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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
 
 
Form 10-K
 
     
(Mark One)    
þ
  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
    For Fiscal Year Ended July 31, 2010
o
  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
    For the Transition Period From          to          
 
Commission File 000-27597
 
 
 
 
NaviSite, Inc.
(Exact name of registrant as specified in its charter)
 
 
 
 
     
Delaware
  52-2137343
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
Identification No.)
     
400 Minuteman Road
Andover, Massachusetts
(Address of principal executive offices)
  01810
(zip code)
 
Registrant’s telephone number, including area code
(978) 682-8300
 
 
 
 
Securities registered pursuant to Section 12(b) of the Act:
 
     
Title of Each Class
 
Name of Each Exchange on Which Registered
 
Common Stock, $0.01 par value
  The NASDAQ Stock Market LLC
 
Securities registered pursuant to Section 12(g) of the Act:
None
 
 
 
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o     No þ
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.  Yes o     No þ
 
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 has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o     No o
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  þ
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer o Accelerated filer o Non-accelerated filer o Smaller reporting company þ
(Do not check if a smaller reporting company)
 
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
 
The approximate aggregate market value of registrant’s common stock held by non-affiliates of the Registrant on January 31, 2010, based upon the closing price of a share of the Registrant’s common stock on such date as reported by the NASDAQ Capital Market: $48,239,132
 
On October 12, 2010, the Registrant had outstanding 37,930,512 shares of common stock, $0.01 par value.
 
DOCUMENTS INCORPORATED BY REFERENCE
 
Portions of the registrant’s definitive proxy statement for its annual meeting of stockholders for the fiscal year ended July 31, 2010, which statement will be filed with the Securities and Exchange Commission within 120 days after the end of the registrant’s fiscal year, are incorporated by reference into Part III hereof.
 


 

 
NAVISITE, INC.

2010 ANNUAL REPORT
ON FORM 10-K

TABLE OF CONTENTS
 
             
        Page
        Number
 
  Business     3  
  Risk Factors     12  
  Unresolved Staff Comments     20  
  Properties     21  
  Legal Proceedings     21  
  Removed and Reserved     22  
 
PART II
  Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities     23  
  Selected Financial Data     24  
  Management’s Discussion and Analysis of Financial Condition and Results of Operations     25  
  Quantitative and Qualitative Disclosures About Market Risk     36  
  Financial Statements and Supplementary Data     36  
  Changes in and Disagreements with Accountants on Accounting and Financial Disclosure     36  
  Controls and Procedures     36  
  Other Information     37  
 
PART III
  Directors, Executive Officers and Corporate Governance     37  
  Executive Compensation     38  
  Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters     38  
  Certain Relationships and Related Transactions, and Director Independence     38  
  Principal Accounting Fees and Services     38  
 
PART IV
  Exhibits, Financial Statement Schedules     38  
Signatures     39  
Index to NaviSite, Inc. Consolidated Financial Statements     F-1  
 EX-10.6
 EX-10.7
 EX-10.8
 EX-10.9
 EX-10.60
 EX-21
 EX-23
 EX-31.1
 EX-31.2
 EX-32.1
 EX-32.2


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PART I

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
 
This Annual Report on Form 10-K of NaviSite, Inc. (“NaviSite,” the “Company,” “we,” “us” and “our”) contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), that involve risks and uncertainties. All statements other than statements of historical information provided herein are forward-looking statements and may contain information about financial results, economic conditions, trends and known uncertainties. Our actual results could differ materially from those discussed in the forward-looking statements as a result of a number of factors, which include those discussed in this section and elsewhere in this report and the risks discussed in our other filings with the Securities and Exchange Commission (the “SEC”). Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect our management’s analysis, judgment, belief or expectation only as of the date hereof. Investors are warned that actual results may differ materially from our expectations. We undertake no obligation to publicly reissue or update these forward-looking statements to reflect events or circumstances that arise after the date hereof. All logos and company and product names may be trademarks or registered trademarks of their respective owners.
 
Item 1.   Business
 
Our Business
 
NaviSite is a global information-technology (“IT”) provider of cloud enabled enterprise-hosting and application management services. We help approximately 1,300 customers reduce the cost and complexity of IT, increase the performance and availability of the IT infrastructure, and free-up IT resources to focus on their core businesses by offering a comprehensive suite of customized IT-as-a-service solutions. Our goal is to be the leading provider of cloud based enterprise-hosting and managed-application services by leveraging our deep knowledge, experience, technology platform, and commitment to our customers’ success.
 
Our core competency is to provide outsourced IT services. These services include managed cloud computing service, complex enterprise hosting solutions, customized managed application services and remote operations services of our customer’s data centers. Our managed cloud computing service, called NaviCloud Managed Cloud Services (“MCS”) is currently offered from two of our datacenters and uses an industry-leading, feature rich user interface, AppCenter, which was developed by NaviSite. Our suite of managed applications includes the Oracle suite (e-Business Suite, PeopleSoft Enterprise, Siebel, JD Edwards and Hyperion), the Microsoft Dynamics suite, Deltek Costpoint, Microsoft e-mail and collaboration suite (Exchange, Sharepoint and OCS) and Lotus Domino suite. By managing applications and infrastructure and providing comprehensive services, we are able to address the key IT challenges faced by organizations today: increasing complexity, pressures on capital and operating expenses, resource constraints and depth of technology expertise.
 
We provide our services from a global platform of 10 data centers in the United States and in the United Kingdom, totaling approximately 160,000 square feet of usable space, and two redundant network operations centers (“NOC”) located in India and Andover, Massachusetts. Our NaviCloud MCS services are currently offered from nodes in our San Jose, California and Andover, Massachusetts facilities. Using this infrastructure, we leverage innovative and scalable uses of technology along with the subject-matter expertise of our professional staff to deliver cost-effective, flexible technology solutions that provide responsive and predictable levels of service to meet our customers’ business needs. These solutions often augment a customer’s existing operation as a transparent extension of their IT infrastructure and staff. Combining our technology, domain expertise and competitive fixed-cost infrastructure, we offer our customers the cost and functional advantages of outsourcing with a proven partner like NaviSite. We are dedicated to delivering quality services and meeting rigorous standards, including maintaining our SAS 70 Type II compliance and Microsoft Gold and Oracle Certified Partner certifications.


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In addition to our standard services, we leverage our infrastructure to deliver our partners’ software on demand and thereby provide an alternative to the traditional licensing of software. This is primarily facilitated by our NaviCloud MCS offering in conjunction with our NaviViewtm application management portal. As the provider of Infrastructure-as-a Service (“IaaS”) for an increasing number of independent software vendors (“ISVs”) and providers of Software-as-a-Service (“SaaS”), we enable solutions and services to a diverse, growing customer base. With NaviCloud, AppCenter and NaviViewtm we have adapted our infrastructure to provide services specific to the needs of our customers in order to increase our market share. We believe that our data centers and infrastructure have the capacity necessary to expand our business for the foreseeable future. Further, trends in hardware virtualization and the density of computing resources, which reduce the required square footage and power, or footprint, in the data center, are favorable to NaviSite’s NaviCloud services-oriented offerings, as compared with traditional co-location or managed-hosting providers. Our services, as described below, combine our developed infrastructure with established processes and procedures for delivering outsourced IT services. Our high-availability infrastructure, enterprise class monitoring systems and proactive and collaborative problem-resolution and change-management processes are designed to identify and address potentially crippling problems before they disrupt our customers’ operations.
 
We currently serve approximately 1,300 customers. Our hosted customers typically enter into service agreements for a term of one to five years, with monthly payments, that provide us with a recurring revenue base. Our revenue growth comes from adding new customers and delivering additional services to existing customers. Our recurring revenue base is affected by new customers and renewals and terminations with existing customers.
 
Our Services
 
We offer our customers a broad range of cloud computing, enterprise-hosting and managed-application services that can be deployed quickly and cost effectively. Our expertise allows us to meet an expanding set of increasingly complex customer requirements. Our experience, flexibility and capabilities save our customers the time and cost of developing expertise in house and we increasingly serve as the primary technical and function owner of our customers’ outsourced IT services. We provide these services to a range of industries — including financial services, healthcare and pharmaceuticals, manufacturing and distribution, publishing, media and communications, business services, public sector and software — through our own sales force and sales-channel relationships.
 
Our strategy is to leverage our cloud offering both as a standalone IaaS offering (NaviCloud MCS) as well as a platform for our complex enterprise hosting and application management services. All of our services are supported and facilitated by our proprietary AppCenter and NaviViewtm management and interaction portals. Our NaviCloud and NaviViewtm platforms enable us to provide highly efficient, effective and customized management of enterprise applications and hosted infrastructure. Comprised of a suite of third-party and proprietary products, both toolsets are designed specifically to meet the needs of customers who outsource IT functions.
 
Supporting our services requires a range of hardware and software designed for the specific needs of our customers. With NaviCloud, NaviSite is a leader in using virtual computing, shared and dedicated storage and networking as ways to optimize services for performance, cost and operational efficiency. We strive to continually innovate as technology develops.
 
Our services are grouped and described further as follows:
 
NaviCloud Managed Cloud Services
 
NaviSite’s NaviCloud MCS is a utility platform providing compute, memory, storage, network, security and bandwidth. Geared to the enterprise market, NaviCloud provides production quality IaaS solutions combining the best features of cloud with enterprise class management. Services are accessible on-demand, are scalable and usage billed. NaviCloud nodes are available in our San Jose, California and Andover, Massachusetts data centers.


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Customers access the underlying physical resources of NaviCloud via a proprietary application called AppCenter. AppCenter facilitates the end-to-end management of a virtual data center including the rapid provisioning and management of virtual machines, management of firewalls and load balancers, capacity and load management and people/process controls for use of the environment. All functions within the virtual data center can be managed without intervention from NaviSite personnel.
 
The underlying hardware and third party software consists of various vendor offerings including products from Cisco Systems, Inc., Hewlett-Packard, VMware, Inc. and IBM. The key differentiators of NaviCloud are its (i) enterprise focus, (ii) self or fully-managed options and, (iii) consumption or utilization billing. We offer NaviCloud services on a month-to-month basis.
 
The key features and function supported in the current version of AppCenter and the underlying NaviCloud infrastructure include:
 
  •  security and compliance;
 
  •  performance management;
 
  •  availability and reliability guarantees;
 
  •  control and simplified operation of complete virtual data center;
 
  •  integration with existing environments — physical or virtual;
 
  •  consumption based billing; and
 
  •  roles based access control.
 
Enterprise-Hosting Services
 
NaviSite’s hosting services provide highly dependable and secure technology solutions for our customers’ critical IT infrastructure and service needs. Enterprise hosting service can be implemented on the NaviCloud utility platform, dedicated physical hardware or a combination of both.
 
  •  Managed Hosting Service — Support provided for hardware and software located in one of our managed services data centers. We also provide bundled offerings packaged as content-delivery services. Specific services include:
 
  •  dedicated and virtual servers;
 
  •  business continuity and disaster recovery;
 
  •  connectivity;
 
  •  content distribution;
 
  •  database administration and performance tuning;
 
  •  help desk support;
 
  •  hardware management;
 
  •  monitoring;
 
  •  network management;
 
  •  security;
 
  •  server and operating management; and
 
  •  storage management.
 
  •  Software-as-a-Service — Enablement of SaaS to the ISV community. Services include SaaS starter kits and services specific to the needs of ISVs that want to offer their software in an on-demand or subscription mode.


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  •  Co-location — Physical space offered in a data center. In addition to providing the physical space, NaviSite offers environmental support, specified power with backup power generation and network-connectivity options.
 
Application Management
 
NaviSite’s application management services provide highly dependable and secure application solutions for our customers’ critical IT application needs. Enterprise hosting service can be implemented on the NaviCloud utility platform, dedicated physical hardware or a combination of both.
 
We provide implementation and operational services for the packaged applications listed below. We offer — in addition to packaged enterprise-resource-planning, or ERP, applications — outsourced messaging, including the monitoring and management of Microsoft Exchange and Lotus Domino and the associated collaboration solutions. Application-management services are available either in a NaviSite data center or, through remote management on customers’ premises. Moreover, our customers can choose to use dedicated or shared servers. We also provide specific services to help customers migrate from legacy or proprietary messaging systems to Microsoft Exchange or Lotus Domino, and our experts can customize messaging and collaborative applications. We offer user provisioning, spam filtering, archiving, disaster recovery and business continuity, virus protection and enhanced monitoring and reporting.
 
  •  ERP Application-Management Services — Defined services provided for specific packaged applications. Services include implementation, upgrade assistance, monitoring, diagnostics, problem resolution and functional end-user support. Applications include:
 
  •  Oracle e-Business Suite;
 
  •  PeopleSoft Enterprise;
 
  •  Siebel;
 
  •  JD Edwards;
 
  •  Hyperion;
 
  •  Deltek Costpoint;
 
  •  Microsoft Dynamics;
 
  •  Microsoft Exchange; and
 
  •  Lotus Domino.
 
  •  ERP Professional Services — Planning, implementation, optimization, enhancement and upgrades for supported third-party ERP applications.
 
  •  Custom-Development Professional Services — Planning, implementation, optimization and enhancement for custom applications developed by us or our customers.
 
NaviViewtm Platform
 
Our proprietary NaviViewtm platform is a critical element of our service offerings, each of which can be customized to meet our customers’ particular needs. Using this platform, we offer valuable flexibility without the significant costs associated with traditional customization. NaviViewtm allows us to work with our customers’ IT teams, systems integrators and other third parties to deliver services to customers. Our NaviViewtm platform and its user interface help ensure full transparency to the customer and seamless operation of outsourced applications and infrastructure, including (i) hardware, operating-system, database and application monitoring, (ii) event management, (iii) problem-resolution management and (iv) integrated change- and configuration-management tools. Our NaviViewtm platform includes the following elements.


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Event-Detection System — Our proprietary technology allows our operations personnel to efficiently process alerts across heterogeneous computing environments. This system collects and aggregates data from all of the relevant systems-management software packages utilized by an IT organization.
 
Synthetic-Transaction Monitoring — Our proprietary synthetic-transaction methods simulate the end-user experience and monitor for application latency or malfunctions that affect user productivity.
 
Automated Remediation — Our NaviViewtm platform also allows us to proactively monitor, identify and correct common problems associated with the applications we manage on behalf of our customers. These automated corrections help ensure availability and reliability by remediating known issues in real time and keeping applications up and running while underlying problems or potential problems are diagnosed.
 
Component-Information Manager — This central repository provides a unified view of disparate network, database, application and hardware information.
 
Escalation Manager — This workflow-automation technology allows us to streamline routine tasks and escalate critical issues in a fraction of the time that manual procedures require. Our escalation manager initiates specific orders and tasks based on pre-defined conditions, ensuring clear and consistent communication with our customers.
 
We believe that the combination of NaviViewtm, our dedicated and virtual utility platform, with our physical infrastructure and technical staff gives us a unique ability to provide complex enterprise hosting and application management services. NaviViewtm is hardware-, application- and operating-system-neutral. Designed to enable enterprise-hosting and software applications to be monitored and managed, our NaviViewtm technology allows us to offer new solutions to our software vendors and new products to our current customers.
 
Our History
 
We began operations in 1996 within CMGI, Inc. (currently known as ModusLink Global Solutions, Inc. (“ModusLink”)), our former majority stockholder, to support the networks and host websites of ModusLink, its subsidiaries and several of its affiliated companies. In 1997 we began offering and supplying website-hosting and -management services to companies not affiliated with ModusLink. We were incorporated in Delaware in December 1998.
 
Acquisitions in Fiscal Year 2008
 
  •  In August 2007 we acquired the assets of Alabanza LLC and Hosting Ventures LLC (together, “Alabanza”) and all of the issued and outstanding stock of Jupiter Hosting, Inc. (“Jupiter”). These acquisitions provided additional managed-hosting customers, proprietary software for provisioning and additional data-center space in the Bay Area market.
 
  •  In September 2007 we acquired netASPx, Inc. (“netASPx”), based in Minneapolis, Minnesota. The acquisition of netASPx added functional expertise in the Lawson and Kronos ERP applications and approximately 18,000 square feet of data-center capacity.
 
  •  In October 2007 we acquired the assets of iCommerce, Inc. (“iCommerce”), a re-seller of dedicated hosting services.
 
Asset Sales in Fiscal Year 2010
 
During fiscal year 2010, we engaged in an effort to sell certain of our assets to reduce our outstanding debt obligations and allow us to focus on a selling enterprise level managed services from a smaller number of core data centers.
 
  •  In February 2010, we sold substantially all of the assets of netASPx for a gross sale price of $56.0 million and used the net proceeds to reduce our outstanding debt obligations.


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  •  In March 2010, we sold substantially all of the assets of two of our co-location data centers for a gross sale price of $5.4 million and used the net proceeds to reduce our outstanding debt obligations.
 
Our Industry
 
The dramatic and continued growth in Internet use and the enhanced functionality, accessibility and security of Internet-based applications and software as a service (or subscription-based software) have made conducting business on the Internet a necessity for today’s enterprises. In addition, the costs, complexity and technological challenges faced by today’s businesses have them increasingly looking to outsourcing IT services. The growing use of virtualization has added to the complexity of IT while also offering the opportunity for reduced costs. We believe that a fast-growing trend is the increased use of cloud based services and outsourced IT infrastructure by companies to allow them to focus and enhance their core business operations, increase efficiencies and remain competitive. Enterprise hosting and related applications extend beyond traditional websites to business-process software applications in such areas as finance, e-mail, enterprise-resource planning, supply-chain management and customer-relationship management. Organizations have become increasingly dependent on these applications, which have evolved into important business components. In addition, we believe that the pervasiveness of the Internet and quality of network infrastructure, along with the dramatic decline in the pricing of computing technology and the emergence of blade-based virtualization and cloud computing, have made the outsourced-delivery model an attractive choice for enterprise customers. We believe that the accelerated acceptance of alternative software-licensing models by software-industry market leaders and the growing number of software-as-a-service offerings are driving other software vendors in this direction and, consequently, generating strong industry growth.
 
As enterprises seek to remain competitive and improve profitability, we believe that they will continue to implement increasingly sophisticated applications and delivery models. Some of the potential benefits of these applications and delivery models include the ability to:
 
  •  increase business-operating efficiencies and reduce costs by using best-of-breed applications;
 
  •  build and enhance customer relationships by providing Internet-enabled customer service and technical support;
 
  •  manage vendor and supplier relationships through Internet-enabled technologies, such as online training and online sales and marketing;
 
  •  communicate and conduct business more rapidly and cost-effectively with customers, suppliers and employees worldwide; and
 
  •  improve service and lower the cost of software ownership by the adoption of new Internet-enabled software-delivery models.
 
These benefits have driven increased use of IT infrastructure and applications, and this trend in turn has created a strong demand for specialized IT support and outsourced IT services as an extension of the enterprise. An increasing number of businesses are choosing to use public and private cloud based services and outsource the hosting and management of IT services.
 
The trend towards outsourced hosting and management of IT infrastructure and applications by today’s business organizations is driven by a number of factors, including:
 
  •  developments by major hardware and software vendors that facilitate outsourcing, such as the production of rack-based blade servers designed to be shared by a number of customers;
 
  •  advances in virtualization and high-density computing that are beyond the skill and cost ability of the typical IT department;
 
  •  the need to improve the reliability, availability and overall performance of applications as they increase in importance and complexity;
 
  •  the need to focus on core business operations;


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  •  challenges and costs of hiring, training and retaining application engineers and IT employees with the requisite range of IT expertise;
 
  •  the increasing complexity of managing the operations of applications that need to function in house, with business partners and on the public Internet;
 
  •  utility-like “cloud” service offerings that enable companies to scale their services based on fluctuating requirements; and
 
  •  the ability to extend internal infrastructure to less expensive, cloud based infrastructure for a wide range of uses.
 
Notwithstanding increasing demand for these services, the number of suppliers of these services has decreased over the past five years, primarily as a result of industry consolidation. We believe that this consolidation trend will continue and will benefit the relatively few service providers with sufficient resources and infrastructure to provide the cost-effective scalability, performance, reliability and business continuity that customers expect.
 
Our Strategy
 
Our goal is to become the leading provider of cloud-enabled enterprise-hosting and managed-application services. Further, our financial objective is to market and deliver high-value services to generate the highest revenue per square foot of available capacity in our data centers. Key elements of our strategy are as follows:
 
Provide Excellent Customer Service.  We are committed to providing all of our customers with a high level of customer support. We believe that we have the benefit of consolidating best-of-breed account-management and customer-support practices that ensure that we are achieving this goal.
 
Innovate and Leverage Our Technology Platform.  We will continue to expand our platform leverage by continued use of virtualization and utility-type services, including the development of a virtual enterprise cloud platform. We believe that the typical middle-market organization is not able to take advantage of these technology developments because of their complexity and cost. By continually updating our platform, we will continue to drive our competitiveness with higher-value services at competitive prices.
 
Expand Our Global-Delivery Capabilities.  We believe that global delivery is an integral piece of our long-term strategy to the extent that it directly leads to our overall goal of service and operational excellence for our customers. By leveraging a global-delivery solution, we believe that we will be able to continue to deliver superior services and technical expertise at a competitive cost and enhance the value proposition for our customers.
 
Improve Operating Margins Through Operational Efficiencies.  We have made significant improvements to our overall cost structure. We intend to continue to improve operating margins as we grow revenue and improve the efficiency of our operations. As we grow, we will take advantage of our infrastructure capacity, our NaviViewtm platform and our automated processes. We believe that, due to the relatively fixed-cost nature of our infrastructure, increasing our customer revenue would incrementally improve our operating margins.
 
Focus Our Service Offerings.  We continue to focus our service offerings to compete more effectively by being the best at what we do for the packaged solutions we support. With our professional services and deep operational expertise, we effectively deliver to our customers a full range of services for Oracle, PeopleSoft, J. D. Edwards, Siebel, Microsoft Dynamics, Microsoft Exchange and Lotus Domino solutions. We believe that these services will help our customers achieve peak effectiveness with their systems. As a full-service provider for a broad range of applications, we are able to create leverage and cross- and up-sell opportunities in a manner that is unparalleled in the marketplace.


