigation substantially consistent with a memorandum of
understanding negotiated among proposed class plaintiffs, the issuer defendants and the insurers
for such issuer defendants. Among other contingencies, any such settlement would be subject to
approval by the Court. Plaintiffs filed on June 14, 2004, a motion for preliminary approval of the
Stipulation And Agreement Of Settlement With Defendant Issuers And Individuals (the Preliminary
Approval Motion). On February 15, 2005, the Court approved the Preliminary Approval Motion in a
written opinion which detailed the terms of the settlement stipulation, its accompanying documents
and schedules, the proposed class notice and, with a modification to the bar order to be entered,
the proposed settlement order and judgment. A further conference was held on April 13, 2005, at
which time the Court considered additional submissions but did not make final determinations
regarding the exact form, substance and program for notifying the proposed settlement class. On
August 31, 2005, the Court entered a further Preliminary Order in Connection with Settlement
Proceedings (the Preliminary Approval Order), which granted preliminary approval to the issuers
settlement with the plaintiffs in the IPO Securities Litigation. The Court subsequently held a Fed.
R. Civ. P. 23 fairness hearing on April 24, 2006 in order to consider the written and oral
submissions addressing whether the Court should enter final approval of the settlement. On November
15, 2006, a second amendment to the settlement stipulation was filed (Amendment # 2). Amendment
#2 modifies how the Recovery Deficit, as defined in the settlement stipulation, is to be
calculated and also deletes certain provisions pursuant to which the insurers could have recouped
certain Notice Costs, Litigation Trust Costs and Defense Costs as defined in the settlement
stipulation. The matter was taken under advisement and remains pending with the Court.
On October 13, 2004, the Court granted a contested motion for class certification in a
sub-group of cases consolidated in the IPO Securities Litigation. On December 5, 2006, a panel of
the United States Court of Appeals for the Second Circuit (the Second Circuit) issued an opinion
vacating the Courts class certification decision because, among others, the plaintiffs-appellees
therein could not satisfy the predominance requirement for a Fed. R. Civ. P. 23(b)(3) class action.
On January 5, 2007, the plaintiffs-appellees filed a petition with the Second Circuit for rehearing
and rehearing en banc (the Petition). In response to a January 24, 2007 order by the Second
Circuit, on February 7, 2007, defendants-appellants filed a response to the Petition. The Petition
was denied by the Second Circuit on April 6, 2007. The Mandate issued on May 30, 2007, and the
matter has been remanded to the Court for further proceedings. The Court held a status conference
on May 30, 2007, at which plaintiffs orally indicated an intent to renew their class certification
motion as to redefined classes pursuant to Fed. R. Civ. P. 23(b)(3) and 23(c)(4). A further status
conference is scheduled for June 11, 2007.
The ultimate effect, if any, that the Second Circuits ruling may have on the pending issuers
settlement is not known at this time but may result in withdrawal of the settlement or denial of
the motion for final approval. If the proposed issuers settlement is completed and then approved
by the Court without further modifications to its material terms, we and the participating insurers
acting on our behalf may be responsible for providing funding of approximately $3.4 million towards
the total amount plaintiffs are guaranteed by the proposed issuers settlement to recover in the
IPO Securities Litigation. The amount of the guarantee allocable to us could be reduced or
eliminated in its entirety in the event that plaintiffs are able to recover some or all of the
total amount of such overall guarantee from settlements with or judgments obtained against the
non-settling defendants. Even if no additional recovery is obtained from any of the non-settling
defendants, the settlement amount allocable to us is expected to be fully covered by our existing
insurance policies and is not expected to have a material effect on our business, financial
condition, results of operations or cash flows.
We believe that the allegations against us are without merit and, if the settlement is not
approved by the Court and finalized, we intend to vigorously defend against the plaintiffs claims.
Due to the inherent uncertainty of litigation, we are not able to predict the possible outcome of
the suits and their ultimate effect, if any, on our business, financial condition, results of
operations or cash flows.