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Our Infrastructure
 
Our infrastructure has been designed specifically to meet the demanding technical requirements of delivering our services to our customers. We securely deliver our services across Windows and Unix platforms. We believe that our infrastructure, together with our trained and experienced staff, enable us to offer market-leading levels of service backed by high-service-level guarantees.
 
Network-Operations Centers — We monitor the operations of our infrastructure and customer applications from our own state-of-the-art network-operations centers. Network and system management and monitoring tools continuously monitor our network server and application performance. Our network operations centers perform first-level problem identification, validation and resolution. We have redundant network operations centers in New Delhi, India, and Andover, Massachusetts, that are staffed 24 hours a day, seven days a week, with network, security, Windows and Unix database and application personnel. We have technical and functional application-support personnel located in our facilities in San Jose, California; Syracuse, New York; Houston, Texas; Atlanta, Georgia; Andover, Massachusetts; and New Delhi, India. These employees provide initial and escalated support 24 hours a day, seven days a week, for our customers. Our engineers and support personnel are promptly alerted to problems, and we have established procedures for rapidly resolving technical issues that may arise.
 
Data Centers — We currently operate in 10 data centers in the United States and the United Kingdom. Our data centers incorporate technically sophisticated components that are designed to be fault-tolerant. The components used in our data centers include redundant core routers, redundant core-switching hubs and secure virtual local-area networks. We utilize the equipment and tools necessary for our data-center operations, including our infrastructure hardware, networking and software products, from industry leaders such as BMC Software, Cisco Systems, Inc., Dell, IBM, EMC, Hewlett-Packard, Microsoft, Oracle and Sun Microsystems.
 
Virtualization — We employ virtualization technologies (also known as “Cloud Computing”), for processing, storage and networking. By using this approach, we are able to maximize the benefit of our capital expenditures, minimize the amount of valuable data center space and power used and create additional operating efficiencies that lower our cost. Virtualization decreases our time to provision and thereby accelerates our ability to recognize revenue. With its inherent redundancy and scalability, virtualization adds business continuity and, for Internet-based applications and hosting, reliability. Virtualization also brings otherwise unaffordable IT progress within the reach of the typical middle-market customer.
 
Internet Connectivity — We have redundant high-capacity Internet connections with providers such as Global Crossing, Level 3 Communications Inc., Cogent Communications, AT&T and XO Communications and others. We have deployed direct private-transit and peering Internet connections to utilize the provider’s peering capabilities and to enhance routes via their networks that improve global performance. Our private-transit system enables us to provide fast, reliable access for our customers’ IT infrastructure and applications.
 
Sales and Marketing
 
Sales — Our sales teams are located in the United States, the United Kingdom and India and focus on the identification, quoting and sale of solutions to new customers. Our sales professionals meet with these prospective customers to understand and identify their individual business requirements and to offer tailor-made solutions. The sales teams are focused on cloud computing, enterprise hosting, application management and professional services, with respect to which domain knowledge and expertise are a significant differentiator. Our sales teams are supported by solution architects who assess the infrastructure and application requirements to develop an optimal design and cost analysis. The quoting for prospective opportunities with less complex requirements is automated and is provided online directly to our sales professionals.
 
The sales teams are augmented by account managers assigned to specific accounts to identify and manage up-sellng and cross-selling opportunities of additional services and the renewal of contracts approaching term. To date, most of our sales have been realized through our direct-sales-force teams. Our sales representatives call potential customers from our offices in the United States and India to develop new opportunities and


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consult with smaller mid-market companies. We also leverage business development resources to create market demand for our products and services.
 
Automation and Platform-Based Sales — In 2008 we launched an automated platform to allow new customers to purchase and provision hosted Microsoft Exchange. This automated system allows customers to buy services immediately without interaction with NaviSite staff.
 
Marketing — Our marketing organization is responsible for defining our overall market strategy, generating qualified leads for our field and inside sales forces and increasing the overall awareness of our brand. Our lead-generation programs include comprehensive online and offline marketing programs and emphasize online search, e-mail, banner advertising, outbound telemarketing efforts, trade conferences and webinars. We maintain a data-driven, rigorous measurement and monitoring approach to maximize the efficacy of our marketing investments and deliver the highest possible return on investment.
 
Customers
 
Our customers include mid-sized companies, divisions of large multinational companies and government agencies. Our customers operate in a wide variety of industries, such as technology, manufacturing and distribution, healthcare and pharmaceuticals, publishing, media and communications, financial services, retail, business services and government agencies.
 
As of July 31, 2010, NaviSite serviced approximately 1,300 hosted customers.
 
No customer represented 10% or more of our revenue for the fiscal years ended July 31, 2010, 2009 and 2008. Substantially all of our revenues are derived from the United States.
 
Competition
 
We compete in the outsourced IT and professional-services markets. These markets are fragmented, highly competitive and likely to be characterized by industry consolidation.
 
We believe that participants in these markets must grow rapidly and achieve a significant presence to compete effectively. We believe that the primary competitive factors determining success in our markets include:
 
  •  the quality of services delivered;
 
  •  the ability to consistently measure, track and report operational metrics;
 
  •  application-hosting, infrastructure and messaging-management expertise;
 
  •  fast, redundant and reliable Internet connectivity;
 
  •  a robust infrastructure providing availability, speed, scalability and security;
 
  •  comprehensive and diverse service offerings and the timely addition of value-add services;
 
  •  brand recognition;
 
  •  strategic relationships;
 
  •  competitive pricing; and
 
  •  adequate capital to permit continued investment in infrastructure, customer service and support and sales and marketing.
 
Based on the breadth of our service offerings, the strength of our NaviViewtm platform, our existing infrastructure capacity and our pricing, we believe that we compete effectively.
 
Our current and prospective competitors include:
 
  •  cloud, hosting and related services providers, including Terremark, Inc., Rackspace Hosting, Inc., Savvis, Inc., IBM, AT&T, and other local and regional hosting providers;


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  •  application-services providers, such as IBM, AT&T, CedarCrestone, Inc., Oracle On Demand and Computer Sciences Corporation;
 
  •  co-location providers, including Savvis, Equinix, Inc. and Terremark; and
 
  •  messaging providers, including Apptix, USA.Net, Inc. and Intermedia.
 
Intellectual Property
 
We rely on a combination of trademark, service mark, copyright, patent and trade-secret laws and contractual restrictions to establish and protect our proprietary rights and promote our reputation and the growth of our business. Our business is not substantially dependent on any single or group of related patents, trademarks, copyrights or licenses.
 
Employees
 
As of July 31, 2010, we had 584 employees, 579 of whom were full-time employees. Of these employees, 390 were principally engaged in operations, 96 were principally engaged in sales and marketing and 98 were principally engaged in general and administrative functions. None of our employees is party to a collective-bargaining agreement, and we believe that our relationship with our employees is good. We also retain consultants and independent contractors on a regular basis to assist in the completion of projects.
 
Available Information
 
We make our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports available through our website under “Investors,” free of charge, as soon as reasonably practicable after we file such material with, or furnish it to, the SEC. Our Internet address is http://www.navisite.com. The contents of our website are not incorporated by reference in this annual report on Form 10-K or any other report filed with, or furnished to, the SEC.
 
Item 1A.   Risk Factors
 
We operate in a rapidly changing environment that involves a number of risks, some of which are beyond our control. Forward-looking statements in this report and those made from time to time by us through our senior management are made pursuant to the safe-harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements concerning our expected future revenues, earnings or financial results; project plans; performance; or development of products and services, as well as other estimates related to future operations, are necessarily only estimates of future results. We cannot assure you that actual results will not materially differ from expectations. Forward-looking statements represent our management’s current expectations and are inherently uncertain. We do not undertake any obligation to update forward-looking statements. If any of the following risks actually occurs, our business, financial condition and operating results could be materially adversely affected.
 
We have a history of losses and may never achieve or sustain profitability.  We reached profitability in the fiscal year ended July 31, 2010 as a result of the gain on the sale of certain assets. As of July 31, 2010, our stockholders’ deficit is approximately $20.8 million. We have incurred losses from continuing operations since our incorporation and 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.
 
Our financing agreement with a syndicated group of lenders includes various covenants and restrictions that may negatively affect our liquidity and our ability to operate and manage our business.  As of September 30, 2010, we owed approximately $53.2 million under a credit agreement with a syndicated group of lenders. The credit agreement:
 
  •  restricts our ability to create, incur, assume or permit to exist any additional indebtedness, excluding limited exemptions;


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  •  restricts our ability to create, incur, assume or permit to exist any lien on any of our assets, excluding limited exemptions;
 
  •  restricts our ability to make investments, with limited exemptions;
 
  •  requires that we meet financial covenants for leverage, fixed charges, minimum EBITDA, minimum liquidity and capital expenditures;
 
  •  restricts our ability to enter into any transaction of merger or consolidation, excluding limited exemptions;
 
  •  restricts our ability to sell assets or purchase or otherwise acquire the property of any person, excluding limited exceptions;
 
  •  restricts our ability to authorize, declare or pay dividends, excluding limited exemptions;
 
  •  restricts our ability to enter into any transaction with any affiliate except on terms and conditions that are at least as favorable to us as those that could reasonably be obtained in a comparable arm’s-length transaction with a person who is not an affiliate; and
 
  •  restricts our ability to amend our organizational documents.
 
If we breach the credit agreement, a default could result. A default, if not waived, could result in, among other things, our not being able to borrow additional amounts under the credit agreement. In addition, all or a portion of our outstanding amounts may become immediately due and payable on an accelerated basis, which would adversely affect our liquidity and our ability to manage our business. The maturity date of the term loan is June 8, 2013, and our revolving-credit facility terminates on June 8, 2012. Interest on the term loan is payable in arrears on the first business day of August, November, February and May, for alternative-base-rate (“ABR”) loans, and the last day of the chosen interest period (which can be one, two, three, six, nine or twelve months), or every three months, if the chosen interest period is greater than three months, for London-interbank-offered-rate (“LIBOR”) loans.
 
The term loan amortizes on the first day of each fiscal quarter (commencing on August 1, 2007) in equal quarterly installments during the periods set forth below in the aggregate amounts set forth opposite such periods:
 
         
Year
  Percentage of Term Loan
 
1
    1.0 %
2
    1.0 %
3
    1.0 %
4
    1.0 %
5
    1.0 %
6
    95.0 %
 
In addition, the credit agreement exposes us to interest-rate fluctuations that could significantly increase the interest we pay.
 
We may be unable to borrow the full amount of the revolving-credit facility, up to $9.0 million, if any of the lenders are unable to make a loan in an amount equal to their applicable commitments under the revolving-credit facility.
 
We may need to obtain additional debt or equity financing in order to satisfy any mandatory redemption of our preferred stock.  The holders of Series A Convertible Preferred Stock (“Preferred Stock”) have rights that could require us to redeem any or all of the issued and outstanding Preferred Stock on or after August 2013. We may need to obtain additional debt or equity financing in order to satisfy any mandatory redemption, but that financing may not be available on favorable terms or at all. In addition, our credit agreement restricts our ability to incur additional indebtedness, which could negatively affect our ability to fulfill our obligations to the holders of the Preferred Stock.


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Disruption in financial and currency markets could have a negative effect on our business.  As has been widely reported, financial markets in the United States, Europe and Asia have in recent years experienced disruption, including unusual volatility in security prices, diminished liquidity and credit availability, rating downgrades of certain investments and declining valuations of others. Governments took unprecedented actions intended to address these market conditions which include restricted credit and declines in real estate values. While currently these conditions have not impaired our ability to operate our business, there can be no assurance that there will not be a further deterioration in financial markets and confidence in major economies, a circumstance that could lead to challenges in the operation of our business. These economic developments affect businesses such as ours in a number of ways. The current tightening of credit in financial markets adversely affects the ability of customers and suppliers to obtain financing for significant purchases and operations and could result in a decrease in orders and spending for our products and services. We are unable to predict future disruptions in financial markets and adverse economic conditions and the effects that they would have on our business and financial condition.
 
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.  Atlantic Investors, LLC (“Atlantic”) — together with its two managing members, Unicorn Worldwide Holdings Limited and Madison Technology LLC — own approximately 34% of our outstanding voting securities. As of July 31, 2010, Atlantic alone held approximately 33% of our outstanding voting securities. Atlantic, 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, Arthur Becker, our former chief executive officer and a current member of our board of directors, Unicorn Worldwide Holdings and Madison Technology LLC, 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.
 
Members of our board of directors have significant interests in Atlantic Investors, LLC, that may create conflicts of interest.  Two of the members of our board of directors also serve as members of the management group of Atlantic and its affiliates. Specifically, Andrew Ruhan, the chairman of our board of directors, holds an equity interest in Unicorn Worldwide Holdings Limited, a managing member of Atlantic. Arthur P. Becker, our former president and chief executive officer and a current member of our board of directors, is the managing member of Madison Technology LLC, a managing member of Atlantic. As a result, these NaviSite directors may face potential conflicts of interest with our stockholders. In their capacity as our directors, they may face situations that conflict with their fiduciary obligations to Atlantic, which in turn may have interests that conflict with the interests of our other stockholders.
 
Our common stockholders may suffer dilution in the future upon exercise of outstanding convertible securities or the issuance of additional securities in potential future acquisitions or financings.  In connection with a financing agreement with Silver Point Finance, LLC, we issued warrants to SPCP Group, LLC, and SPCP Group III LLC, two affiliates of Silver Point Finance, to purchase an aggregate of 3,930,136 shares of our common stock. If the warrants are exercised, Silver Point Finance may obtain a significant equity interest in NaviSite and other stockholders may experience significant and immediate dilution. As of September 30, 2010, SPCP Group, LLC, and SPCP Group III LLC have partially exercised the warrants to acquire 2,730,005 shares of our common stock, and warrants for the purchase of 1,200,131 shares of our common stock remain outstanding.
 
In connection with our acquisition of netASPx, we issued to its stockholders 3,125,000 shares of our Preferred Stock. Additional shares of the Preferred Stock have been and will be issued each fiscal quarter to the former shareholders of netASPx, as in-kind dividends that accrue on the outstanding Preferred Stock. The Preferred Stock may be converted into shares of common stock at a price of $8.00 per share subject to adjustment. If converted, the shares of Preferred Stock convert into the number of shares of common stock determined by dividing the redemption price per share of the Preferred Stock by the conversion price applicable to such shares. As of September 30, 2010, such a conversion would result in one share of common stock being issued upon the conversion of one share of Preferred Stock. The conversion and redemption prices are subject to adjustment in certain circumstances or upon default of our agreement. However, in no event are


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the number of shares of common stock to be issued upon the conversion of the Preferred Stock to equal or exceed 6,692,856 (which represents 19.9% of the outstanding shares of our common stock on September 10, 2007) without the approval of our stockholders in accordance with the applicable rules and regulations of the Nasdaq Stock Market. As of September 30, 2010, 37,529 shares of Preferred Stock have been converted into shares of our common stock.
 
Our stockholders will also experience dilution to the extent that additional shares of our common stock are issued in potential future acquisitions or financings.
 
A failure to meet customer specifications or expectations could result in lost revenues, increased expenses, negative publicity, claims for damages and harm to our reputation and cause demand for our services to decline.  Our agreements with customers require us to meet specified service levels for the services we provide, and our customers may have additional expectations about our services. Any failure to meet customers’ specifications or expectations could result in:
 
  •  delayed or lost revenue;
 
  •  requirements to provide additional services to a customer at reduced charges or no charge;
 
  •  negative publicity about us, which could adversely affect our ability to attract or retain customers; and
 
  •  claims by customers for substantial damages against us, regardless of our responsibility for the failure, which claims may neither be covered by insurance policies nor limited by the contractual terms of our engagement.
 
Our ability to successfully market our services could be substantially impaired if we are unable to deploy new infrastructure systems and applications or if we do deploy them but they prove unreliable, defective or incompatible.  We may experience difficulties that could delay or prevent the successful development, introduction or marketing of hosting- and application-management services in the future. If any newly introduced infrastructure systems and applications suffer from reliability, quality or compatibility problems, market acceptance of our services could be greatly hindered and our ability to attract new customers significantly reduced. We cannot assure you that new applications deployed by us will be free from any reliability, quality or compatibility problems. If we incur increased costs or are unable, for technical or other reasons, to host and manage new infrastructure systems and applications or enhancements of existing applications, our ability to successfully market our services could be substantially limited.
 
Any interruption in, or degradation of, our private-transit Internet connections could result in the loss of customers or hinder our ability to attract new customers.  Our customers rely on our ability to move their digital content as efficiently as possible to the people accessing their websites and infrastructure systems and applications. We utilize our direct private-transit Internet connections to major network providers, such as Level 3 and Global Crossing, as a means of avoiding congestion and resulting performance degradation at public Internet exchange points. We rely on these telecommunications-network suppliers to maintain the operational integrity of their networks so that our private-transit Internet connections operate effectively. If our private-transit Internet connections are interrupted or degraded, we may face claims by, or loss of, customers and harm to our reputation in the industry, either of which result would likely cause demand for our services to decline.
 
If we are unable to maintain existing, and develop additional, relationships with software vendors, the sales and marketing of our service offerings may be unsuccessful.  We believe that, to penetrate the market for managed — IT-services, we must maintain existing, and develop additional, relationships with industry- leading software vendors. We license or lease select software applications from software vendors, including IBM, Microsoft and Oracle. Our relationships with Microsoft and Oracle are critical to the operations and success of our business. The loss of our ability to continue to obtain, utilize or depend on any of these applications or relationships could substantially weaken our ability to provide services to our customers. It may also require us to obtain substitute software applications that may be of lower quality or performance standards or at greater cost. In addition, because we generally license applications on a non-exclusive basis, our competitors may license and utilize the same software applications. In fact, many of the companies with


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which we have strategic relationships currently have, or could enter into, similar license agreements with our competitors or prospective competitors. We cannot assure you that software applications will continue to be available to us from software vendors on commercially reasonable terms. If we are unable to identify and license software applications that meet our targeted criteria for new application introductions, we may have to discontinue or delay introduction of services relating to these applications.
 
Our network infrastructure could fail, which failure would impair our ability to provide guaranteed levels of service and could result in significant operating losses.  To provide our customers with guaranteed levels of service, we must operate our network infrastructure 24 hours a day, seven days a week, without interruption. We must, therefore, protect our network infrastructure, equipment and customer files against damage from human error, natural disasters, unexpected equipment failure, power loss or telecommunications failures, terrorism, sabotage or other intentional acts of vandalism. Even if we take precautions, the occurrence of a natural disaster, equipment failure or other unanticipated problem at one or more of our data centers could result in interruptions in the services we provide to our customers. We cannot assure you that our disaster-recovery plan will address all, or even most, of the problems we may encounter in the event of a disaster or other unanticipated problem. We have experienced service interruptions in the past, and any future service interruptions could:
 
  •  require us to spend substantial amounts of money to replace equipment or facilities;
 
  •  entitle customers to claim service credits or seek damages for losses under our service-level guarantees;
 
  •  cause customers to seek alternate providers; or
 
  •  impede our ability to attract new customers, retain current customers or enter into additional strategic relationships.
 
Our dependence on third parties increases the risk that we will not be able to meet our customers’ needs for software, systems and services on a timely or cost-effective basis, which inability could result in the loss of customers.  Our services and infrastructure rely on products and services of third-party providers. We purchase key components of our infrastructure, including networking equipment, from a limited number of suppliers, such as Hewlett Packard, Sun Microsystems, IBM, Cisco Systems, Inc., Microsoft and Oracle. We cannot assure you that we will not experience operational problems attributable to the installation, implementation, integration, performance, features or functionality of third-party software, systems and services. We cannot assure you that we will have the necessary hardware or parts on hand or that our suppliers will be able to provide them in a timely manner in the event of equipment failure. Our inability to timely obtain and continue to maintain the necessary hardware or parts could result in sustained equipment failure and a loss of revenue due to customer loss or claims for service credits under our service-level guarantees.
 
We could be subject to increased operating costs, as well as claims, litigation or other potential liability, in connection with risks associated with Internet security and the security of our systems.  A significant barrier to the growth of e-commerce and communications over the Internet has been the need for secure transmission of confidential information. Several of our infrastructure systems and application services use encryption and authentication technology licensed from third parties to provide the protections necessary to ensure secure transmission of confidential information. We also rely on security systems designed by third parties and the personnel in our network-operations centers to secure those data centers. Any unauthorized access, computer viruses, accidental or intentional actions or other disruptions could result in increased operating costs. For example, we may incur additional significant costs to protect against these interruptions and the threat of security breaches or to alleviate problems caused by these interruptions or breaches. If a third party were able to misappropriate a consumer’s personal or proprietary information, including credit-card information, during the use of an application solution provided by us, we could be subject to claims, litigation or other potential liability.
 
Third-party infringement claims against our technology suppliers, customers or us could result in disruptions in service, the loss of customers or costly and time-consuming litigation.  We license or lease most technologies used in the infrastructure systems and application services that we offer. If our technology suppliers become subject to third-party infringement or other claims and assertions, they may become unable


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or unwilling to continue to license their technologies to us. We cannot assure you that third parties will not assert claims against us in the future or that these claims will not succeed. Any infringement claim arising out of our technologies or services, regardless of its merit, could result in delays in service, installation or upgrades; the loss of customers; or costly and time-consuming litigation.
 
We may be subject to legal claims in connection with the information disseminated through our network, and these claims could divert management’s attention and require us to expend significant financial resources.  We may face liability for claims of defamation, negligence, copyright, patent or trademark infringement and other claims based on the nature of the materials disseminated through our network. For example, lawsuits may be brought against us claiming that content distributed by some of our customers may be regulated or banned. In these and other instances, we may be required to engage in protracted and expensive litigation that could have the effect of diverting management’s attention from our business and require us to expend significant financial resources. Our general-liability insurance may not cover any of these claims or may not be adequate to protect us against all liability that may be imposed. In addition, on a limited number of occasions in the past, businesses, organizations and individuals have sent unsolicited commercial e-mails from servers hosted at our facilities to a number of people, typically to advertise products or services. This practice, known as “spamming,” can lead to statutory liability as well as complaints against any service providers that enable these activities, particularly where recipients view the materials received as offensive. We have received, and may receive, letters from recipients of information transmitted by our customers objecting to the transmission. Although we contractually prohibit our customers from spamming, we cannot assure you that none of them will engage in this practice, which could subject us to claims for damages.
 
Concerns relating to privacy and protection of customer and job-seeker data on our America’s Job Exchange website could damage our reputation and deter current and potential customers and job seekers from using our products and services.  In fiscal year 2008 we launched America’s Job Exchange, a successor to America’s Job Bank. Concerns about our practices for America’s Job Exchange with regard to the collection, use, disclosure or security of personal information or other privacy-related matters, even if unfounded, could damage our reputation, which damage in turn could significantly harm our business, financial condition and operating results. While we strive to comply with all applicable data-protection laws and regulations and our own posted privacy policies, any actual or perceived failure to comply may result in proceedings or actions against us by government entities or others, which proceedings or actions could adversely affect our business. Moreover, the actual or perceived failure to comply with our policies or applicable requirements related to the collection, use, sharing or security of personal information or other privacy-related matters could result in a loss of customer and job-seeker confidence in us, which loss could adversely affect our business. Laws related to data protection continue to evolve. Certain jurisdictions may enact laws or regulations that impact our ability to offer our products and services and result in reduced traffic or contract terminations in those jurisdictions, any of which effects could harm our business.
 
Unauthorized access, phishing schemes and other disruptions could jeopardize the security of customer and job-seeker information stored in our systems, result in significant liability to us and cause existing customers and job seekers to refrain from doing business with us.
 
If we fail to attract or retain key officers, management and technical personnel, our ability to successfully execute our business strategy, to continue to provide services and technical support to our customers or to attract new ones could be adversely affected.  We believe that attracting, training, retaining and motivating technical and managerial personnel, including individuals with significant levels of infrastructure systems and application expertise, is a critical component of the future success of our business. Qualified technical personnel are likely to remain a limited resource for the foreseeable future, and competition for these personnel is intense. The departure of any of our executive officers or core members of our sales and marketing teams or technical service personnel, could have negative ramifications on our customer relations and operations. The departure of our executive officers could adversely affect the stability of our infrastructure and our ability to provide the guaranteed service levels our customers expect. Any officer or employee can terminate his or her relationship with us at any time. In addition, we do not carry life insurance on any of our personnel.


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The unpredictability of our quarterly results may cause the trading price of our common stock to fluctuate or decline.  Our quarterly operating results have previously varied, and may continue to vary, significantly as a result of a number of factors, many of which are beyond our control and any one of which may cause our stock price to fluctuate. The primary factors that may affect our operating results include the following:
 
  •  a reduction of market demand or acceptance of our services;
 
  •  our ability to develop, market and introduce new services on a timely basis;
 
  •  the length of the sales cycle for our services;
 
  •  the timing and level of sales of our services, both of which depend on the budgets of our customers;
 
  •  downward price adjustments by our competitors;
 
  •  changes in the mix of services provided by our competitors;
 
  •  technical difficulties or system downtime affecting the Internet or our hosting operations;
 
  •  our ability to meet any increased technological demands of our customers; and
 
  •  the amount and timing of costs related to our marketing efforts and service introductions.
 
Due to the above factors, we believe that quarter-to-quarter or period-to-period comparisons of our operating results may not be a good indicator of our future performance. Our operating results for any particular quarter may fall short of our expectations or those of stockholders or securities analysts. In this event, the trading price of our common stock would likely fall.
 
If we are unsuccessful in pending and potential litigation matters, our financial condition may be adversely affected.  We are currently involved in various pending and potential legal proceedings, including a class-action lawsuit related to our initial public offering. If we are ultimately unsuccessful in any litigation matter, we could be required to pay substantial amounts of cash to the other parties. The amount and timing of any of these payments could adversely affect our financial condition.
 
If the markets for outsourced IT infrastructure and applications, Internet commerce and communication decline, there may be insufficient demand for our services and, as a result, our business strategy and objectives may fail.  The increased use of the Internet for retrieving, sharing and transferring information among businesses and consumers continues to develop, and the market for the purchase of products and services over the Internet is still relatively new and emerging. Our industry has experienced periods of rapid growth followed by sharp declines in demand for products and services, which downturns have sometimes led to the failure of many companies focused on developing Internet-related businesses. If acceptance and growth of the Internet as a medium for commerce and communication declines, our business strategy and objectives may fail because there may not be sufficient market demand for our managed-IT-services.
 
If we do not respond to rapid changes in the technology sector, we will lose customers.  The markets for the technology-related services we offer are characterized by rapidly changing technology, evolving industry standards, frequent new service introductions, shifting distribution channels and changing customer demands. We may not be able to adequately adapt our services or to acquire new services that can compete successfully. In addition, we may not be able to establish or maintain effective distribution channels. We risk losing customers to our competitors if we are unable to adapt to this rapidly evolving marketplace.
 
The market in which we operate is highly competitive and is likely to consolidate, and we may lack the financial and other resources, expertise or capability necessary to capture increased market share or maintain our market share.  We compete in the managed-IT-services market. This market is rapidly evolving, highly competitive and likely to be characterized by overcapacity and industry consolidation. Our competitors may consolidate with one another or acquire software-application vendors or technology providers, enabling them to more effectively compete with us. We believe that participants in this market must grow rapidly and achieve a significant presence to compete effectively. This consolidation could affect prices and other


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competitive factors in ways that would impede our ability to compete successfully in the managed-IT-services market.
 
Further, our business is not as developed as that of many of our competitors. Many of our competitors have substantially greater financial, technical and market resources, greater name recognition and more established relationships in the industry. Many of our competitors may be able to:
 
  •  develop and expand their network infrastructure and service offerings more rapidly;
 
  •  adapt to new or emerging technologies and changes in customer requirements more quickly;
 
  •  take advantage of acquisitions and other opportunities more readily; or
 
  •  devote greater resources to the marketing and sale of their services and adopt more aggressive pricing policies than we can.
 
We may lack the financial and other resources, expertise or capability necessary to maintain or capture increased market share in this environment in the future. Because of these competitive factors and due to our comparatively small size and our lack of financial resources, we may be unable to successfully compete in the managed-IT-services market.
 
Difficulties presented by international economic, political, legal, accounting and business factors could harm our business in international markets.  We currently operate two data centers in the United Kingdom. Revenue from our foreign operations accounted for approximately 11% of our total revenue during the fiscal year ended July 31, 2010. By expanding our operations into India in fiscal year 2006, we broadened our customer-service support. Although we expect to focus most of our growth efforts in the United States, we may enter into joint ventures or outsourcing agreements with third parties, acquire complementary businesses or operations or establish and maintain new operations outside of the United States. Some risks inherent in conducting business internationally include:
 
  •  unexpected changes in regulatory, tax and political environments;
 
  •  longer payment cycles and problems collecting accounts receivable;
 
  •  geopolitical risks, such as political and economic instability, hostilities among countries or terrorism;
 
  •  reduced protection of intellectual-property rights;
 
  •  fluctuations in currency-exchange rates or impositions of restrictive currency controls;
 
  •  our ability to secure and maintain the necessary physical and telecommunications infrastructure;
 
  •  challenges in staffing and managing foreign operations;
 
  •  employment laws and practices in foreign countries;
 
  •  laws and regulations on content distributed over the Internet that are more restrictive than those currently in place in the United States; and
 
  •  significant changes in immigration policies or difficulties in obtaining required immigration approvals.
 
Any one or more of these factors could adversely affect our international operations and, consequently, our business.
 
We may become subject to burdensome government regulation and legal uncertainties that could substantially harm our business or expose us to unanticipated liabilities.  It is likely that laws and regulations directly applicable to the Internet or to hosting and managed-application service providers may be adopted. These laws may cover a variety of issues, including user privacy and the pricing, characteristics and quality of products and services. The adoption or modification of laws or regulations relating to commerce over the Internet could substantially impair the growth of our business or expose us to unanticipated liabilities. Moreover, the applicability of existing laws to the Internet and hosting and managed-application service providers is uncertain. These existing laws could expose us to substantial liability if they are found to apply to


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our business. Because we offer services over the Internet in many states in the United States and internationally and facilitate the activities of our customers in those jurisdictions, we may become required to qualify to do business or subject to taxation or other laws and regulations there even without any physical presence, employees or property there.
 
The price of our common stock has been volatile and may continue to experience wide fluctuations.  Since January 2010 our common stock has closed as low as $1.98 per share and as high as $3.68 per share. The trading price of our common stock has been, and may continue to be, subject to wide fluctuations due to the risk factors discussed in this section and elsewhere in this report. Fluctuations in the market price of our common stock may cause investors in our common stock to lose some or all of their investments.
 
Anti-takeover provisions in our corporate documents may discourage or prevent a takeover.  Provisions in our certificate of incorporation and bylaws may have the effect of delaying or preventing an acquisition or merger in which we are acquired or a transaction that changes our board of directors. These provisions:
 
  •  authorize the board to issue preferred stock without stockholder approval;
 
  •  prohibit cumulative voting in the election of directors;
 
  •  limit the persons who may call special meetings of stockholders; and
 
  •  establish advance-notice requirements for nominations for the election of directors or for proposing matters that can be acted on by stockholders at stockholder meetings.
 
Our ability to use U.S. net-operating-loss carryforwards might be limited.  As of July 31, 2010, we had consolidated net-operating-loss carryforwards of $158.8 million, of which $154.2 million were for U.S. federal and state tax purposes. These loss carryforwards expire between fiscal years 2012 and 2029. To the extent that these net-operating-loss carryforwards are available, we intend to use them to reduce the corporate-income-tax liability associated with our operations. Section 382 of the U.S. Internal Revenue Code generally imposes an annual limitation on the amount of net-operating-loss carryforwards that can be used to offset taxable income when a corporation has undergone significant changes in stock ownership. We have experienced ownership changes during calendar years 2007 and 2002 that have reduced the use of our net-operating-loss carryforwards. To the extent that we experience future significant changes in stock ownership which results in limiting our use of net-operating-loss carryforwards, our income could be subject to corporate income tax earlier than it would if we were able to use net-operating-loss carryforwards, which taxation could result in lower profits.
 
Item 1B.   Unresolved Staff Comments
 
None.


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Item 2.   Properties
 
Facilities
 
Our executive offices are located at 400 Minuteman Road, Andover, Massachusetts. We lease offices and data centers in various cities across the United States and have an office and data centers in the United Kingdom and an office in India. The table below sets forth a list of our leased offices and data centers:
 
                 
        Square Footage
   
        Leased
   
Location
  Type   (Approximate)  
Lease Expiration
 
San Jose, CA
  Data center and office     66,350     November 2016
Atlanta, GA
  Office     4,598     September 2012
Chicago, IL
  Data center     13,600     November 2012
Chicago, IL
  Office     2,212     April 2012
Oak Brook, IL
  Data center     17,659     September 2019
Andover, MA
  Office     25,896     January 2018
Andover, MA
  Data center and office     86,931     January 2018
Syracuse, NY
  Data center     21,374     November 2020
Syracuse, NY
  Office     1,933     November 2010
New York, NY
  Office     1,500     December 2015
New York, NY
  Data center     33,286     May 2018
Dallas, TX
  Data center     27,370     March 2020
Houston, TX
  Data center and office     12,956     January 2019
Herndon, VA(1)(2)
  Office     5,515     June 2011
Gurgaon, Haryana, India
  Office     12,706     August 2011
Watford, England
  Data center     11,160     January 2015
London, England(3)
  Data center     4,017     March 2010
 
 
(1) We have idle office space at this facility from which we derive no economic benefit.
 
(2) We have subtenants for all of this space.
 
(3) Our lease expired in March 2010. We are currently negotiating with the landlord on a new lease agreement. We are still in this location.
 
We believe that these offices and data centers are adequate to meet our foreseeable requirements and that suitable additional or substitute space will be available on commercially reasonable terms, if needed.
 
Item 3.   Legal Proceedings
 
IPO Securities Litigation
 
In 2001, lawsuits naming more than 300 issuers and over 50 investment banks were filed in the U.S. District Court for the Southern District of New York (the “Court”) for all pretrial purposes (the “IPO Securities Litigation”). Between June 13, 2001, and July 10, 2001, five purported class-action lawsuits seeking monetary damages were filed against us; Joel B. Rosen, our then-chief executive officer; Kenneth W. Hale, our then-chief financial officer; Robert E. Eisenberg, our then president; and the underwriters of our initial public offering of October 22, 1999. On September 6, 2001, the Court consolidated the five similar cases and a consolidated, amended complaint was filed on April 19, 2002 on behalf of all persons who acquired shares of our common stock between October 22, 1999, and December 6, 2000 (the “Class-Action Litigation”), 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. The plaintiffs uniformly alleged that all defendants, including the NaviSite Defendants, violated Sections 11 and 15


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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 in the offering without disclosing to investors that some of the underwriters, including the lead underwriters, allegedly had solicited and received 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. Plaintiffs did not specify the amount of damages they sought in the Class-Action Litigation. On April 2, 2009, a stipulation and agreement of settlement among the plaintiffs, issuer defendants (including any present or former officers and directors) and underwriters was submitted to the Court for preliminary approval (the “Global Settlement”). Pursuant to the Global Settlement, all claims against the NaviSite Defendants would be dismissed with prejudice and our pro-rata share of the settlement consideration would be fully funded by insurance. By Opinion and Order dated October 5, 2009, after conducting a settlement fairness hearing on September 10, 2009, the Court granted final approval to the Global Settlement and directed the clerk to close each of the actions comprising the IPO Securities Litigation, including the Class-Action Litigation. A proposed final judgment in the Class-Action Litigation was filed on November 23, 2009, and was signed by the Court on November 24, 2009 and entered on the docket on December 29, 2009.
 
The settlement remains subject to numerous conditions, including the resolution of several appeals that have been filed in the United States Court of Appeals for the Second Circuit (the “Court of Appeals”), and there can be no assurance that the Court’s approval of the Global Settlement will be upheld in all respects upon appeal. The deadline for appellants to submit their papers to the Court of Appeals was October 6, 2010. Two appellants filed opening briefs, and the remaining appellants filed a stipulation of dismissal of their appeals pursuant to Fed. R. App. P. 42(d). Appellees’ responding brief is due to be filed no later than February 3, 2011. We believe that the allegations against us are without merit, and, if the litigation continues, we intend to vigorously defend against the plaintiffs’ claims. Because of the inherent uncertainty of litigation, and because the settlement remains subject to numerous conditions and appeals, 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.
 
On October 12, 2007, a purported NaviSite stockholder filed a complaint for violation of Section 16(b) of the Exchange Act, which provision prohibits short-swing trading, against two of the underwriters of the public offering at issue in the Class-Action Litigation. The complaint is pending in the U.S. District Court for the Western District of Washington (the “District Court”) and is captioned Vanessa Simmonds v. Bank of America Corp., et al. Plaintiff seeks the recovery of short-swing profits from the underwriters on behalf of the Company, which is named only as a nominal defendant and from which no recovery is sought. Simmonds’ complaint was dismissed without prejudice by the District Court on the grounds that she had failed to make an adequate demand on us before filing her complaint. Because the District Court dismissed the case on the grounds that it lacked subject-matter jurisdiction, it did not specifically reach the issue of whether the plaintiff’s claims were barred by the applicable statute of limitations. However, the District Court also granted the underwriter defendants’ joint motion to dismiss with respect to cases involving other issuers, holding that the cases were time-barred because the issuers’ stockholders had notice of the potential claims more than five years before filing suit.
 
The plaintiff filed a notice of appeal with the Ninth Circuit Court of Appeals on April 10, 2009, and the underwriter defendants filed a cross-appeal, asserting that the dismissal should have been with prejudice. The appeal and cross-appeal are fully briefed. On October 5, 2010, oral argument was held before the Ninth Circuit Court of Appeals. We do not expect that this claim will have a material impact on our financial position or results of operations.
 
Item 4.   Removed and Reserved


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PART II
 
 
Item 5.   Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
 
Price Range of Common Stock
 
Our common stock is currently traded on the NASDAQ Capital Market under the symbol “NAVI.” As of October 1, 2010, there were approximately 224 holders of record of our common stock. The following table sets forth the high and low sales prices for our common stock as reported on the NASDAQ Capital Market for the periods indicated.
                 
    High     Low  
 
Fiscal Year Ended July 31, 2010
               
May 1, 2010, through July 31, 2010
  $ 2.98     $ 1.81  
February 1, 2010, through April 30, 2010
  $ 3.31     $ 2.47  
November 1, 2009, through January 31, 2010
  $ 3.04     $ 1.76  
August 1, 2009, through October 31, 2009
  $ 2.76     $ 1.32  
Fiscal Year Ended July 31, 2009
               
May 1, 2009, through July 31, 2009
  $ 1.96     $ 0.37  
February 1, 2009, through April 30, 2009
  $ 0.52     $ 0.22  
November 1, 2008, through January 31, 2009
  $ 0.88     $ 0.15  
August 1, 2008, through October 31, 2008
  $ 3.92     $ 0.50  
 
We believe that a number of factors may cause the market price of our common stock to fluctuate significantly. See Item 1A (“Risk Factors”).
 
We have never paid cash dividends on our common stock. We currently anticipate retaining all available earnings, if any, to finance internal growth and product and service development. Payment of dividends in the future will depend upon our earnings, financial condition, anticipated cash needs and such other factors as the directors may consider or deem appropriate at the time. In addition, the terms of our credit agreement with a syndicated group of lenders restrict the payment of cash dividends on our common stock. Further, on September 12, 2007, we issued 3,125,000 shares of Preferred Stock, and additional shares of the Preferred Stock have been and will be issued as in-kind dividends that accrue on the outstanding Preferred Stock. The holders of the Preferred Stock are entitled to receive dividends prior and in preference to any declaration or payment of any dividend to a common stockholder.
 
We did not repurchase any shares of common stock during fiscal year 2010.
 
Information regarding our equity-compensation plans and the securities authorized for issuance thereunder is set forth in Item 12 below.
 
Recent Issuances of Unregistered Securities
 
On September 12, 2007, we acquired the outstanding capital stock of netASPx, an application-management service provider, for a total consideration of $40.8 million. The consideration consisted of $15.5 million in cash, subject to adjustment based on netASPx’s cash at the closing date, and the issuance of 3,125,000 shares of the Preferred Stock with a fair value of $24.9 million at the time of issuance. The Preferred Stock accrues payment-in-kind (“PIK”) dividends at 12% per annum. The Preferred Stock is convertible into our common stock, at any time, at the option for the holder, at $8.00 per share, adjusted for stock splits, dividends and other similar adjustments.
 
Pursuant to the obligation described above, on June 15 and September 15, 2010, we issued a PIK dividend of 120,127 and 122,605 shares, respectively, in aggregate, of the Preferred Stock to their holders.
 
On July 20, 2010, the Company issued 37,529 shares of our common stock to a former netASPx employee upon the conversion of 37,529 shares of Preferred Stock to common stock.
 
The shares issued as described in this Item 5 were not registered under the Securities Act. We relied on the exemption from registration provided by Section 4(2) of the Securities Act as an issuance by us not involving a public offering. No underwriters were involved with the issuance of the Preferred Stock or the common stock issued upon conversion.


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Item 6.   Selected Financial Data
 
The following selected consolidated financial data should be read in conjunction with our consolidated financial statements and related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this annual report on Form 10-K. Historical results are not necessarily indicative of results of any future period.
 
                                         
    Year Ended July 31,  
    2010     2009     2008     2007     2006  
    (In thousands, except per share data)  
 
Revenue, net
  $ 125,844     $ 125,033     $ 131,762     $ 122,886     $ 105,836  
Revenue, related parties
    303       346       372       322       243  
                                         
Total revenue
    126,147       125,379       132,134       123,208       106,079  
Cost of revenue
    78,838       81,065       91,628       81,774       71,547  
Impairment, restructuring and other
          209                    
                                         
Total cost of revenue
    78,838       81,274       91,628       81,774       71,547  
                                         
Gross profit
    47,309       44,105       40,505       41,434       34,532  
Operating expenses:
                                       
Selling and marketing
    20,569       19,206       19,032       16,924       14,756  
General and administrative
    21,617       22,867       22,411       22,043       21,787  
Loss on settlement
          5,736                    
Impairment, restructuring and other
          180             (231 )     1,373  
                                         
Total operating expenses
    42,186       47,989       41,443       38,736       37,916  
                                         
Income (loss) from operations
    5,123       (3,884 )     (938 )     2,698       (3,384 )
Other income (expense):
                                       
Interest income
    23       43       264       337       283  
Interest expense
    (8,096 )     (9,287 )     (7,760 )     (12,036 )     (9,145 )
Loss on debt extinguishment
                (1,651 )     (15,712 )      
Other income (expense), net
    288       690       2,295       864       437  
                                         
Loss from continuing operations before income taxes and discontinued operations
    (2,662 )     (12,438 )     (7,790 )     (23,849 )     (11,809 )
Income taxes
    (755 )     (1,241 )     (1,152 )     (1,173 )     (1,173 )
                                         
Income (loss) from continuing operations
    (3,417 )     (13,679 )     (8,942 )     (25,022 )     (12,982 )
Income (loss) from discontinued operations, net of income taxes
    (3,604 )     (1,432 )     258       (888 )     (949 )
Gain on sale of discontinued operations, net of income taxes
    20,494                          
                                         
Net income (loss)
    13,473       (15,111 )     (8,684 )     (25,910 )     (13,931 )
Accretion of preferred-stock dividends
    (3,718 )     (3,350 )     (2,656 )            
                                         
Net income (loss) attributable to common shareholders
  $ 9,755     $ (18,461 )   $ (11,340 )   $ (25,910 )   $ (13,931 )
                                         
Basic and diluted net income (loss) per common share
                                       
Loss from continuing operations attributable to common stockholders
  $ (0.19 )   $ (0.48 )   $ (0.33 )   $ (0.82 )   $ (0.46 )
Income (loss) from discontinued operations
  $ (0.10 )   $ (0.04 )   $     $ (0.03 )   $ (0.03 )
Gain on sale of discontinued operations
  $ 0.56     $     $     $     $  
                                         
Net income (loss) attributable to common stockholders
  $ 0.27     $ (0.52 )   $ (0.33 )   $ (0.85 )   $ (0.49 )
                                         
Basic and diluted weighted average number of common shares outstanding
    36,354       35,528       34,731       30,512       28,601  
                                         
Balance-Sheet Data:
                                       
Working capital (deficit)
  $ (6,470 )   $ (976 )   $ 2,048     $ 10,611     $ (9,072 )
Total assets
  $ 117,037     $ 163,680     $ 175,713     $ 116,244     $ 102,409  
Long-term obligations
  $ 67,977     $ 132,280     $ 133,736     $ 97,072     $ 70,817  
Stockholders’ deficit
  $ (20,820 )   $ (35,103 )   $ (18,772 )   $ (13,864 )   $ (1,976 )


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Item 7.   Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
This Annual Report on Form 10-K contains forward-looking statements, within the meaning of Section 21E of the Exchange Act and Section 27A of the Securities Act, 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 1A (“Risk Factors”) and the risks discussed in our other filings with the SEC. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s analysis, judgment, belief or expectation only as of the date hereof. We undertake no obligation to publicly revise these forward-looking statements to reflect events or circumstances that arise after the date hereof.
 