31
Item 1A. Risk Factors
In addition to the other information set forth in this report, you should carefully consider
the factors discussed in Part I, Item 1A. Risk Factors in our Annual Report on Form 10-K for the
fiscal year ended July 31, 2006, which could materially affect our business, financial condition or
future results. The risks described in our Annual Report on Form 10-K are not the only risks we
face. Additional risks and uncertainties not currently known to us or that we currently deem to be
immaterial also may materially adversely affect our business, financial condition and/or operating
results. Other than with respect to the risk factors below, there have been no material changes
from the risk factors disclosed in our Annual Report on Form 10-K. The risk factors below were
disclosed on our Annual Report on Form 10-K and have been updated as of April 30, 2007.
We have a history of losses and may never achieve or sustain profitability.
We have never been profitable and may never become profitable. As of April 30, 2007, we had
incurred losses since our incorporation resulting in an accumulated deficit of approximately $478.7
million. During the fiscal quarter ended April 30, 2007, we had a net loss of approximately $2.4
million. We may continue to incur losses in the future. As a result, we can give no assurance that we will achieve profitability or be capable of
sustaining profitable operations.
A significant portion of our revenue comes from one customer and our loss of this customer may have
a significant adverse impact on our business results and cash flows.
The New York State Department of Labor represented approximately 8% and 10% of our
consolidated revenue for the fiscal quarters ended April 30, 2007 and 2006, respectively. We have
multiple projects and services covered under our contract with the New York State Department of
Labor. For the fiscal quarter ended April 30, 2007, services relating to the Americas Job Bank
program represented approximately 6% of our consolidated revenue from the New York State Department
of Labor, and projects and services relating to the Americas One Stop Operating System program
represented approximately 2% of our consolidated revenue from the New York State Department of
Labor.
The agreement with the New York State Department of Labor is set to expire on June 14, 2007. We
have been notified by the New York State Department of Labor that funding for the Americas Job
Bank program will cease at the expiration of our current contract. We have launched
AmericasJobExchange.com as a successor site to Americas Job Bank. We expect to receive revenues
from advertising placement and subscriptions as well as other ancillary services, but we cannot
ensure that revenue will remain at the same level or that cash flows will not be adversely
impacted.
Atlantic Investors, LLC, Unicorn Worldwide Holdings Limited and Madison Technology LLC may have
interests that conflict with the interests of our other stockholders and have significant
influence over corporate decisions.
Unicorn Worldwide Holdings Limited and Madison Technology LLC, Atlantic Investors two
managing members, together with Atlantic Investors owned approximately 50% of our outstanding
capital stock as of June 1, 2007. Following the closing of the amendment to our senior secured
term loan facility with Silver Point Finance, LLC on February 13, 2007, Atlantic Investors
ownership alone was approximately 42% on a fully diluted basis. Atlantic Investors LLC, Unicorn
Worldwide Holdings Limited and Madison Technology LLC, together have significant power in the
election of our Board of Directors. Regardless of how our other stockholders may vote, Atlantic
Investors, Unicorn Worldwide Holdings and Madison Technology acting together may have the ability
to determine whether to engage in a merger, consolidation or sale of our assets and any other
significant corporate transaction.
Item 5. Other Information
During the quarter ended April 30, 2007, we made no material changes to the procedures by
which stockholders may recommend nominees to our Board of Directors, as described in our most
recent proxy statement.
32
Item 6. Exhibits
The Exhibits listed in the Exhibit Index immediately preceding such Exhibits are filed with,
or incorporated by reference in, this report.
33
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
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|
June 7, 2007 |
|
NAVISITE, INC. |
|
|
|
|
|
|
|
|
|
|
|
By:
|
|
/s/ James W. Pluntze
James W. Pluntze
|
|
|
|
|
|
|
(Principal Financial and Accounting Officer) |
|
|
34
EXHIBIT INDEX
|
|
|
Exhibit |
|
|
Number |
|
Description |
|
|
|
31.1
|
|
Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
|
|
|
31.2
|
|
Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
|
|
|
32.1
|
|
Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002. |
|
|
|
32.2
|
|
Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002. |
35