Overview
 
We offer our customers a broad range of cloud computing services, enterprise-hosting and managed-application services that can be deployed quickly and cost effectively. Our expertise allows us to meet an expanding set of increasingly complex customer requirements. Our experience, flexibility and capabilities save our customers the time and cost of developing expertise in house, and we increasingly serve as the sole manager of our customers’ outsourced IT services.
 
We provide these services to a range of industries — including financial services, healthcare and pharmaceuticals, manufacturing and distribution, publishing, media and communications, business services, public sector and software — through our own sales force and sales-channel relationships.
 
We provide our services to customers typically pursuant to agreements with a term of one to five years and monthly payment installments. As a result, these agreements provide us with a base of recurring revenue. Our revenue increases by adding new customers or selling additional services to existing customers. Our overall base of recurring revenue is affected by new customers, renewals or terminations of agreements with existing customers. We continue to experience increasing recurring revenues from both new and existing customers off-set by a decline from our professional-services related revenues.
 
A large portion of the costs to operate our data centers — such as rent, product development and general and administrative expenses — does not depend strictly on the number of customers or the amount of services we provide. As we add new customers or new services to existing customers, we generally incur limited incremental costs relating to telecommunications, utilities, hardware and software costs and payroll expenses. We have substantial capacity to add customers to our data centers. Our relatively fixed cost base, sufficient capacity for expansion and limited incremental variable costs provide us with the opportunity to grow profitably. However, these same fixed costs present us with the risk that we may incur losses if we are unable to generate sufficient revenue. As our professional-services related revenues have declined as a percentage of our overall revenues our gross margins have increased and we anticipate that this trend will continue as we focus on higher margin hosting related revenues.
 
Our fiscal year ends on July 31 of each year. During fiscal year 2008, we completed four acquisitions. In August 2007 we acquired the outstanding capital stock of Jupiter — a privately held company based in Santa Clara, California, that provides managed-hosting services — and acquired the assets and assumed certain liabilities of Alabanza. Alabanza was a provider of dedicated and shared managed-hosting services. In September 2007 we acquired the outstanding capital stock of netASPx, an application-management service provider, and in October 2007 we acquired the assets of iCommerce, a reseller of dedicated hosting services. All of the acquisitions during fiscal year 2008 were accounted for using the purchase method of accounting, and, as such, the results of operations and cash flow related to these acquisitions were included in our consolidated statement of operations and consolidated statement of cash flows from their respective dates of acquisition. During fiscal year 2010, we completed two separate asset sales transactions. In February 2010 we sold substantially all of the assets of our netASPx business and in March 2010 we sold two of our co-location data centers. Net proceeds from the sales were used to reduce our outstanding debt obligations. We have accounted for the sales of these assets as discontinued operations (see Note 5 Discontinued Operations to the


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consolidated financial statements). The results of operations for the fiscal years ended July 31, 2010, 2009 and 2008 reflect this accounting treatment. The Company is considering selling a number of additional non-strategic data centers. The potential sales of these data centers will result in a reduction of recurring revenues as well as a reduction in corresponding fixed and variable expenses.
 
Results of Operations for the Three Years Ended July 31, 2010, 2009 and 2008
 
The following table sets forth the percentage relationships of certain items from our consolidated statements of operations as a percentage of total revenue for the periods indicated.
 
                         
    Year Ended July 31,
    2010   2009   2008
 
Revenue, net
    99.8 %     99.7 %     99.7 %
Revenue, related parties
    0.2 %     0.3 %     0.3 %
                         
Total revenue
    100.0 %     100.0 %     100.0 %
Cost of revenue, excluding depreciation and amortization and restructuring charge
    49.4 %     50.9 %     57.2 %
Depreciation and amortization
    13.1 %     13.7 %     12.1 %
Restructuring charge
    %     0.2 %     %
                         
Total cost of revenue
    62.5 %     64.8 %     69.3 %
                         
Gross profit
    37.5 %     35.2 %     30.7 %
                         
Operating expenses:
                       
Selling and marketing
    16.3 %     15.3 %     14.4 %
General and administrative
    17.1 %     18.2 %     17.0 %
Loss on settlement
    %     4.6 %     %
Restructuring charge
    %     0.2 %     %
                         
Total operating expenses
    33.4 %     38.3 %     31.4 %
                         
Income (loss) from operations
    4.1 %     (3.1 )%     (0.7 )%
Other income (expense):
                       
Interest income
    0.0 %     0.0 %     0.2 %
Interest expense
    (6.4 )%     (7.4 )%     (5.8 )%
Loss on debt extinguishment
    %     %     (1.3 )%
Other income (expense), net
    0.2 %     0.6 %     1.7 %
                         
Loss from continuing operations before income taxes and discontinued operations
    (2.1 )%     (9.9 )%     (5.9 )%
Income taxes
    (0.6 )%     (1.0 )%     (0.9 )%
                         
Loss from continuing operations
    (2.7 )%     (10.9 )%     (6.8 )%
Income (loss) from discontinued operations, net of income taxes
    (2.9 )%     (1.1 )%     0.2 %
Gain on sale of discontinued operations, net of income taxes
    16.3 %     %     %
                         
Net income (loss)
    10.7 %     (12.0 )%     (6.6 )%
Accretion of preferred stock dividends
    (3.0 )%     (2.7 )%     (2.0 )%
                         
Net income (loss) attributable to common stockholders
    7.7 %     (14.7 )%     (8.6 )%
                         


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Comparison of the Years 2010, 2009 and 2008
 
Revenue
 
We derive our revenue from managed-IT services — including cloud computing services, hosting, managed-application and co-location services comprised of a variety of service offerings and professional services — to both enterprise and mid-market companies and organizations.
 
Total revenue for the fiscal year ended July 31, 2010, increased 0.6% to approximately $126.1 million from approximately $125.4 million for the fiscal year ended July 31, 2009. The overall increase of approximately $0.7 million in revenue was mainly due to an increase of $5.4 million in our enterprise-hosting and application services revenue to new and existing customers and an increase of $0.7 million due to increased sales from America’s Job Exchange, our employment-services website (“AJE”). These increases were off-set by a decrease of approximately $2.6 million in revenue from our decision not to renew our LA data center lease in the third quarter of fiscal year 2009 and a decrease of approximately $2.9 million in professional-services revenues. Revenue from related parties decreased 12.4% during the year ended July 31, 2010, to approximately $303,000 from approximately $346,000 during the year ended July 31, 2009.
 
Total revenue for the fiscal year ended July 31, 2009, decreased 5.1% to approximately $125.4 million from approximately $132.1 million for the fiscal year ended July 31, 2008. The overall decline of approximately $6.7 million in revenue was mainly due to a $12.9 million reduction in professional-services revenues coupled with a reduction of approximately $0.8 million in revenue due to our decision not to renew our LA data center lease in the third quarter of fiscal year 2009. This decline of approximately $13.7 million was offset by an increase of $5.7 million in revenue from our enterprise-hosting and application services to new and existing customers, inclusive of a reduction of approximately $3.6 million due to changes in foreign-currency exchange rates and an increase of $1.2 million from AJE. Revenue from related parties decreased 7.0% during the year ended July 31, 2009, to approximately $346,000 from approximately $372,000 during the year ended July 31, 2008.
 
No customer accounted for more than 5% of total revenues in fiscal year 2010, 2009 or 2008.
 
In addition to the asset sales transactions noted above, the Company is considering selling a number of additional non-strategic co-location data centers. The potential sale of these data centers will result in a reduction in future recurring revenues offset by a reduction in the fixed and variable costs required to support this revenue.
 
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.
 
Total cost of revenue of $78.8 million for the fiscal year ended July 31, 2010, decreased approximately $2.5 million, or 3.0%, from the cost of revenue of approximately $81.3 million for the fiscal year ended July 31, 2009. As a percentage of revenue, total cost of revenue for the fiscal year ended July 31, 2010, decreased to 62.5% from 64.8% for the fiscal year ended July 31, 2009. The overall decrease of approximately $2.5 million was primarily due to a decrease of $1.0 million in employee-related expenses, decreased facilities-related expenses, including rent, utilities and telecommunication, of approximately $0.9 million due in part to our decision not to renew the lease of our LA data center and lower utility rates in fiscal year 2009. Additionally, there was a decrease of $0.9 million of external consulting expenses, related primarily to lower professional-services revenue, a decrease in amortization expense of approximately $1.1 million and billable travel expense decreased by approximately $0.9 million. These decreases of $4.8 million were partially offset by increased depreciation expense of approximately $0.5 million; and increased third-party software and hardware-maintenance and licensing costs of approximately $1.8 million.
 
Total cost of revenue of $81.3 million for the fiscal year ended July 31, 2009, decreased approximately $10.3 million, or 11.3%, from the cost of revenue of approximately $91.6 million for the fiscal year ended


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July 31, 2008. As a percentage of revenue, total cost of revenue for the fiscal year ended July 31, 2009, decreased to 64.8% from 69.3% for the fiscal year ended July 31, 2008. The overall decrease of approximately $10.3 million was primarily due to a decrease of $8.3 million in employee-related expenses, inclusive of a $0.2 million restructuring charge for severance and related costs for our professional-services organization. In addition, external consulting expenses, related primarily to lower professional-services revenue, were lower by approximately $1.2 million, facility related costs, including telecommunication and bandwidth cost were lower by $0.5 million, amortization expense decreased by approximately $1.1 million, and travel expense decreased by approximately $2.3 million. These decreases of $13.4 million were partially offset by increased depreciation expense of approximately $2.3 million; increased facility-related expenses, and increased hardware and software maintenance and licensing costs of approximately $0.8 million.
 
In addition to the asset sales transactions noted above, the Company is considering selling a number of additional non-strategic co-location data centers. The potential sale of these data centers will result in a corresponding reduction in costs of revenues, both fixed and variable.
 
During fiscal year ended July 31, 2009, we initiated the restructuring of our professional-services organization in an effort to realign resources. As a result of this initiative, we terminated several employees, resulting in a restructuring charge for severance and related costs of $0.4 million, of which approximately $0.2 million was included in cost of revenue.
 
Gross profit of $47.3 million for the fiscal year ended July 31, 2010, increased approximately $3.2 million, or 7.3%, from a gross profit of approximately $44.1 million for the fiscal year ended July 31, 2009. Gross profit for the fiscal year ended July 31, 2010, represented 37.5% of total revenue, as compared to 35.2% of total revenue for the fiscal year ended July 31, 2009. Gross-profit percentage was positively impacted during fiscal year 2010, as compared to fiscal 2009, primarily due to our continued focus on cost containments and the cost reductions in response to the lower professional-services revenue noted above.
 
Gross profit of $44.1 million for the fiscal year ended July 31, 2009, increased approximately $3.6 million, or 8.9%, from a gross profit of approximately $40.5 million for the fiscal year ended July 31, 2008. Gross profit for the fiscal year ended July 31, 2009, represented 35.2% of total revenue, as compared to 30.7% of total revenue for the fiscal year ended July 31, 2008. Gross-profit percentage was negatively impacted during fiscal year 2008, as compared to fiscal year 2009, mainly due to higher levels of professional-services business, which carries overall lower gross profit.
 
Operating Expenses
 
Selling and Marketing — Selling and marketing expense consists primarily of salaries and related benefits, commissions and marketing expenses such as advertising, product literature, trade-show costs and marketing and direct-mail programs.
 
Selling and marketing expense increased 7.1% to approximately $20.6 million, or 16.3% of total revenue for the fiscal year ended July 31, 2010, from approximately $19.2 million, or 15.3% of total revenue for the fiscal year ended July 31, 2009. The increase of approximately $1.4 million resulted primarily from increased salary and related headcount expenses of approximately $1.0 million due to increased headcount levels of commissioned sales personnel, inclusive of increased commission and referral-partner expenses of $0.6 million. Additionally there was an increase of approximately $0.3 million related to marketing related program expenses and $0.1 million increase in depreciation expense.
 
Selling and marketing expense increased 0.9% to approximately $19.2 million, or 15.3% of total revenue for the fiscal year ended July 31, 2009, from approximately $19.0 million, or 14.4% of total revenue for the fiscal year ended July 31, 2008. The increase of approximately $0.2 million resulted primarily from an increase in marketing related program costs.
 
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. Such expenses may be reduced if we are successful in our attempts to sell any of the non-strategic data centers.


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General and administrative expense decreased 5.5% to approximately $21.6 million for the fiscal year ended July 31, 2010, from approximately $22.9 million for the fiscal year ended July 31, 2009. General and administrative expense decreased to 17.1% of total revenue for the fiscal year ended July 31, 2010, from 18.2% of total revenue for the fiscal year ended July 31, 2009. The decreased expense of $1.3 million was attributable to a decrease in external professional services related primarily to legal fees of approximately $1.5 million, due in part to fewer litigation matters during the year. In addition, there was a decrease in bad-debt expense of $0.9 million, excluding $0.7 million related to the receivables that were written off in connection with the “Loss on settlement” in fiscal year 2009, noted below. These decreases of approximately $2.4 million were off-set by an increase in facility related costs, inclusive of property tax expenses and depreciation of $1.1 million.
 
General and administrative expense increased 2.0% to approximately $22.9 million for the fiscal year ended July 31, 2009, from approximately $22.4 million for the fiscal year ended July 31, 2008. General and administrative expense increased to 18.2% of total revenue for the fiscal year ended July 31, 2009, from 17.0% of total revenue for the fiscal year ended July 31, 2008. The total increased expenses of $0.5 million were attributable to an increase of $0.9 million in consulting and professional services and an increase in bad-debt expense of $0.6 million, excluding $0.7 million related to the receivables that were written off in connection with the “Loss on settlement” noted below. The increased expenses were offset by lower employee related costs (including stock-based compensation) of $1.0 million.
 
Loss on settlement.  During fiscal year 2009 we entered into a settlement agreement with a former Jupiter customer to settle all pending litigation matters between us. We recorded a loss on settlement of $5.7 million, comprised of a $5.0 million cash settlement payment to this former customer and the write-off of $0.7 million of outstanding accounts receivable from this former customer, which accounts receivable were written off as part of this settlement.
 
Restructuring charge.  During fiscal year 2009 we initiated the restructuring of our professional-services organization in an effort to realign resources. As a result of this initiative, we terminated several employees, resulting in a restructuring charge for severance and related costs of $0.4 million, of which approximately $0.2 million was included in operating expenses. No restructuring charges were recorded in fiscal years ending July 31, 2010 or 2008.
 
Interest Income
 
Interest income remained relatively consistent during the fiscal years 2010 and 2009. We recognized minimal interest income during the reporting periods due to the fact that interest rates were low and we used available cash to pay down outstanding debt.
 
Interest income decreased $221,000 to approximately $43,000 for the fiscal year ended July 31, 2009. The decrease is mainly due to lower levels of average cash balances during the fiscal year ended July 31, 2009, as compared to the fiscal year ended July 31, 2008.
 
Interest Expense
 
Interest expense decreased 12.8% to approximately $8.1 million, or 6.4% of total revenue, for the fiscal year ended July 31, 2010, from approximately $9.3 million, or 7.4% of total revenue, for the fiscal year ended July 31, 2009. The decrease of $1.2 million was primarily due to the change in the equipment lease classification from capital to operating resulting from the equipment lease modification in our UK data center. This lease modification resulted in a shift of expenses from interest expense under the initial capital lease to operating rent expense under the new operating lease. In addition, the average outstanding term-loan balance was reduced in the current year as compared to the prior year. We paid down the term-loan by $52.0 million during fiscal year 2010 from proceeds from the three data center asset sales. The interest rate was also reduced effective February 1, 2010 as a result of our ability to reduce the leverage ratio to a predetermined threshold.
 
Interest expense increased 19.7% to approximately $9.3 million, or 7.4% of total revenue, for the fiscal year ended July 31, 2009, from approximately $7.8 million, or 5.8% of total revenue, for the fiscal year ended


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July 31, 2008. The increase of $1.5 million is primarily related to an increased rate of interest and higher average outstanding long-term debt balance during the fiscal year ended July 31, 2009.
 
If we are successful in our attempts to sell any additional non-strategic co-location data centers, net proceeds from such sales would be used primarily to pay down outstanding debt obligations thereby reducing interest expense in future periods.
 
Loss on Debt Extinguishment
 
No loss on debt extinguishment was recorded during the fiscal years ended July 31, 2009 and 2010.
 
During the fiscal year ended July 31, 2008, we recorded a loss on debt extinguishment of $1.7 million in connection with the September 2007 refinancing of our credit agreement. The total amount of the loss on debt extinguishment consisted of the write-off of unamortized transaction fees and expenses related to the prior refinancing of our long-term debt in June 2007.
 
Other Income (Expense), Net
 
Other income consists of sublease rental income and other miscellaneous income. Other income was approximately $0.3 million for the fiscal year ended July 31, 2010, as compared to other income of approximately $0.7 million for the fiscal year ended July 31, 2009. The decrease was primarily due to the reduction in sublease income attributable to a non-renewed lease that ceased in February 2010.
 
Other income was approximately $0.7 million for the fiscal year ended July 31, 2009, as compared to other income of approximately $2.3 million for the fiscal year ended July 31, 2008. Other income for fiscal year ended July 31, 2008 consisted of a $1.6 million gain attributed to the settlement of the AppliedTheory litigation matter coupled with $0.7 million for sublease rental income and other miscellaneous income.
 
Income-Tax Expense
 
We recorded income tax expense of $0.8 million, $1.2 million and $1.2 million for fiscal years ended July 31, 2010, 2009 and 2008, respectively. The income tax expense in fiscal year ended July 31, 2010 resulted primarily from deferred income tax expense, net of income tax benefit, from losses incurred during the year that will be offset by the tax impact of the gain from the disposition of assets recorded within discontinued operations. The deferred tax expense results from tax goodwill amortization related to the asset acquisitions of Surebridge, AppliedTheory business, Alabanza and the iCommerce. For financial statement purposes, goodwill is not amortized for any acquisitions 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 (“NOL”) carryforwards that expire within a definite period.
 
Loss from Discontinued Operations
 
During the fiscal year ended July 31, 2010 we completed two separate asset sale transactions. In February 2010, we sold substantially all of the assets of our netASPx business and in March 2010 we sold two of our co-location data centers.
 
We have accounted for the sales of these assets as discontinued operations (see Note 5 Discontinued Operations to the consolidated financial statements). Accordingly, the revenue, costs of revenue, expenses, applicable interest expense and income taxes have been broken out separately for these assets to determine the loss from discontinued operations from these sales.
 
Loss from discontinued operations was $3.6 million for the fiscal year ended July 31, 2010 as compared to a loss of $1.4 million for the fiscal year ended July 31, 2009. The increase to the loss from discontinued operations of $2.2 million was due primarily to lower gross margins, which were negatively impacted in fiscal year ended July 31, 2010 due in part to increased costs recognized prior to disposal.


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Loss from discontinued operations was $1.4 million for the fiscal year ended July 31, 2009 as compared to income of $0.3 million for the fiscal year ended July 31, 2008. The $1.7 million increase in loss from discontinued operations for fiscal year ended July 31, 2009 as compared to fiscal year ended July 31, 2008, was due primarily to the increased allocation of interest expense. Our netASPx business was acquired in September 2007 and only a partial year of interest was allocated for fiscal year 2008.
 
We recorded income tax expense of $0.9 million, $0.7 million and $0.7 million within discontinued operations during the fiscal years ended July 31, 2010, 2009 and 2008, respectively. The income tax expense recorded within discontinued operations in fiscal year ended July 31, 2010 is primarily related to the reversal of a deferred tax liability related to goodwill tax amortization associated with the netASPx business, and state income tax expense due to the sale of the netASPx business. For federal income tax purposes, the gain from the dispositions of the netASPx business and the data center assets will be offset by net operating losses carried forward from prior years and the current year loss from continuing operations.
 
Gain on Sale of Discontinued Operations
 
During fiscal year ended July 31, 2010, we recognized a gain on sale of discontinued operation of $20.5 million. The gain was based on the proceeds, net of transaction costs, of $58.6 million offset by net assets of the business of $6.8 million and the write-off of goodwill and intangibles of $20.4 million and $10.9 million, respectively.
 
Liquidity and Capital Resources
 
As of July 31, 2010, our principal sources of liquidity included cash and cash equivalents of $4.6 million and a revolving-credit facility of $9.0 million provided under our credit agreement with a lending syndicate. At July 31, 2010, we had borrowed $4.0 million under the revolving-credit facility. Our current assets, including cash and cash equivalents of $4.6 million, were approximately $6.5 million less than our current liabilities at July 31, 2010, as compared to a negative working capital of $1.0 million, including cash and cash equivalents of $10.5 million, at July 31, 2009.
 
Cash and cash equivalents decreased approximately $5.9 million for the fiscal year ended July 31, 2010 as compared to the prior fiscal year. Our primary sources of cash included approximately $24.6 million and $21.6 million in cash provided by operating activities for the fiscal years ended July 31, 2010 and 2009, respectively. The fixed cost nature of our business allows us to generate positive operating cash flow from the revenues from new customers that are in excess of customer terminations. Specifically the $3.0 million year-over-year increase in cash provided by operating activities for the fiscal year ended July 31, 2010 from the fiscal year ended July 31, 2009 was due to an increase in cash generated from other long term assets of $5.4 million off set by a decrease in cash generated from other long-term liabilities of $3.4 million and a decrease in cash generated from working capital of $2.8 million. During the fiscal year ended July 31, 2010 non-cash items included depreciation and amortization expense of $21.2 million, stock-based compensation of $3.0 million, provision for bad debt expense of $0.3 million and deferred income tax expense of $1.5 million. The $15.6 million year-over-year increase in cash provided by operating activities for the fiscal year ended July 31, 2009 from the fiscal year ended July 31, 2008 was due to improved cash generated from working capital of $10.4 million, increase of $8.7 million in cash generated from accrued expenses and deferred revenue, and increase of $2.3 million in cash generated from other long term liabilities, off-set by a increase of $1.8 million in cash generated from other assets. During the fiscal year ended July 31, 2009, non-cash items included depreciation and amortization expense of $23.6 million, stock-based compensation of $3.1 million, deferred income tax expense of $1.9 million, and $1.9 million provision for bad debt. The potential sale of our non-strategic data centers is not expected to have a significant impact on our liquidity. Our cash flows from operations are dependent on several factors including the overall performance of the managed-IT-services sector as well as our ability to continue to acquire profitable new customers in excess of future contract terminations.
 
Investing activities provided cash of $39.3 million and used cash of $10.6 million for the fiscal years ended July 31, 2010 and 2009, respectively. Cash for investing activities, excluding the cash generated from the sale of our discontinued operations, is mainly used for the purchase of capital equipment to support the


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revenue from new customers in excess of terminated customers and the renewal of existing customers. The $39.3 million of cash provided by investing activities for the year ended July 31, 2010 resulted primarily from the proceeds from the sale of discontinued operations of $56.3 million off-set by the purchases of property and equipment utilized to support both customer and internal capital requirements. The $10.5 million of cash used in investing activities for the year ended July 31, 2009 resulted primarily from $10.6 million of cash used to purchase property and equipment to support both customer and internal capital requirements.
 
Financing activities used cash of $69.8 million for the fiscal year ended July 31, 2010 and $3.6 million for the fiscal year ended July 31, 2009. The $69.8 million of cash used for financing activities for the fiscal year ended July 31, 2010 primarily related to $65.3 million in net repayments of notes payable; $6.6 million in proceeds from notes payable off-set by $71.9 million of repayments of notes payable, primarily from the proceeds of the assets sales during the fiscal year 2010. Additionally, in fiscal year 2010 the Company made $5.1 million of capital lease repayments and incurred $0.5 million in debt issuance costs off set by $1.1 million in proceeds from stock option exercises. The $3.6 million of cash used for financing activities for the fiscal year ended July 31, 2009 primarily related to $1.4 million in net proceeds from notes payable; $10.4 million in proceeds from notes payable off-set by $9.0 million of repayments of notes payable, and $0.3 million in proceeds from stock option exercises. These net proceeds of $1.7 million were off-set by $4.1 million of capital lease repayments and $1.2 million in debt issuance costs.
 
Our current Credit Agreement consists of a six-year term loan, expiring in June 2013 and a five-year revolving-credit facility, expiring in June 2012. The Credit Agreement is subject to prepayment in the case of an event of default. Our revolving-credit facility allows for maximum borrowing of $9.0 million. Outstanding amounts bear interest at either LIBOR plus 6% or, at our option, the Base Rate, as defined in our credit agreement, plus 5%. Interest becomes due, and is payable, quarterly in arrears. In addition to our current Credit Agreement, we have redeemable preferred stock that is redeemable at the option of the holders on or after August 2013. Should additional capital be needed to fund these commitments we may seek to raise additional capital through offerings of the Company’s stock or through debt refinancing. There can be no assurance, however, that we would be able to raise additional capital on terms that are favorable to us, or at all.
 
We believe that our existing cash and cash equivalents, cash flow from operations and existing amounts available under our credit facility will be sufficient to meet our anticipated cash needs for at least the next 12 months. There are no material capital expenditure commitments as of July 31, 2010. Ongoing capital requirements to grow the business are currently funded and are expected to be primarily funded in the future by cash generated from operations.
 
Off-Balance Sheet Financing Arrangements
 
We do 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. In accordance therewith, we must make certain estimates, judgments and assumptions that we believe are reasonable based on the information available. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses for the periods presented. The significant accounting policies that we believe are the most critical to aid in fully understanding and evaluating our reported financial results are revenue recognition; allowance for doubtful accounts; impairment of long-lived assets, goodwill and other intangible assets; stock-based compensation; and income taxes. We review our estimates on a regular basis and make adjustments based on historical experiences, current conditions and future expectations. We perform these reviews regularly and make adjustments in light of currently available information. We believe that these estimates are reasonable, but actual results could differ from these estimates.


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Revenue Recognition.  We derive our revenue from monthly fees for website and Internet-application management and hosting, co-location services and professional services. Reimbursable expenses charged to customers are included in revenue and cost of revenue. Revenue is recognized as services are performed in accordance with all applicable revenue-recognition criteria.
 
Application-management, hosting and co-location services are billed and recognized as revenue over the term of the applicable contract based on actual customer usage. These terms generally are one to five years. Installation fees associated with application-management, hosting and co-location services are billed when the installation service is provided and recognized as revenue over the term of the related contract. Installation fees generally consist of fees charged to set up a specific technological environment for a customer within a NaviSite data center. In instances where payment for a service is received in advance of performing those services, the related revenue is deferred until the period in which such services are performed. The direct and incremental costs associated with installation and setup activities are capitalized and expensed over the term of the related contract.
 
Professional-services revenue is recognized on a time and materials basis as the services are performed for time- and materials-type contracts or on a percentage-of-completion method for fixed-price contracts. We estimate the percentage of completion using the ratio of hours incurred on a contract to the projected hours expected to be incurred to complete the contract. Estimates to complete contracts are prepared by project managers and reviewed by management each month. 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 as the amount by which the estimated service costs of the contract exceed the estimated revenue that will be generated by the contract. Historically, our estimates have been consistent with actual results. Unbilled accounts receivable represent 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.
 
In accordance with Accounting Standards Update (“ASU”) No 2009-13, “Multiple-Deliverable Revenue Arrangements”, which amends FASB Accounting Standards Codification (“ASC”) Topic 605, “Revenue Recognition” when more than one element — such as professional services, hardware and hosting services — are contained in a single arrangement, we allocate arrangement consideration at the inception of an arrangement to all deliverables using the relative selling price method, so long as each element meets the criteria for treatment as a separate unit of accounting. The ASU establishes a selling price hierarchy for determining the selling price of a deliverable, which includes (1) vendor-specific objective evidence, if available, (2) third-party evidence, if vendor-specific objective evidence is not available, and (3) estimated selling price, if neither vendor-specific nor third-party evidence is available. For those arrangements with respect to which the deliverables do not qualify as a separate unit of accounting, revenue from all deliverables is treated as one accounting unit and generally recognized ratably over the term of the arrangement.
 
Existing customers are subject to initial and ongoing credit evaluations. Credit evaluations are based on credit reviews that we perform, including payment history and other factors, inclusive of a review of the customer’s financial condition and general economic trends. If it is determined, subsequent to our initial evaluation at any time during the arrangement, that collectability is not reasonably assured, revenue is recognized as cash is received, as collectability is not considered probable at the time the services are performed.
 
Allowance for Doubtful Accounts.  We perform initial and periodic credit evaluations of our customers’ financial condition. We make estimates of the collectability of our accounts receivable 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 creditworthiness (including the customer’s financial performance and its business history), current economic trends and changes in our customers’ payment patterns when evaluating the adequacy of the allowance for doubtful accounts. We specifically reserve for 100% of the balance of customer accounts deemed uncollectible. For all other customer accounts, we reserve as needed based upon management’s estimates of uncollectible amounts based on historical bad debt experience and other relevant factors. Changes in economic conditions or the financial viability of our customers may result in additional provisions for doubtful accounts in excess of our current


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estimate. Historically, our estimates have been consistent with actual results. A 5% to 10% unfavorable change in our provision requirements would result in an approximate $0.09 million to $0.2 million decrease to income from operations for the fiscal year ended July 31, 2010.
 
Impairment of Long-Lived Assets and Goodwill and Other Intangible Assets.  We review our long-lived assets, subject to amortization and depreciation, for impairment whenever events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable. Long-lived and other intangible assets include customer lists, customer-contract backlog, developed technology, vendor contracts, trademarks, non-compete agreements and property and equipment. Factors we consider important that could trigger an impairment review include:
 
  •  significant underperformance relative to 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 the future undiscounted cash flows expected to be generated by the asset. If the undiscounted cash flows expected to be generated by the use and disposal of the asset are less than its carrying value and therefore impaired, we recognize the impairment loss as measured by the amount by which the carrying value of the assets exceeds its fair value. Fair value is determined based on discounted cash flows or values determined by reference to third-party valuation reports, 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.
 
In accordance with FASB ASC 350-20-35, the Company assesses goodwill for impairment at the reporting unit level, which is defined as an operating segment or one level below an operating segment, referred to as a component. The Company has determined that it has two reporting units for which discrete financial information is available and for which the Chief Operating Decision Maker (“CODM”) and segment managers regularly review information about operating results. We review the valuation of our goodwill in the fourth quarter of each fiscal year, or on an interim basis, if a triggering event occurs. Our valuation methodology for assessing impairment requires us to make judgments and assumptions based on historical experience and to rely heavily on projections of future operating performance. We operate in highly competitive environments, and our projections of future operating results and cash flows may vary significantly from actual results. If the assumptions that we use in preparing our estimates of our reporting unit’s projected performance for purposes of impairment testing differ materially from actual future results, we may record impairment changes in the future and our operating results may be adversely affected. At July 31, 2010, we completed our annual impairment review of goodwill and concluded that there was no goodwill impairment as the fair value of the reporting units were substantially in excess of book value. No impairment indicators have arisen since that date to cause us to perform an impairment assessment since that date. At July 31, 2010 and 2009, the carrying value of goodwill and other intangible assets totaled $52.8 million and $88.7 million, respectively.
 
Stock-Based Compensation.  FASB ASC 718 “Compensation — Stock Compensation,” (“ASC 718”), requires companies to estimate the fair value of stock-based payment awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in our consolidated statement of operations.
 
Stock-based compensation expense recognized during the period is based on the value of the portion of stock-based payment awards that is ultimately expected to vest during the period, reduced for estimated forfeitures. ASC 718 requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. In our pro forma information required under ASC 718 for the periods prior to August 1, 2005, we established estimates for forfeitures. Stock-based compensation expense recognized in our consolidated statements of operations for the fiscal years ended


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July 31, 2008 included compensation expense for stock-based payment awards granted before, but unvested as of, July 31, 2005, based on the grant-date fair value estimated in accordance with the pro forma provisions of ASC 718, and compensation expense for the stock-based payment awards granted after July 31, 2005, based on the grant-date fair value estimated in accordance with the provisions of ASC 718.
 
In accordance with ASC 718, we use the Black-Scholes option-pricing model (the “Black-Scholes Model”). In utilizing the Black-Scholes Model, we are required to make certain estimates in order to determine the grant-date fair value of equity awards. These estimates can be complex and subjective and include the expected volatility of our common stock, our divided rate, a risk-free interest rate, the expected term of the equity award and the expected forfeiture rate of the equity award. Any changes in these assumptions may materially affect the estimated fair value of our recorded stock-based compensation.
 
Income Taxes.  Income taxes are accounted for under the provisions of SFAS No. 109, “Accounting for Income Taxes,”  which is now part of FASB ASC 740, “Income Taxes” (“FASB ASC 740”), using the asset-and-liability method, whereby deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial-statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year 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. FASB ASC 740 also requires that the deferred tax assets be reduced by a valuation allowance if, based on the weight of available evidence, it is more likely than not that some or all of the recorded deferred tax assets will not be realized in future periods. This methodology is subjective and requires significant estimates and judgments in the determination of the recoverability of deferred tax assets and in the calculation of certain tax liabilities. At July 31, 2010 and 2009, respectively, a valuation allowance has been recorded against gross deferred tax assets since we believe that, after considering all the available objective evidence — positive and negative, historical and prospective, with greater weight given to historical evidence — it is more likely than not that these assets will not be realized. In each reporting period, we evaluate the adequacy of our valuation allowance on our deferred tax assets. In the future, if we can demonstrate a consistent trend of pre-tax income, then, at that time, we may reduce our valuation allowance accordingly. Our federal and state net-operating-loss carryforwards at July 31, 2010, totaled $154.2 million. A 5% reduction in our current valuation allowance on these federal and state net- operating-loss carryforwards would result in an income-tax benefit of approximately $3.1 million for the fiscal 2010 reporting period.
 
In addition, the calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax regulations in several tax jurisdictions. We are periodically reviewed by domestic and foreign tax authorities regarding the amount of taxes due. These reviews include questions regarding the timing and amount of deductions and the allocation of income among various tax jurisdictions. In evaluating the exposure associated with various filing positions, we record estimated reserves for exposures. Based on our evaluation of current tax positions, we believe that we have appropriately accrued for exposures.
 
Recent Accounting Pronouncements
 
Effective August 1, 2009, we adopted ASU No. 2009-13, “Multiple-Deliverable Revenue Arrangements” (“ASU 2009-13”), which amends FASB ASC “Topic 605,” “Revenue Recognition.” ASU 2009-13 amends the FASB ASC to eliminate the residual method of allocation for multiple-deliverable revenue arrangements, and requires that arrangement consideration be allocated at the inception of an arrangement to all deliverables using the relative selling price method. The ASU also establishes a selling price hierarchy for determining the selling price of a deliverable, which includes (1) vendor-specific objective evidence, if available, (2) third-party evidence, if vendor-specific objective evidence is not available, and (3) estimated selling price, if neither vendor-specific nor third-party evidence is available. Additionally, ASU 2009-13 expands the disclosure requirements related to a vendor’s multiple-deliverable revenue arrangements. This guidance was effective for us on August 1, 2010; however, we elected to early adopt as permitted by the guidance. As such, we prospectively applied the provisions of ASU 2009-13 to all revenue arrangements entered into or materially modified after August 1, 2009. During fiscal year ending July 31, 2010 the adoption of ASU 2009-13 did not have a significant impact.


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In November 2008 the SEC issued for comment a proposed roadmap regarding the potential use by U.S. issuers of financial statements prepared in accordance with International Financial Reporting Standards (“IFRS”). IFRS is a comprehensive series of accounting standards published by the International Accounting Standards Board (the “IASB”). Under the proposed roadmap, in fiscal 2015 we could be required to prepare financial statements in accordance with IFRS. The SEC will make a determination in 2011 regarding the mandatory adoption of IFRS. We are currently assessing the impact that this change would have on our consolidated financial statements, and we will continue to monitor the development of the potential implementation of IFRS.
 
Effective August 1, 2009, we adopted FASB Staff Position (“FSP”) No. 142-3, “Determination of the Useful Life of Intangible Assets,” which was primarily codified into “Topic 350” — “Intangibles — Goodwill and Other” (“FASB ASC 350”) in the FASB ASC. This guidance amends the factors that should be considered in developing renewal or extension assumptions used to determine the estimated useful life of a recognized intangible asset and requires enhanced related disclosures. FASB ASC 350 improves the consistency between the useful life of a recognized intangible asset and the period of expected cash flows used to measure the fair value of the asset. This guidance must be applied prospectively to all intangible assets acquired as of and subsequent to fiscal years beginning after December 15, 2008. This guidance became effective for us on August 1, 2009. Although future transactions involving intangible assets may be affected by this guidance, it did not impact our financial position or results of operations as we did not acquire any intangible assets during fiscal year 2010.
 
Effective August 1, 2009, we adopted FSP No. 107-1 and APB Opinion 28-1, “Interim Disclosures about Fair Value of Financial Instruments,” which is now part of FASB ASC 825, “Financial Instruments” (“FASB ASC 825”). FASB ASC 825 requires disclosures about fair value of financial instruments for interim and annual reporting periods and is effective for interim reporting periods ending after June 15, 2009. Such adoption did not have a material impact on our disclosures, financial position or results of operations.
 
In August 2009, the FASB issued ASU No. 2009-05, “Measuring Liabilities at Fair Value” (“ASU 2009-05”), which amends ASC “Topic 820”, “Fair Value Measurements and Disclosures.” ASU 2009-05 provides clarification and guidance regarding how to value a liability when a quoted price in an active market is not available for that liability. Changes to the FASB ASC as a result of this update were effective for us on November 1, 2009. The adoption of these changes did not have a material effect on our financial position or results of operations.
 
Item 7A.   Quantitative and Qualitative Disclosures About Market Risk
 
Not required.
 
Item 8.   Financial Statements and Supplementary Data
 
Our consolidated financial statements and schedules and the reports of our independent registered public accounting firm appear beginning on page F-2 of this report and are incorporated herein by reference.
 
Item 9.   Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
 
None.
 
Item 9A.   Controls and Procedures
 
Evaluation of Disclosure Controls and Procedures.  Based on our evaluation (with the participation of our principal executive and financial officers), as of the end of the period covered by this report, our principal executive and financial officers have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act) are effective to ensure that information that we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that the


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information is accumulated and communicated to our management, including our principal executive and financial officers, as appropriate to allow timely decisions regarding required disclosure.
 
Changes in Internal Control.  There was no change in our internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act) during the fourth fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
 
Management’s Report on Internal Control over Financial Reporting
 
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act. Our internal-control system was designed to provide reasonable assurance to our management and board of directors regarding the preparation and fair presentation of published financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risks that controls may become inadequate because of changes in conditions and that the degree of compliance with the policies or procedures may deteriorate.
 
Our management assessed the effectiveness of our internal control over financial reporting as of July 31, 2010. In making this assessment, we used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in “Internal Control — Integrated Framework.” Having assessed such controls accordingly, our management concluded that, as of July 31, 2010, our internal control over financial reporting is effective based on those criteria.
 
This Annual Report on Form 10-K does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our independent registered public accounting firm pursuant to rules of the SEC that permit us to provide only a management’s report in this Annual Report.
 
Item 9B.   Other Information
 
None.
 
PART III
 
Certain information required by Part III of this Form 10-K is omitted because we will file a definitive proxy statement pursuant to Regulation 14A (the “Proxy Statement”) not later than 120 days after the end of the fiscal year covered by this Form 10-K, and certain information to be included therein is incorporated herein by reference.
 
Item 10.   Directors, Executive Officers and Corporate Governance
 
Incorporated by reference to the portions of the Proxy Statement entitled “Proposal No. 1 — Election of Directors,” “Corporate Governance and Board Matters,” “Management,” “Additional Information — Section 16(a) Beneficial Ownership Reporting Compliance” and “Additional Information — Audit Committee Financial Expert.”
 
During the fourth quarter of fiscal year 2010, we made no material changes to the procedures by which our stockholders may recommend nominees to our board of directors, as described in our most recent proxy statement.
 
Code of Ethics.  We have adopted a code of business conduct and ethics that applies to all of our directors, officers and employees, including our chief executive officer, chief financial officer, controller and other senior financial officers. Our code of business conduct and ethics is posted under the “Corporate Governance” section of our website, www.navisite.com. We intend to satisfy the disclosure requirement regarding any amendment to, or waiver of, a provision of the code of business conduct and ethics applicable to our chief executive officer, chief financial officer, controller or other senior financial officers by posting such information on our website.


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Item 11.   Executive Compensation
 
Incorporated by reference to the portions of the Proxy Statement entitled “Executive Compensation.”
 
Item 12.   Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
 
Incorporated by reference to the portion of the Proxy Statement entitled “Security Ownership of Certain Beneficial Owners and Management.”
 
Equity Compensation Plan Information as of July 31, 2010
 
The following table sets forth certain information regarding our equity-compensation plans as of July 31, 2010.
 
                         
            (c)
            Number of Securities
    (a)
  (b)
  Available for Future
    Number of Securities to
  Weighted-Average
  Issuance
    be Issued Upon Exercise
  Exercise Price of
  Under Equity Compensation
    of Outstanding Options,
  Outstanding Options,
  Plans (Excluding Securities
Plan Category
  Warrants and Rights   Warrants and Rights   Reflected in Column(a))
 
Equity-compensation plans approved by security holders
    6,648,494     $ 3.15       724,933  
Equity-compensation plans not approved by security holders
                   
                         
Total
    6,648,494               724,933  
                         
 
Item 13.   Certain Relationships and Related Transactions, and Director Independence
 
Incorporated by reference to the portions of the Proxy Statement entitled “Additional Information — Certain Relationships and Related Transactions,” and “Corporate Governance and Board Matters.”
 
Item 14.   Principal Accounting Fees and Services
 
Incorporated by reference to the portion of the Proxy Statement entitled “Additional Information — Independent Registered Public Accounting Firm Fees” and “Additional Information — Policy on Audit Committee Pre-Approval of Audit and Permissible Non-Audit Services of Independent Registered Public Accounting Firm.”
 
PART IV
 
Item 15.   Exhibits, Financial Statement Schedules
 
1. Financial Statements.
 
The financial statements listed in the Index to Consolidated Financial Statements are filed as part of this report.
 
2. Financial Statement Schedule.
 
The Financial Statement Schedule of NaviSite and the corresponding Report of Independent Registered Public Accounting Firm on Financial Statement Schedule are filed as part of this report. All other financial statement schedules have been omitted because they are not required or not applicable or the information is otherwise included.
 
3. Exhibits.
 
The exhibits listed in the Exhibit Index immediately preceding such exhibits are filed with, or incorporated by reference in, this report.


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SIGNATURES
 
Pursuant to the requirements of Section 13 or 15(d) 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.
 
NaviSite, Inc.
 
October 22, 2010
  By: 
/s/  R. Brooks Borcherding
R. Brooks Borcherding
President and Chief Executive Officer
 
 
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been duly signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
 
             
Signatures
 
Title
 
Date
 
         
/s/  Andrew Ruhan

Andrew Ruhan
  Chairman of the Board   October 22, 2010
         
/s/  R. Brooks Borcherding

R. Brooks Borcherding
  President and Chief Executive Officer (Principal Executive Officer)   October 22, 2010
         
/s/  James W. Pluntze

James W. Pluntze
  Chief Financial Officer
(Principal Financial Officer and
Principal Accounting Officer)
  October 22, 2010
         
/s/  Arthur P. Becker

Arthur P. Becker
  Director   October 22, 2010
         
/s/  James H. Dennedy

James H. Dennedy
  Director   October 22, 2010
         
/s/  Larry W. Schwartz

Larry W. Schwartz
  Director   October 19, 2010
         
/s/  Thomas R. Evans

Thomas R. Evans
  Director   October 22, 2010


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INDEX TO EXHIBITS
 
         
Exhibit No.
 
Description of Exhibit
 
  2 .1   Asset Purchase Agreement, dated as of August 10, 2007, by and among NaviSite, Inc.; Navi Acquisition Corp.; Alabanza, LLC; and Hosting Ventures, LLC, is incorporated herein by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on August 16, 2007 (File No. 000-27597).
  2 .2   Stock Purchase Agreement, dated August 10, 2007, by and among NaviSite, Inc.; Jupiter Hosting, Inc.; and the stockholders of Jupiter Hosting, Inc., is incorporated herein by reference to Exhibit 10.2 to the Registrant’s Current Report on Form 8-K filed on August 16, 2007 (File No. 000-27597).
  2 .3   Agreement and Plan of Merger, dated as of September 12, 2007, by and among NaviSite, Inc.; NSite Acquisition Corp.; netASPx, Inc.; and GTCR Fund VI, L.P., is incorporated herein by reference to Exhibit 10.3 to the Registrant’s Current Report on Form 8-K filed on September 18, 2007 (File No. 000-27597).
  2 .4   Asset Purchase Agreement, dated as of February 19, 2010, by and among NaviSite, Inc.; NaviSite Disposition, LLC (f/k/a netASPx, LLC); NaviSite Disposition Corp. (f/k/a netASPx Acquisition, Inc.); Network Computing Services, Inc.; NCS Holding Company; and Velocity Technology Solutions II, Inc., is incorporated herein by reference to Exhibit 2.1 to the Registrant’s Current Report on Form 8-K filed on February 25, 2010 (File No. 000-27597),
  3 .1   Amended and Restated Certificate of Incorporation is incorporated herein by reference to Exhibits to the Registrant’s Quarterly Report on Form 10-Q for the fiscal quarter ended October 31, 1999 (File No. 000-27597).
  3 .2   Certificate of Amendment of Amended and Restated Certificate of Incorporation, dated as of January 4, 2003, is incorporated herein by reference to Exhibits to the Registrant’s Quarterly Report on Form 10-Q for the fiscal quarter ended January 31, 2003 (File No. 000-27597).
  3 .3   Certificate of Amendment of Amended and Restated Certificate of Incorporation, dated as of January 7, 2003, is incorporated herein by reference to Exhibits to the Registrant’s Quarterly Report on Form 10-Q for the fiscal quarter ended January 31, 2003 (File No. 000-27597).
  3 .4   Certificate of Designation of Rights, Preferences, Privileges and Restrictions of Series A Convertible Preferred Stock, dated as of September 12, 2007, is incorporated herein by reference to Exhibit 3.1 to the Registrant’s Current Report on Form 8-K filed on September 18, 2007 (File No. 000-27597).
  3 .5   Waiver of Certificate of Designation of Rights, Preferences, Privileges and Restrictions of Series A Convertible Preferred Stock by netASPx Holdings, Inc., dated September 25, 2007, is incorporated herein by reference to Exhibit 3.1 to the Registrant’s Quarterly Report on Form 10-Q for the fiscal quarter ended January 31, 2008 (File No. 000-27597).
  3 .6   Amended and Restated By-Laws is incorporated herein by reference to Exhibits to the Registrant’s Quarterly Report on Form 10-Q for the fiscal quarter ended October 31, 1999 (File No. 000-27597).
  4 .1   Specimen certificate representing shares of common stock is incorporated herein by reference to Exhibits to the Registrant’s Registration Statement on Form S-1/A (File No. 333-83501).
  4 .2   Specimen Certificate of Series A Convertible Preferred Stock of NaviSite, Inc., is incorporated herein by reference to Exhibit 4.1 to the Registrant’s Current Report on Form 8-K filed on September 18, 2007 (File No. 000-27597).
  10 .1   Lease, dated as of May 14, 1999, by and between 400 River Limited Partnership and the Registrant, is incorporated herein by reference to Exhibits to the Registrant’s Registration Statement on Form S-1 (File No. 333-83501).
  10 .2   Amendment No. 1 to Lease, by and between 400 River Limited Partnership and the Registrant, is incorporated by reference to Exhibits to the Registrant’s Quarterly Report on Form 10-Q for the fiscal quarter ended October 31, 2003 (File No. 000-27597).
  10 .3   Amendment No. 2 to Lease, dated December 1, 2003, by and between 400 River Limited Partnership and the Registrant, is incorporated herein by reference to Exhibits to the Registrant’s Registration Statement on Form S-2 filed January 22, 2004 (File No. 333-112087).


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Exhibit No.
 
Description of Exhibit
 
  10 .4   Amendment No. 3 to Lease, by and between 400 River Limited Partnership and the Registrant, is incorporated herein by reference to Exhibit 99.1 to the Registrant’s Current Report on Form 8-K dated September 21, 2004 (File No. 000-27597).
  10 .5   Amendment No. 5 to Lease, dated as of August 15, 2008, by and between 400 Minuteman LLC and the Registrant, is incorporated herein by reference to Exhibit 10.1 to the Registrant’s Quarterly Report on Form 10-Q for the fiscal quarter ended October 31, 2008 (File No. 000-27597).
  10 .6   Amendment No. 6 to Lease, dated as of November 20, 2008, by and between 400 Minuteman LLC and the Registrant.
  10 .7   Amendment No. 7 to Lease, dated as of March 11, 2009, by and between 400 Minuteman LLC and the Registrant.
  10 .8   Amendment No. 8 to Lease, dated as of January 19, 2010, by and between 400 Minuteman LLC and the Registrant.
  10 .9   Amendment No. 9 to Lease, dated as of January 29, 2010, by and between 400 Minuteman LLC and the Registrant.
  10 .10   Lease, made as of April 30, 1999, by and between CarrAmerica Realty Corporation and the Registrant, is incorporated herein by reference to Exhibits to the Registrant’s Registration Statement on Form S-1 (File No. 333-83501).
  10 .11   First Amendment to Lease, dated as of August 9, 2006, by and between the Registrant and Carr NP Properties L.L.C., is incorporated herein by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K dated September 11, 2006 (File No. 000-27597).
  10 .12*   Amended and Restated 1998 Equity Incentive Plan is incorporated herein by reference to Exhibits to the Registrant’s Quarterly Report on Form 10-Q for the fiscal quarter ended October 31, 1999 (File No. 000-27597).
  10 .13*   NaviSite, Inc., Amended and Restated 1999 Employee Stock Purchase Plan is incorporated herein by reference to Appendix I to the Registrant’s Definitive Proxy Statement filed November 13, 2007 (File No. 000-27597).
  10 .14*   Amendment No. 1 to Amended and Restated 1999 Employee Stock Purchase Plan is incorporated herein by reference to Appendix I to the Registrant’s Definitive Proxy Statement filed October 30, 2009 (File No. 000-27597).
  10 .15*   2000 Stock Option Plan is incorporated herein by reference to Exhibits to the Registrant’s Annual Report on Form 10-K/A for the fiscal year ended July 31, 2002 (File No. 000-27597).
  10 .16*   Employment Agreement, dated as of February 21, 2003, by and between Arthur Becker and the Registrant, is incorporated herein by reference to Exhibits to the Registrant’s Quarterly Report on Form 10-Q for the fiscal quarter ended January 31, 2003 (File No. 000-27597).
  10 .17*   Separation Agreement dated as of April 3, 2006, by and between the Registrant and Arthur P. Becker, is incorporated herein by reference to Exhibit 99.1 to the Registrant’s Current Report on Form 8-K dated April 6, 2006 (File No. 000-27597).
  10 .18*   Amendment No. 1 to Separation Agreement, dated as of December 4, 2008, by and between the Registrant and Arthur P. Becker, is incorporated herein by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on December 9, 2008 (File No. 000-27597).
  10 .19   Warrant Purchase Agreement, dated as of February 13, 2007, by and among the Registrant, SPCP Group, LLC, and SPCP Group III, LLC, is incorporated herein by reference to Exhibit 10.1 of the Registrant’s Current Report on Form 8-K filed on February 20, 2007 (File No. 000-27597).
  10 .20   Warrant to Purchase Common Stock, dated February 13, 2007, issued by the Registrant to SPCP Group, LLC, is incorporated herein by reference to Exhibit 10.2 of the Registrant’s Current Report on Form 8-K filed on February 20, 2007 (File No. 000-27597).
  10 .21   Warrant to Purchase Common Stock, dated February 13, 2007, issued by the Registrant to SPCP Group III, LLC, is incorporated herein by reference to Exhibit 10.3 of the Registrant’s Current Report on Form 8-K filed on February 20, 2007 (File No. 000-27597).


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Exhibit No.
 
Description of Exhibit
 
  10 .22   Warrant Purchase Agreement, dated as of April 11, 2006, by and among the Registrant, SPCP Group, L.L.C. and SPCP Group III LLC is incorporated herein by reference to Exhibit 10.4 to the Registrant’s Quarterly Report on Form 10-Q for the fiscal quarter ended April 30, 2006 (File No. 000-27597).
  10 .23   Warrant, dated as of April 11, 2006, issued by the Registrant to SPCP Group, LL. is incorporated herein by reference to Exhibit 10.5 to the Registrant’s Quarterly Report on Form 10-Q for the fiscal quarter ended April 30, 2006 (File No. 000-27597).
  10 .24   Warrant, dated as of April 11, 2006, issued by the Registrant to SPCP Group III LLC is incorporated herein by reference to Exhibit 10.6 to the Registrant’s Quarterly Report on Form 10-Q for the fiscal quarter ended April 30, 2006 (File No. 000-27597).
  10 .25   Amendment No. 1 to Warrant, dated as of February 13, 2007, by and between the Registrant and SPCP Group, LLC, is incorporated herein by reference to Exhibit 10.8 to the Registrant’s Quarterly Report on Form 10-Q for the fiscal quarter ended January 31, 2007 (File No. 000-27597).
  10 .26   Credit Agreement, dated as of June 8, 2007, by and among NaviSite, Inc.; certain of its subsidiaries; Canadian Imperial Bank of Commerce, through its New York agency, as issuing bank, administrative agent for the Lenders and as collateral agent for the Secured Parties and the issuing bank; CIBC World Markets Corp., as sole lead arranger, documentation agent and bookrunner; CIT Lending Services Corporation, as syndication agent; and certain affiliated entities, is incorporated herein by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K dated as of June 13, 2007 (File No. 000-27597).
  10 .27   Security Agreement, dated as of June 8, 2007, by and among NaviSite, Inc.; certain of its subsidiaries; and Canadian Imperial Bank of Commerce, acting through its New York agency, as collateral agent, is incorporated herein by reference to Exhibit 10.2 to the Registrant’s Current Report on Form 8-K dated as of June 13, 2007 (File No. 000-27597).
  10 .28   Form of Term Note, to be made by NaviSite, Inc., is incorporated herein by reference to Exhibit 10.3 to the Registrant’s Current Report on Form 8-K dated as of June 13, 2007 (File No. 000-27597).
  10 .29   Form of Revolving Note to be made by NaviSite, Inc., is incorporated herein by reference to Exhibit 10.4 to the Registrant’s Current Report on Form 8-K dated as of June 13, 2007 (File No. 000-27597).
  10 .30   Amendment, Waiver and Consent Agreement No. 1, dated as of August 10, 2007, by and among NaviSite, Inc.; certain of its subsidiaries; Canadian Imperial Bank of Commerce, through its New York agency, as issuing bank, administrative agent for the Lenders and as collateral agent for the Secured Parties and the issuing bank; CIBC World Markets Corp., as sole lead arranger, documentation agent and bookrunner; CIT Lending Services Corporation, as syndication agent; and certain affiliated entities, is incorporated herein by reference to Exhibit 10.3 to the Registrant’s Current Report on Form 8K dated as of August 16, 2007 (File No. 000-27597).
  10 .31   Amended and Restated Credit Agreement, dated as of September 12, 2007, by and among NaviSite, Inc.; certain of its subsidiaries; Canadian Imperial Bank of Commerce, through its New York agency, as issuing bank, administrative agent for the Lenders and as collateral agent for the Secured Parties and the issuing bank; CIBC World Markets Corp., as sole lead arranger, documentation agent and bookrunner; CIT Lending Services Corporation, as syndication agent; and certain affiliated entities, is incorporated herein by reference to Exhibit 10.1 to the Registrant’s Quarterly Report on Form 10-Q for the fiscal quarter ended April 30, 2010 (File No. 000-27597).
  10 .32   Term Note, dated as of September 12, 2007, issued by NaviSite, Inc., to CIBC, Inc., is incorporated herein by reference to Exhibit 10.2 to the Registrant’s Current Report on Form 8-K dated as of September 18, 2007 (File No. 000-27597).


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Exhibit No.
 
Description of Exhibit
 
  10 .33   Waiver No. 2, dated as of November 2, 2007, by and among NaviSite, Inc.; certain of its subsidiaries; Canadian Imperial Bank of Commerce, through its New York agency, as issuing bank, administrative agent for the Lenders and as collateral agent for the Secured Parties and the issuing bank; CIBC World Markets Corp., as sole lead arranger, documentation agent and bookrunner; CIT Lending Services Corporation, as syndication agent; and certain affiliated entities, is incorporated herein by reference to Exhibit 10.2 to the Registrant’s Quarterly Report on Form 10-Q for the fiscal quarter ended October 31, 2007 (File No. 000-27597).
  10 .34   Amendment, Waiver and Consent Agreement No. 3, dated as of January 31, 2008, by and among NaviSite, Inc.; certain of its subsidiaries; Canadian Imperial Bank of Commerce, through its New York agency, as issuing bank, administrative agent for the Lenders and as collateral agent for the Secured Parties and the issuing bank; CIBC World Markets Corp., as sole lead arranger, documentation agent and bookrunner; CIT Lending Services Corporation, as syndication agent; and certain affiliated entities, is incorporated herein by reference to Exhibit 10.3 to the Registrant’s Quarterly Report on Form 10-Q for the fiscal quarter ended October 31, 2007 (File No. 000-27597).
  10 .35   Amendment and Consent Agreement No. 4, dated as of June 20, 2008, by and among NaviSite, Inc.; certain of its subsidiaries; Canadian Imperial Bank of Commerce, through its New York agency, as issuing bank, administrative agent for the Lenders and as collateral agent for the Secured Parties and the issuing bank; CIBC World Markets Corp., as sole lead arranger, documentation agent and bookrunner; CIT Lending Services Corporation, as syndication agent; and certain affiliated entities, is incorporated herein by reference to Exhibit 10.5 to the Registrant’s Quarterly Report on Form 10-Q for the fiscal quarter ended April 30, 2008 (File No. 000-27597).
  10 .36   Amendment, Waiver and Consent Agreement No. 5, dated as of October 30, 2008, by and among NaviSite, Inc.; certain of its subsidiaries; Canadian Imperial Bank of Commerce, through its New York agency, as issuing bank, administrative agent for the Lenders and as collateral agent for the Secured Parties and the issuing bank; CIBC World Markets Corp., as sole lead arranger, documentation agent and bookrunner; CIT Lending Services Corporation, as syndication agent; and certain affiliated entities, is incorporated herein by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K dated as of October 29, 2008 (File No. 000-27597).
  10 .37   Amendment, Waiver and Consent Agreement No. 7, dated as of February 19, 2010, by and among NaviSite, Inc.; certain of its subsidiaries; Canadian Imperial Bank of Commerce, through its New York agency, as issuing bank, administrative agent for the Lenders and as collateral agent for the Secured Parties and the issuing bank; CIBC World Markets Corp., as sole lead arranger, documentation agent and bookrunner; CIT Lending Services Corporation, as syndication agent; and certain affiliated entities, is incorporated herein by reference to Exhibit 10.2 to the Registrant’s Quarterly Report on Form 10-Q for the fiscal quarter ended April 30, 2010 (File No. 000-27597).
  10 .38   Amendment and Consent Agreement No. 8, dated as of April 30, 2010, by and among NaviSite, Inc.; certain of its subsidiaries; Canadian Imperial Bank of Commerce, through its New York agency, as issuing bank, administrative agent for the Lenders and as collateral agent for the Secured Parties and the issuing bank; CIBC World Markets Corp., as sole lead arranger, documentation agent and bookrunner; CIT Lending Services Corporation, as syndication agent; and certain affiliated entities, is incorporated herein by reference to Exhibit 10.3 to the Registrant’s Amendment No. 1 to Quarterly Report on Form 10-Q/A for the fiscal quarter ended April 30, 2010 (File No. 000-27597).
  10 .39   Registration Rights Agreement, dated as of September 12, 2007, by and between NaviSite, Inc., and GTCR Fund VI, L.P., is incorporated herein by reference to Exhibit 10.4 to the Registrant’s Current Report on Form 8-K dated September 18, 2007 (File No. 000-27597).
  10 .40   Warrant to Purchase Stock, dated January 30, 2004, issued by the Registrant to Silicon Valley Bank, is incorporated herein by reference to Exhibit 10.3 to the Registrant’s Current Report on Form 8-K dated January 30, 2004 (File No. 000-27597).


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Exhibit No.
 
Description of Exhibit
 
  10 .41*   Form of Indemnification Agreement, as executed by Messrs. Andrew Ruhan, Arthur P. Becker, James H. Dennedy, Larry W. Schwartz, Thomas R. Evans, James W. Pluntze, R. Brooks Borcherding, Mark Clayman, Denis Martin, Sumeet Sabharwal, Rathin Sinha and Mark Zingale, is incorporated by reference to Exhibits to the Registrant’s Annual Report on Form 10-K for the fiscal year ended July 31, 2003 (File No. 000-27597).
  10 .42   Lease and Services Agreement, by and between NaviSite Europe Limited and Global Switch (London) Limited, is incorporated by reference to Exhibits to the Registrant’s Registration Statement on Form S-2/A filed on March 8, 2004 (File No. 333-12087).
  10 .43*   NaviSite, Inc., Amended and Restated 2003 Stock Incentive Plan is incorporated herein by reference to Appendix II to the Registrant’s Definitive Schedule 14C filed January 5, 2005 (File No. 000-27597).
  10 .44*   Amendment No. 1 to the NaviSite, Inc., Amended and Restated 2003 Stock Incentive Plan is incorporated herein by reference to Appendix II to the Registrant’s Definitive Schedule 14C filed January 5, 2005 (File No. 000-27597).
  10 .45*   Amendment No. 2 to the Amended and Restated 2003 Stock Incentive Plan is incorporated herein by reference to Appendix II to the Registrant’s Definitive Schedule 14C filed March 14, 2006 (File No. 000-27597).
  10 .46*   Form of Amendment No. 1 to Restricted Stock Agreement Granted Under Amended and Restated 2003 Stock Incentive Plan is incorporated herein by reference to Exhibit 10.1 to the Registrant’s Quarterly Report on Form 10Q for the fiscal quarter ended January 31, 2009 (File No. 000-27597).
  10 .47*   Form of Director Restricted Stock Agreement Granted Under Amended and Restated 2003 Stock Incentive Plan is incorporated herein by reference to Exhibit 10.2 to the Registrant’s Quarterly Report on Form 10-Q for the fiscal quarter ended January 31, 2009 (File No. 000-27597).
  10 .48*   Form of Employee Restricted Stock Agreement Granted Under Amended and Restated 2003 Stock Incentive Plan is incorporated herein by reference to Exhibit 10.3 to the Registrant’s Quarterly Report on Form 10-Q for the fiscal quarter ended January 31, 2009 (File No. 000-27597).
  10 .49*   Separation Agreement, dated as of July 31, 2007, by and between the Registrant and James W. Pluntze, is incorporated herein by reference to Exhibit 99.1 to the Registrant’s Current Report on Form 8-K dated August 2, 2007 (File No. 000-27597).
  10 .50*   Amendment No. 1 to Separation Agreement, dated as of December 4, 2008, by and between the Registrant and James W. Pluntze, is incorporated herein by reference to Exhibit 10.2 to the Registrant’s Current Report on Form 8-K filed on December 9, 2008 (File No. 000-27597).
  10 .51*   NaviSite, Inc., Amended and Restated Director Compensation Plan is incorporated herein by reference to Exhibit 99.1 to the Registrant’s Current Report on Form 8-K dated August 16, 2007 (File No. 000-27597).
  10 .52*   Offer of Employment, dated as of May 19, 2004, by and between the Registrant and Mark Clayman, is incorporated herein by reference to Exhibit 10.1 to the Registrant’s Quarterly Report on Form 10-Q for the fiscal quarter ended April 30, 2008 (File No. 000-27597).
  10 .53*   Separation Agreement, dated as of April 3, 2006, by and between the Registrant and Mark Clayman, is incorporated herein by reference to Exhibit 10.2 to the Registrant’s Quarterly Report on Form 10-Q for the fiscal quarter ended April 30, 2008 (File No. 000-27597).
  10 .54*   Amendment No. 1 to Separation Agreement, dated as of December 7, 2008, by and between the Registrant and Mark Clayman, is incorporated herein by reference to Exhibit 10.3 to the Registrant’s Current Report on Form 8-K filed on December 9, 2008 (File No. 000-27597).
  10 .55*   Offer Letter, dated as of March 27, 2009, effective as of April 3, 2009, by and between the Registrant and R. Brooks Borcherding, is incorporated herein by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on April 13, 2009 (File No. 000-27597).
  10 .56*   Separation Agreement, dated as of April 13, 2009, by and between the Registrant and R. Brooks Borcherding, is incorporated herein by reference to Exhibit 10.52 to the Registrant’s Annual Report on Form 10-K for the fiscal year ended July 31, 2009 (File No. 000-27597).
  10 .57*   Offer Letter, dated as of August 28, 2009, by and between the Registrant and Mark Zingale, is incorporated herein by reference to Exhibit 10.53 to the Registrant’s Annual Report on Form 10-K for the fiscal year ended July 31, 2009 (File No. 000-27597).


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Exhibit No.
 
Description of Exhibit
 
  10 .58*   Separation Agreement, dated as of August 31, 2009, by and between the Registrant and Mark Zingale, is incorporated herein by reference to Exhibit 10.54 to the Registrant’s Annual Report on Form 10-K for the fiscal year ended July 31, 2009 (File No. 000-27597).
  10 .59*   Summary of the Registrant’s FY 2010 Executive Management Bonus Program is incorporated herein by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on September 23, 2009 (File No. 000-27597).
  10 .60*   Summary of the Registrant’s FY 2011 Executive Management Bonus Program.
  10 .61*   Offer Letter, dated as of June 22, 2003, by and between the Registrant and Denis Martin, is incorporated herein by reference to Exhibit 10.56 to the Registrant’s Annual Report on Form 10-K for the fiscal year ended July 31, 2009 (File No. 000-27597).
  10 .62*   Separation Agreement, dated as of April 6, 2006, by and between the Registrant and Denis Martin, is incorporated herein by reference to Exhibit 10.57 to the Registrant’s Annual Report on Form 10-K for the fiscal year ended July 31, 2009 (File No. 000-27597).
  10 .63*   Amendment No. 1 to Separation Agreement, dated as of December 8, 2008, by and between the Registrant and Denis Martin, is incorporated herein by reference to Exhibit 10.58 to the Registrant’s Annual Report on Form 10-K for the fiscal year ended July 31, 2009 (File No. 000-27597).
  10 .64*   Offer Letter, dated as of September 17, 2004, by and between the Registrant and Sumeet Sabharwal, is incorporated herein by reference to Exhibit 10.59 to the Registrant’s Annual Report on Form 10-K for the fiscal year ended July 31, 2009 (File No. 000-27597).
  10 .65*   Separation Agreement, dated as of April 3, 2006, by and between the Registrant and Sumeet Sabharwal, is incorporated herein by reference to Exhibit 10.60 to the Registrant’s Annual Report on Form 10-K for the fiscal year ended July 31, 2009 (File No. 000-27597).
  10 .66*   Amendment No. 1 to Separation Agreement, dated as of December 7, 2008, by and between the Registrant and Sumeet Sabharwal, is incorporated herein by reference to Exhibit 10.1 to the Registrant’s Quarterly Report on Form 10-Q for the fiscal quarter ended October 31, 2009 (File No. 000-27597).
  10 .67*   Offer Letter, dated as of May 8, 2007, by and between the Registrant and Rathin Sinha, is incorporated herein by reference to Exhibit 10.61 to the Registrant’s Annual Report on Form 10-K for the fiscal year ended July 31, 2009 (File No. 000-27597).
  10 .68*   Amended and Restated Separation Agreement, dated as of September 3, 2009, by and between the Registrant and Rathin Sinha, is incorporated herein by reference to Exhibit 10.62 to the Registrant’s Annual Report on Form 10-K for the fiscal year ended July 31, 2009 (File No. 000-27597).
  21     Subsidiaries of the Registrant.
  23     Consent of KPMG LLP, Independent Registered Public Accounting Firm.
  31 .1   Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  31 .2   Certification of 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.
 
 
(*) Management contract or compensatory plan or arrangement.


Table of Contents

 
INDEX TO NAVISITE, INC. CONSOLIDATED FINANCIAL STATEMENTS
 
         
    Page
 
    F-2  
    F-3  
    F-4  
    F-5  
    F-6  
    F-7  
    F-36  
    F-37  


F-1


Table of Contents

 
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
The Board of Directors and Stockholders
NaviSite, Inc. and Subsidiaries:
 
We have audited the accompanying consolidated balance sheets of NaviSite, Inc. and subsidiaries (the “Company”) as of July 31, 2010 and 2009, and the related consolidated statements of operations, changes in convertible preferred stock and stockholders’ deficit and comprehensive income (loss), and cash flows for each of the years in the three-year period ended July 31, 2010. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
 
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
 
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of NaviSite, Inc. and subsidiaries as of July 31, 2010 and 2009, and the results of their operations and their cash flows for each of the years in the three-year period ended July 31, 2010, in conformity with U.S. generally accepted accounting principles.
 
/s/  KPMG LLP
 
Boston, Massachusetts
October 22, 2010


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Table of Contents

NAVISITE, INC.

CONSOLIDATED BALANCE SHEETS
 
                 
    July 31,  
    2010     2009  
    (In thousands, except par value)  
 
ASSETS
Current assets:
               
Cash and cash equivalents
  $ 4,620     $ 10,534  
Accounts receivable, less allowance for doubtful accounts of $1,812 and $1,820 at July 31, 2010 and 2009, respectively
    12,532       16,417  
Unbilled accounts receivable
    730       1,361  
Prepaid expenses and other current assets
    11,244       6,336  
                 
Total current assets
    29,126       34,648  
Property and equipment, net
    29,914       32,048  
Intangible assets, net of accumulated amortization
    6,579       22,093  
Goodwill
    46,189       66,566  
Other assets
    4,039       6,769  
Restricted cash
    1,190       1,556  
                 
Total assets
  $ 117,037     $ 163,680  
                 
 
LIABILITIES AND STOCKHOLDERS’ DEFICIT
Current liabilities:
               
Notes payable, current portion
  $ 4,150     $ 10,603  
Capital lease obligations, current portion
    4,830       3,040  
Accounts payable
    7,379       5,375  
Accrued expenses
    12,213       9,822  
Accrued interest
    691       1,837  
Deferred revenue
    5,356       4,285  
Deferred other income and customer deposits
    977       662  
                 
Total current liabilities
    35,596       35,624  
Capital lease obligations, less current portion
    3,505       10,973  
Deferred tax liabilities
    7,393       7,492  
Other long-term liabilities
    8,053       7,661  
Notes payable, less current portion
    49,026       106,154  
                 
Total liabilities
    103,573       167,904  
                 
Series A Convertible Preferred stock, $0.01 par value; designated 5,000 shares; issued and outstanding: 4,087 at July 31, 2010; 3,664 shares at July 31, 2009
    34,284       30,879  
Commitments and contingencies (Note 12)
               
Stockholders’ deficit:
               
Common stock, $0.01 par value; Authorized 395,000 shares; issued and outstanding: 36,943 and 35,911 at July 31, 2010 and 2009, respectively
    369       359  
Accumulated other comprehensive loss
    (905 )     (1,024 )
Additional paid-in capital
    485,817       485,136  
Accumulated deficit
    (506,101 )     (519,574 )
                 
Total stockholders’ deficit
    (20,820 )     (35,103 )
                 
Total liabilities and stockholders’ deficit
  $ 117,037     $ 163,680  
                 
 
See accompanying notes to consolidated financial statements.


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Table of Contents

NAVISITE, INC.
 
CONSOLIDATED STATEMENTS OF OPERATIONS
 
                         
    Years Ended July 31,  
    2010     2009     2008  
    (In thousands, except per share data)  
 
Revenue, net
  $ 125,844     $ 125,033     $ 131,762  
Revenue, related parties
    303       346       372  
                         
Total revenue
    126,147       125,379       132,134  
                         
Cost of revenue
    62,314       63,854       75,630  
Depreciation and amortization
    16,524       17,211       15,999  
Restructuring charge
          209        
                         
Total cost of revenue
    78,838       81,274       91,629  
                         
Gross profit
    47,309       44,105       40,505  
                         
Operating expenses:
                       
Selling and marketing
    20,569       19,206       19,032  
General and administrative
    21,617       22,867       22,411  
Loss on settlement
          5,736        
Restructuring charge
          180        
                         
Total operating expenses
    42,186       47,989       41,443  
                         
Income (loss) from operations
    5,123       (3,884 )     (938 )
Other income (expense):
                       
Interest income
    23       43       264  
Interest expense
    (8,096 )     (9,287 )     (7,760 )
Loss on debt extinguishment
                (1,651 )
Other income, net
    288       690       2,295  
                         
Loss from continuing operations before income taxes and discontinued operations
    (2,662 )     (12,438 )     (7,790 )
Income taxes
    (755 )     (1,241 )     (1,152 )
                         
Loss from continuing operations
    (3,417 )     (13,679 )     (8,942 )
Income (loss) from discontinued operations, net of income taxes
    (3,604 )     (1,432 )     258  
Gain on sale of discontinued operations, net of income taxes
    20,494              
                         
Net income (loss)
    13,473       (15,111 )   $ (8,684 )
Accretion of preferred stock dividends
    (3,718 )     (3,350 )     (2,656 )
                         
Net income (loss) attributable to common stockholders
  $ 9,755     $ (18,461 )   $ (11,340 )
                         
Basic and diluted net income (loss) per common share:
                       
Loss from continuing operations attributable to common stockholders
  $ (0.19 )   $ (0.48 )   $ (0.33 )
Loss from discontinued operations
  $ (0.10 )   $ (0.04 )   $  
Gain on sale of discontinued operations
  $ 0.56     $     $  
                         
Net income (loss) attributable to common stockholders
  $ 0.27     $ (0.52 )   $ (0.33 )
                         
Basic and diluted weighted average number of common shares outstanding
    36,354       35,528       34,731  
                         
Stock-based compensation expense:
                       
Cost of revenue
  $ 1,023     $ 1,274     $ 1,794  
Selling and marketing
    682       557       746  
General and administrative
    1,297       1,292       1,830  
Restructuring charge
          19        
                         
Total stock-based compensation expense
  $ 3,002     $ 3,142     $ 4,370  
                         
 
See accompanying notes to consolidated financial statements.


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Table of Contents

NAVISITE, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN CONVERTIBLE PREFERRED STOCK AND
STOCKHOLDERS’ DEFICIT AND COMPREHENSIVE INCOME (LOSS)
 
                                                                           
                              Accumulated
                         
                              Other
    Additional
          Stockholders’
       
    Preferred Stock       Common Stock     Comprehensive
    Paid-in
    Accumulated
    Equity
    Comprehensive
 
    Shares     Amount       Shares     Amount     Income (Loss)     Capital     Deficit     (Deficit)     Income (Loss)  
    (In thousands)  
Balance at July 31, 2007
                  33,506       335       381       481,199       (495,779 )     (13,864 )        
Exercise of common stock options and shares issued under employee stock purchase plan
                  664       7             1,947             1,954          
Issuance of preferred stock
    3,125       24,873                                                  
Preferred stock dividend
    195       2,656                           (2,656 )             (2,656 )        
Issuance of common stock related to acquisition
                  25                   226             226          
Exercise of common stock purchase warrants
                  1,000       10                         10          
Vesting of restricted stock and stock-based compensation
                  37                   4,370             4,370          
Net loss
                                          (8,684 )     (8,684 )     (8,684 )
Currency translation adjustment
                              (128 )                 (128 )     (128 )
                                                                           
Total comprehensive loss
                                                      (8,812 )
                                                                           
Balance at July 31, 2008
    3,320     $ 27,529         35,232     $ 352     $ 253     $ 485,086     $ (504,463 )   $ (18,772 )        
Exercise of common stock options and shares issued under employee stock purchase plan
                  519       5             259             264          
Preferred stock dividend
    344       3,350                           (3,350 )             (3,350 )        
Vesting of restricted stock and stock-based compensation
                  160       2             3,141             3,143          
Net loss
                                          (15,111 )     (15,111 )     (15,111 )
Currency translation adjustment
                              (1,277 )                 (1,277 )     (1,277 )
                                                                           
Total comprehensive loss
                                                      (16,388 )
                                                                           
Balance at July 31, 2009
    3,664     $ 30,879         35,911     $ 359     $ (1,024 )   $ 485,136     $ (519,574 )   $ (35,103 )        
                                                                           
Exercise of common stock options and shares issued under employee stock purchase plan
                  760       8             1,086             1,094          
Preferred stock dividend
    460       3,718                           (3,718 )           (3,718 )        
Conversion of preferred stock to common stock
    (37 )     (313 )       37                   313             313          
Vesting of restricted stock and stock-based compensation
                  235       2             3,000             3,002          
Net income
                                          13,473       13,473       13,473  
Currency translation adjustment
                              119                   119       119  
                                                                           
Total comprehensive income
                                                      13,592  
                                                                           
Balance at July 31, 2010
    4,087     $ 34,284         36,943     $ 369     $ (905 )   $ 485,817     $ (506,101 )   $ (20,820 )        
                                                                           
                                                                           
 
See accompanying notes to consolidated financial statements.


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Table of Contents

NAVISITE, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS
 
                         
    Years Ended July 31,  
    2010     2009     2008  
    (In thousands)  
 
Cash flows from operating activities:
                       
Net income (loss)
  $ 13,473     $ (15,111 )   $ (8,684 )
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
                       
Depreciation and amortization
    21,159       23,638       21,223  
Gain on the sale of discontinued operations
    (20,494 )            
Mark to market for interest rate cap
    85       73       91  
Deferred income tax expense
    1,530       1,894       1,834  
Loss (gain) on disposal of assets
    86       (14 )     17  
Gain on settlements
                (1,607 )
Non-cash stock compensation
    3,002       3,142       4,370  
Provision for bad debts
    299       1,908       581  
Loss on debt extinguishment
                1,651  
Changes in operating assets and liabilities, net of impact of acquisitions Accounts receivable
    1,325       278       (500 )
Unbilled accounts receivable
    640       299       (765 )
Prepaid expenses and other current assets, net
    (2,969 )     5,474       (7,222 )
Other assets
    3,550       (1,874 )     (87 )
Accounts payable
    1,783       (1,553 )     2,241  
Deferred other income and customer deposits
    490       (464 )     (132 )
Accrued expenses and deferred revenue
    849       680       (7,970 )
Other long-term liabilities
    (217 )     3,204       936  
                         
Net cash provided by operating activities
    24,591       21,574       5,977  
                         
Cash flows from investing activities:
                       
Purchase of property and equipment
    (16,986 )     (10,648 )     (11,975 )
Capitalized software development costs
    (471 )            
Proceeds from the sale of discontinued operations
    56,329              
Cash used for acquisitions, net of cash acquired
                (31,373 )
Proceeds from the sale of equipment
          32       1  
Changes in restricted cash position
    470       45       13,535  
                         
Net cash provided by (used for) investing activities
    39,342       (10,571 )     (29,812 )
                         
Cash flows from financing activities:
                       
Proceeds from exercise of stock options & employee stock purchase plan
    1,094       264       1,954  
Proceeds from exercise of warrants
                10  
Proceeds from notes payable
    6,575       10,436       28,881  
Repayment of notes payable
    (71,855 )     (8,997 )     (10,114 )
Debt issuance costs
    (511 )     (1,184 )     (1,509 )
Payments on capital lease obligations
    (5,114 )     (4,091 )     (3,827 )
                         
Net cash used for financing activities
    (69,811 )     (3,572 )     15,395  
                         
Effect of exchange rate changes on cash and cash equivalents
    (36 )     (158 )      
Net (decrease) increase in cash and cash equivalents
    (5,914 )     7,273       (8,440 )
Cash and cash equivalents, beginning of year
    10,534       3,261       11,701  
                         
Cash and cash equivalents, end of year
  $ 4,620     $ 10,534     $ 3,261  
                         
Supplemental disclosure of cash flow information:
                       
Cash paid for interest
  $ 10,224     $ 11,950     $ 11,397  
Cash paid for income taxes
  $ 1,710     $ 49     $ 38  
Supplemental disclosure of non-cash transactions:
                       
Equipment purchased under capital leases
  $ 10,684     $ 2,514     $ 17,652  
Issuance of Series A Convertible Preferred Stock in connection with netASPx acquisition
  $     $     $ 24,873  
Accretion of Preferred Stock
  $ 3,718     $ 3,350     $ 2,656  
 
See accompanying notes to consolidated financial statements.


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Table of Contents

NAVISITE, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
(1)   Description of Business
 
NaviSite, Inc. (“NaviSite,” the “Company,” “we,” “us” or “our”), provides IT hosting, outsourcing and professional services. 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. Approximately 1,300 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. At July 31, 2010, NaviSite had 10 state-of-the-art data centers in the United States and United Kingdom and a network operations center in India. Substantially all revenue is generated from customers in the United States.
 
(2)   Summary of Significant Accounting Policies
 
(a)   Basis of Presentation and Background
 
NaviSite commenced operations in 1996 within CMGI, Inc. (currently known as ModusLink Global Solutions, Inc. (“ModusLink”)), our former majority stockholder, to support the networks and host websites of ModusLink, its subsidiaries and several of its affiliated companies. In 1997 we began offering and supplying website-hosting and -management services to companies not affiliated with ModusLink. We were incorporated in Delaware in December 1998. In October 1999 we completed our initial public offering of common stock and remained a majority-owned subsidiary of ModusLink until September 2002, at which time ClearBlue Technologies, Inc. (“CBT”) became our majority stockholder. CBT is no longer our majority stockholder.
 
In August 2007 we acquired the outstanding capital stock of Jupiter Hosting, Inc., a privately held company based in Santa Clara, California, that provides managed-hosting services. We also acquired the assets and assumed certain liabilities of Alabanza, LLC, and Hosting Ventures, LLC (together, “Alabanza”). Alabanza was a provider of dedicated and shared managed hosting services.
 
In September 2007 we acquired the outstanding capital stock of netASPx, Inc., an application-management service provider. In October 2007 we acquired the assets of iCommerce, Inc., a reseller of dedicated hosting services.
 
During fiscal year 2010 we completed two separate asset sales transactions. In February 2010 we sold substantially all of the assets of our netASPx business and in March 2010 we sold the assets associated with two of our primarily co-location data centers.
 
(b)   Principles of Consolidation
 
The accompanying consolidated financial statements include the accounts of NaviSite, Inc., and our wholly owned subsidiaries. All intercompany accounts and transactions have been eliminated.
 
(c)   Use of Estimates
 
The preparation of financial statements in conformity with generally accepted accounting principles requires us 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 that we made include the useful lives of fixed assets and intangible assets, the recoverability of long-lived assets, the collectability of receivables, the determination and valuation of goodwill and acquired intangible assets, the fair value of preferred stock, the determination of revenue and related revenue reserves, the determination of stock-based compensation and the determination of the deferred-tax-valuation allowance.


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Table of Contents

NAVISITE, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
(d)   Cash and Cash Equivalents and Restricted Cash
 
We consider all highly liquid securities with original maturities of three months or less to be cash equivalents. We had restricted cash of $1.4 million and $1.8 million as of July 31, 2010, and July 31, 2009, including $0.2 million that is classified as short-term in our consolidated balance sheet as of July 31, 2010, and included in “Prepaid expenses and other current assets.”
 
At July 31, 2010 and 2009, restricted cash consists of cash-collateral requirements for standby letters of credit associated with several of our facility leases.
 
(e)   Revenue Recognition
 
Revenue, net, consists of monthly fees for application-management services, managed-hosting solutions, co-location and professional services. Reimbursable expenses charged to clients are included in revenue, net and cost of revenue. Application management, managed-hosting solutions and co-location services are billed and recognized as revenue over the term of the contract, generally one to five years. Installation and up-front fees associated with application management, managed-hosting solutions and co-location services are billed at the time that the installation service is provided and recognized as revenue over the longer of the term of the related contract or the expected customer life. The direct and incremental costs associated with installation and setup activities are capitalized and expensed over the term of the related contract. Payments received in advance of providing services are deferred until the period such services are delivered.
 
Revenue from professional services is recognized as services are delivered, for time- and materials-type contracts, and using the percentage-of-completion method, for fixed-price contracts. For fixed-price contracts, progress towards completion is measured by a comparison of the total hours incurred on the project to date to the total estimated hours required upon completion of the project. 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-delivery costs of the contract exceed the estimated revenue that will be generated by the contract. Unbilled accounts receivable represent revenue for services performed that have not yet been billed as of the balance-sheet date. Billings in excess of revenue recognized are recorded as deferred revenue until the applicable revenue-recognition criteria are met.
 
Effective August 1, 2009, we adopted Accounting Standards Update (“ASU”) No. 2009-13, “Multiple-Deliverable Revenue Arrangements,” which amends FASB Accounting Standards Codification (“ASC”) “Topic 605,” “Revenue Recognition.” ASU 2009-13 amends FASB ASC Topic 605 to eliminate the residual method of allocation for multiple-deliverable revenue arrangements, and requires that arrangement consideration be allocated at the inception of an arrangement to all deliverables using the relative selling price method. The ASU also establishes a selling price hierarchy for determining the selling price of a deliverable, which includes (1) vendor-specific objective evidence, if available, (2) third-party evidence, if vendor-specific objective evidence is not available, and (3) estimated selling price, if neither vendor-specific nor third-party evidence is available. Additionally, ASU 2009-13 expands the disclosure requirements related to a vendor’s multiple-deliverable revenue arrangements. This guidance is effective for us on August 1, 2010; however, we have elected to adopt early, as permitted by the guidance. As such, we have prospectively applied the provisions of ASU 2009-13 to all revenue arrangements entered into or materially modified after August 1, 2009.
 
In accordance with ASU 2009-13, we allocate arrangement consideration to each deliverable in an arrangement based on its relative selling price. We determine selling price using vendor-specific objective evidence (“VSOE”), if it exists; otherwise, we use third-party evidence (“TPE”). If neither VSOE nor TPE of selling price exists for a unit of accounting, we use estimated selling price (“ESP”).
 
VSOE is generally limited to the price charged when the same or similar product is sold separately. If a product or service is seldom sold separately, it is unlikely that we can determine VSOE for the product or


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NAVISITE, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
service. We define VSOE as a median price of recent standalone transactions that are priced within a narrow range, as defined by us.
 
TPE is determined based on the prices charged by our competitors for a similar deliverable when sold separately. It may be difficult for us to obtain sufficient information on competitor pricing to substantiate TPE and therefore we may not always be able to use TPE.
 
If we are unable to establish selling price using VSOE or TPE, and the order was received or materially modified after our ASU 2009-13 implementation date of August 1, 2009, we will use ESP in our allocation of arrangement consideration. The objective of ESP is to determine the price at which we would transact if the product or service were sold by us on a standalone basis. Our determination of ESP involves a weighting of several factors based on the specific facts and circumstances of the arrangement. Specifically, we consider the cost to produce or provide the deliverable, the anticipated margin on that deliverable, the selling price and profit margin for similar parts or services, our ongoing pricing strategy and policies, the value of any enhancements that have been built into the deliverable and the characteristics of the varying markets in which the deliverable is sold.
 
We analyze the selling prices used in our allocation of arrangement consideration at a minimum on an annual basis. Selling prices will be analyzed on a more frequent basis if a significant change in our business necessitates a more timely analysis or if we experience significant variances in our selling prices.
 
Each deliverable within a multiple-deliverable revenue arrangement is accounted for as a separate unit of accounting under the guidance of ASU 2009-13 if both of the following criteria are met: (1) the delivered item or items have value to the customer on a standalone basis and (2) for an arrangement that includes a general right of return relative to the delivered item(s), delivery or performance of the undelivered item(s) is considered probable and substantially in our control. We consider a deliverable to have standalone value if we sell this item separately or if the item is sold by another vendor or could be resold by the customer. Further, our revenue arrangements generally do not include a general right of return relative to delivered products.
 
Deliverables not meeting the criteria for being a separate unit of accounting are combined with a deliverable that does meet that criterion. The appropriate allocation of arrangement consideration and recognition of revenue is then determined for the combined unit of accounting.
 
The adoption of ASU 2009-13 did not have a significant impact during fiscal year 2010.
 
(f)   Allowance for Doubtful Accounts
 
We perform initial and periodic credit evaluations of our customers’ financial conditions. We make estimates of the collectability of our accounts receivable 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 creditworthiness (including the customer’s financial performance and its business history), current economic trends and changes in our customers’ payment patterns when evaluating the adequacy of the allowance for doubtful accounts. We specifically reserve for 100% of the balance of customer accounts deemed uncollectible. For all other customer accounts, we reserve as needed based upon management’s estimates of uncollectible amounts based on historical bad debts.
 
(g)   Concentration of Credit Risk
 
Our financial instruments include cash, cash equivalents, restricted cash, accounts receivable, obligations under capital leases, debt agreements, derivative instruments, preferred stock, accounts payable and accrued expenses. As of July 31, 2010 and 2009, the carrying value of cash, cash equivalents, restricted cash, accounts receivable, accounts payable and accrued expenses approximated their fair value because of the short maturity of these instruments. The carrying value of capital lease obligations approximated their fair value, as estimated


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Table of Contents

NAVISITE, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
by using discounted future cash flows based on the Company’s incremental borrowing rates for similar types of borrowing arrangements. The Company notes for purposes of complying with the disclosure requirements of FASB ASC 825, it would be impracticable to accurately determine the fair value of its preferred stock without significant cost to the Company as it does not have the internal expertise to perform these valuations and therefore a third party valuation would be required. See Note 11, Fair Value Measures and Derivative Instruments, for disclosure of the fair value of our debt obligations and derivative instruments.
 
Financial instruments that may subject us to concentrations of credit risk consist primarily of accounts receivable. Concentration of credit risk with respect to trade receivables is limited due to our broad and diverse customer base. No customer accounted for more than 5% of total revenues in fiscal years 2010, 2009 and 2008 or 5% of the total accounts-receivable balance as of July 31, 2010 and 2009.
 
(h)   Comprehensive Income (Loss)
 
Comprehensive income (loss) is defined as the change in equity of a business enterprise during the reporting period from transactions and other events and circumstances from non-owner sources. We record the components of comprehensive income (loss), primarily foreign-currency-translation adjustments, in our consolidated balance sheets as a component of stockholders’ deficit.
 
(i)   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, generally 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 that materially extend the life of an asset are capitalized and depreciated. Upon disposal of an asset, its cost and the related accumulated depreciation are removed from their respective accounts and any gain or loss reflected within “Other income, net,” in our consolidated statements of operations.
 
(j)   Capitalized Software Development Costs
 
The Company capitalizes software development costs incurred after a product’s technological feasibility has been established and before it is available for general use. Amortization of capitalized software costs commences once the software is available for general use and is computed based on the straight-line method over the estimated economic life of the software product of three years. Software development costs qualifying for capitalization was $0.5 million for the fiscal year ended July 31, 2010. The expense recognized in fiscal year 2010 was not significant. There were no software development costs incurred in prior years.
 
(k)   Long-Lived Assets, Goodwill and Other Intangibles
 
We follow the provisions of FASB ASC 360 “Property, Plant and Equipment” (“ASC 360”). ASC 360 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 group may not be recoverable. Recoverability of an asset group to be held and used is measured by a comparison of the carrying amount of the asset group to the undiscounted future net cash flows expected to be generated by the asset group. If such asset group is considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the asset group exceeds its fair value. Assets to be disposed of are reported at the lower of the carrying amount or fair value less cost to sell.


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Table of Contents

NAVISITE, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
We review the valuation of goodwill in accordance with FASB ASC 350 “Intangibles — Goodwill and Other” (“ASC 350”). Under the provisions of ASC 350, 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. In addition to annual testing, 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 is recognized to the extent that the carrying amount of goodwill exceeds its implied fair value. Impairment losses are recognized in operations. Our valuation methodology for assessing impairment requires us to make judgments and assumptions based on historical experience and projections of future operating performance. If these assumptions differ materially from future results, we may record additional impairment charges in the future.
 
(l)   Advertising Costs
 
We charge advertising costs to expense in the period incurred. Advertising expense for the years ended July 31, 2010, 2009 and 2008, were approximately $0.7 million, $0.7 million and $0.7 million, respectively.
 
(m)   Income Taxes
 
Income taxes are accounted for using the asset-and-liability method in accordance with FASB ASC 740 “Income Taxes,” (“ASC 740”). 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, if any, 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 in which the rate change is enacted.
 
(n)   Derivative Financial Instruments
 
Derivative instruments are recorded as either assets or liabilities and measured at fair value. Changes in fair value are recognized currently in earnings, within “Other income, net,” in our consolidated statements of operations. We utilize interest-rate derivatives to minimize the risk related to rising interest rates on a portion of our floating-rate debt and did not qualify to apply hedge accounting. The interest-rate differentials to be received under such derivatives and the changes in the fair value of the instruments are recognized in Other income, net, each reporting period. The principal objectives of the derivative instruments are to minimize the risks and reduce the expenses associated with financing activities. We do not use derivatives financial instruments for trading purposes.
 
(o)   Lease Expense
 
Lease expense for our real estate leases, which generally have escalating lease payments over their terms, is recorded on a straight-line basis over the lease term, as defined in FASB ASC 840, “Leases. The difference between the expense recorded in our consolidated statements of operations and the amount paid is recorded as deferred rent and is included in our consolidated balance sheets. We had deferred rent of $5.8 million and $4.4 million as of July 31, 2010 and 2009, respectively. Included in these amounts are long-term deferred rent balances of $5.4 million and $4.3 million as of July 31, 2010 and 2009, respectively, which amounts are included in the “Other long-term liabilities” caption in our consolidated balance sheets.
 
(p)   Stock-Based Compensation Plans
 
FASB ASC 718, “Compensation — Stock Compensation,” (“ASC 718”) addresses the accounting for share-based payment transactions in which a company receives employee services in exchange for either


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Table of Contents

NAVISITE, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
(i) equity instruments of the company or (ii) liabilities that (A) are based on the fair value of the company’s equity instruments or (B) may be settled by the issuance of such equity instruments. ASC 718 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 our consolidated statement of operations. In March 2005 the SEC issued Staff Accounting Bulletin (“SAB”)  No. 107 regarding its interpretation of SFAS 123(R). SAB No. 107 provides the SEC’s views regarding interpretations of ASC 718 in light of certain SEC rules and regulations and provides guidance related to the valuation of share-based payments for public companies. The interpretive guidance is intended to assist companies in applying the provisions of ASC 718 and investors and users of financial statements in analyzing the information provided.
 
Stock Options
 
The following table summarizes stock-based compensation expense related to employee stock options under ASC 718 for the fiscal years ended July 31, 2010, 2009, and 2008, respectively, and the allocation of such expense.
 
                         
    Years Ended July 31,  
    2010     2009     2008  
    (In thousands)  
 
Cost of revenue
  $ 865     $ 1,052     $ 1,724  
Selling and marketing
    509       457       710  
General and administrative
    545       507       903  
                         
    $ 1,919     $ 2,016     $ 3,337  
                         
 
The fair value of each stock-option grant is estimated on the date of grant using the Black-Scholes Model, (the “Black-Scholes Model”), assuming no expected dividends and the following weighted average assumptions. The weighted average risk-free interest-rate assumption is based on the U.S. Treasury rates as of the month of grant. The expected volatility is based on the historical volatility of our stock price over the expected term of the option. The estimate of the expected life of an option is based on its contractual term and past employee-exercise behavior.
 
                         
    Years Ended July 31,  
    2010     2009     2008  
 
Risk-free interest rate
    1.51 %     1.67 %     3.40 %
Expected volatility
    104.92 %     90.91 %     82.65 %
Expected life (years)
    3.50       2.72       2.50  
Weighted average fair value of options granted
  $ 1.57     $ 0.70     $ 3.21  
 
ASC 718 requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. During the fiscal years ended July 31, 2010, 2009 and 2008, we estimated that 5% of options granted would be forfeited before the end of the first vesting tranche. Forfeitures after the first vesting tranche are not considered to be material.


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Table of Contents

NAVISITE, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
The following table reflects stock-option activity under our equity-incentive plans for the fiscal year ended July 31, 2010.
 
                                 
                Weighted
       
                Average
       
          Weighted
    Remaining
       
    Number
    Average
    Contractual
    Aggregate
 
    of
    Exercise
    Term
    Intrinsic
 
    Shares     Price     (Years)     Value  
                      (Thousands)  
 
Options outstanding, beginning of year
    6,371,203     $ 3.58                  
Granted
    1,889,145     $ 2.26                  
Exercised
    (400,280 )   $ 1.53                  
Forfeited or Expired
    (1,211,574 )   $ 4.56                  
                                 
Options outstanding, July 31, 2010
    6,648,494     $ 3.15       6.24     $ 3,658  
                                 
Options exercisable, July 31, 2010
    4,918,308     $ 3.41       5.16     $ 2,611  
                                 
 
The aggregate intrinsic value of options exercised during the fiscal years ended July 31, 2010, 2009 and 2008, was approximately $0.3 million, $0.1 million and $3.0 million, respectively.
 
As of July 31, 2010, unrecognized stock-based compensation related to stock options was approximately $4.0 million. This cost is expected to be expensed over a weighted average period of 2.81 years.
 
Restricted Stock
 
Restricted stock is shares of common stock that are subject to restrictions on transfer and risk of forfeiture until the fulfillment of specified conditions. Restricted stock is expensed ratably over the term of the restriction period.
 
The following table summarizes stock-based compensation expense related to restricted stock under ASC 718 for the fiscal years ended July 31, 2010, 2009, and 2008, and the allocation of such expense.
 
                         
    Years Ended July 31,  
    2010     2009     2008  
    (In thousands)  
 
Cost of revenue
  $ 30     $ 129     $ 3  
Selling and marketing
    129       66       2  
General and administrative
    690       773       898  
                         
    $ 849     $ 968     $ 903  
                         
 
The fair value of restricted stock is based on the market price of our common stock on the grant date. The total grant-date fair value of restricted stock that vested during the fiscal years ended July 31, 2010 and 2009, was approximately $0.7 million and $0.8 million, respectively. As of July 31, 2010, there was approximately $1.5 million of total unrecognized compensation expense related to restricted stock to be recognized over a weighted average period of 4.17 years.
 
Employee Stock Purchase Plan
 
Under our 1999 Employee Stock Purchase Plan (the “ESPP”), employees who elect to participate instruct the Company to withhold a specified amount through payroll deductions during the offering period of six months. On the last business day of each offering period, the amount withheld is used to purchase newly issued shares of our common stock at an exercise price equal to 85% of the lower of the market price on the first or last business day of the offering period.


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Table of Contents

NAVISITE, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Stock-compensation expense for the ESPP is recognized over the offering period. Each offering period consists of six months.
 
The following table summarizes stock-based compensation expense related to the ESPP under ASC 718 for the fiscal years ended July 31, 2010, 2009 and 2008, and the allocation of such expense.
 
                         
    Years Ended July 31,  
    2010     2009     2008  
    (In thousands)  
 
Cost of revenue
  $ 128     $ 93     $ 67  
Selling and marketing
    44       34       34  
General and administrative
    62       31       29  
                         
    $ 234     $ 158     $ 130  
                         
 
We issued 359,803 and 433,901 shares of common stock under the ESPP in fiscal years ended July 31, 2010 and 2009, respectively. As of July 31, 2010, there was approximately $85,000 of unrecognized compensation expense related to the offering periods in progress at July 31, 2010. The expense is to be recognized over a period of five months.
 
(q)   Basic and Diluted Net Loss per Common Share
 
Basic net loss per share is computed by dividing net loss attributable to common shareholders 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. We utilize the treasury-stock method for options, warrants and non-vested shares and the “if-converted” method for convertible preferred stock and notes, unless such amounts are anti-dilutive.
 
The following table sets forth common-stock equivalents that are not included in the calculation of diluted net loss per share available to common stockholders because to do so would be anti-dilutive for the periods indicated.
 
                         
    Years Ended July 31,  
    2010     2009     2008  
 
Common-stock options
    685,389       105,765       1,943,861  
Common-stock warrants
    1,195,184       1,188,783       1,197,992  
Restricted stock
    87,082       134,222       151,604  
Series A convertible preferred stock
    4,155,003       3,724,844       3,356,202  
ESPP
                28,119  
                         
Total
    6,122,658       5,153,614       6,677,778  
                         
 
(r)  Segment Reporting
 
We currently operate in one segment, managed-IT services. Our chief operating decision-maker reviews financial information at a consolidated level.


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Table of Contents

NAVISITE, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Product and Services Data:
 
We derive our revenue from managed-IT services, professional services, and America’s Job Exchange, our employment-services website (“AJE”). The following is a summary of revenue for the years ended July 31, 2010, 2009 and 2008:
 
                         
    Years Ended July 31,  
    2010     2009     2008  
    (In thousands)  
 
Managed-IT services
  $ 121,449     $ 118,559     $ 112,341  
Professional services
    2,416       5,288       19,480  
AJE
    2,282       1,532       313  
                         
Total revenue
  $ 126,147     $ 125,379     $ 132,134  
                         
 
Geographic Data
 
Total assets located outside of the United States were 5% and 10% of total assets as of July 31, 2010 and 2009, respectively. Long-lived assets located outside of the United States were 2% and 9% of total long-lived assets at July 31, 2010 and 2009, respectively, or $2.2 million and $11.9 million.
 
Revenue for the years ended July 31, 2010, 2009 and 2008 from customers located in the United Kingdom, was 11%, 11% and 9%, respectively, of total revenue after taking into consideration the impact of discontinued operations in all three years. In the following table, revenue is determined based on the contracting location:
 
                         
    Years Ended July 31,  
    2010     2009     2008  
    (In thousands)  
 
United States
  $ 112,640     $ 111,436     $ 120,340  
All other
    13,507       13,943       11,794  
                         
Total revenue
  $ 126,147     $ 125,379     $ 132,134  
                         
 
Other than the United States and the United Kingdom, no individual country represented greater than 10% of total revenues in any year.
 
(s)  Recent Accounting Pronouncements
 
Effective August 1, 2009, we adopted ASU No. 2009-13, “Multiple-Deliverable Revenue Arrangements” (“ASU 2009-13”), which amends FASB ASC “Topic 605,” “Revenue Recognition.” ASU 2009-13 amends the FASB ASC to eliminate the residual method of allocation for multiple-deliverable revenue arrangements, and requires that arrangement consideration be allocated at the inception of an arrangement to all deliverables using the relative selling price method. The ASU also establishes a selling price hierarchy for determining the selling price of a deliverable, which includes (1) vendor-specific objective evidence, if available, (2) third-party evidence, if vendor-specific objective evidence is not available, and (3) estimated selling price, if neither vendor-specific nor third-party evidence is available. Additionally, ASU 2009-13 expands the disclosure requirements related to a vendor’s multiple-deliverable revenue arrangements. This guidance is effective for us on August 1, 2010; however, we have elected to early adopt as permitted by the guidance. As such, we have prospectively applied the provisions of ASU 2009-13 to all revenue arrangements entered into or materially modified after August 1, 2009. During fiscal year ending July 31, 2010 the adoption of ASU 2009-13 did not have a significant impact.
 
In November 2008 the SEC issued for comment a proposed roadmap regarding the potential use by U.S. issuers of financial statements prepared in accordance with International Financial Reporting Standards


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Table of Contents

NAVISITE, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
(“IFRS”). IFRS is a comprehensive series of accounting standards published by the International Accounting Standards Board (the “IASB”). Under the proposed roadmap, in fiscal 2015 we could be required to prepare financial statements in accordance with IFRS. The SEC will make a determination in 2011 regarding the mandatory adoption of IFRS. We are currently assessing the impact that this change would have on our consolidated financial statements, and we will continue to monitor the development of the potential implementation of IFRS.
 
Effective August 1, 2009, we adopted FASB Staff Position (“FSP”) No. 142-3, “Determination of the Useful Life of Intangible Assets,” which was primarily codified into “Topic 350” — “Intangibles — Goodwill and Other” (“FASB ASC 350”) in the FASB ASC. This guidance amends the factors that should be considered in developing renewal or extension assumptions used to determine the estimated useful life of a recognized intangible asset and requires enhanced related disclosures. FASB ASC 350 improves the consistency between the useful life of a recognized intangible asset and the period of expected cash flows used to measure the fair value of the asset. This guidance must be applied prospectively to all intangible assets acquired as of and subsequent to fiscal years beginning after December 15, 2008. This guidance became effective for us on August 1, 2009. Although future transactions involving intangible assets may be affected by this guidance, it did not impact our financial position or results of operations as we did not acquire any intangible assets during fiscal year 2010.
 
Effective August 1, 2009, we adopted FSP No. 107-1 and APB Opinion 28-1, “Interim Disclosures about Fair Value of Financial Instruments,” which is now part of FASB ASC 825, “Financial Instruments” (“FASB ASC 825”). FASB ASC 825 requires disclosures about fair value of financial instruments for interim and annual reporting periods and is effective for interim reporting periods ending after June 15, 2009. Such adoption did not have a material impact on our disclosures, financial position or results of operations.
 
In August 2009, the FASB issued ASU No. 2009-05, “Measuring Liabilities at Fair Value” (“ASU 2009-05”), which amends ASC “Topic 820”, “Fair Value Measurements and Disclosures.” ASU 2009-05 provides clarification and guidance regarding how to value a liability when a quoted price in an active market is not available for that liability. Changes to the FASB ASC as a result of this update were effective for us on November 1, 2009. The adoption of these changes did not have a material effect on our financial position or results of operations.
 
(t)  Foreign Currency
 
The functional currencies of our international 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 the corresponding period for revenue, cost of revenue and expenses. Translation gains and losses are deferred and accumulated as a separate component of stockholders’ deficit under “Accumulated other comprehensive income (loss).”
 
(3)   Reclassifications
 
Certain fiscal-year 2009 and 2008 amounts have been reclassified to conform to the fiscal-year 2010 financial-statement presentation. During fiscal year 2010, the historical results of operations for our netASPx business and the two co-location data centers sold during fiscal year 2010 have been reclassified to discontinued operations for all periods presented in our consolidated statements of operations.
 
(4)   Subsequent Event
 
Effective July 2009, we adopted the provisions of the FASB-issued SFAS No. 165, Subsequent Events,  which is now part of FASB ASC 855, “Subsequent Events” (“FASB ASC 855”). FASB ASC 855 establishes general standards of accounting for, and disclosure of, events that occur after the balance-sheet date but before financial statements are issued or are available to be issued. In accordance with FASB ASC 855, we have evaluated subsequent events through the date of issuance of our consolidated financial statements and have determined that we did not have any material subsequent events.


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Table of Contents

NAVISITE, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
(5)   Discontinued Operations
 
On February 19, 2010, we entered into an Asset Purchase Agreement (the “February 2010 Asset Purchase Agreement”) with Velocity Technology Solutions II, Inc. (“Velocity”), pursuant to which we sold substantially all of the assets related to our netASPx business, which is composed solely of the Lawson and Kronos application management and consulting business and the application management of and consulting with respect to ancillary software applications which provide additional functionality, features and/or benefits to the extent such ancillary software applications are used in conjunction with Lawson and/or Kronos applications.
 
The purchase price for the assets sold was $56.0 million and is subject to further adjustment pursuant to adjustments set forth in the February 2010 Asset Purchase Agreement. Velocity also assumed certain liabilities, including accounts payable, customer credits and liabilities with respect to certain agreements assumed. The sale resulted in a gain of $18.8 million on disposal of the discontinued operations. The gain was primarily comprised of $53.7 million in net cash proceeds inclusive of a working capital adjustment, and estimated realizable portion of certain escrow funds, net of transaction costs, offset by net tangible assets of the business of $6.4 million and write-off of specific goodwill and intangible assets attributable to the netASPx business of $17.6 million and $10.9 million, respectively. On August 18, 2010, we received notice from Velocity that they were making a claim against the February 2010 Asset Purchase Agreement and instructed the escrow agent to withhold distribution of the $4.0 million held in escrow until such claim is resolved. We believe that this claim is without merit and intend to vigorously defend against the claim.
 
On March 31, 2010, we entered into an Asset Purchase Agreement (the “March 2010 Asset Purchase Agreement”) with Virtustream, Inc. and Virtustream DCS, LLC (together, “Virtustream”), pursuant to which we sold substantially all of the assets of two co-location data centers; one located in San Francisco, California and one located in Vienna, Virginia for a purchase price of $5.4 million. The sale of these two data centers resulted in a gain of $1.7 million. The gain was primarily comprised of cash proceeds and escrow funds, net of transaction costs, of $4.9 million offset by net tangible assets of the business of $0.4 million and the write-off of $2.8 million of goodwill.
 
Under both the February 2010 Asset Purchase Agreement and the March 2010 Asset Purchase Agreement, as of July 31, 2010, we remain liable for up to $26.2 million, subject to the new tenants defaulting on the leases. Under certain defined conditions, such obligation may be removed in the future. There was no default by the new tenant as of July 31, 2010.
 
In accordance with ASC 205-20, “Discontinued Operations”, both the netASPx business and the two data center operations have been reflected as discontinued operations for all periods presented in the Company’s consolidated statements of operations. Accordingly, the revenue, costs of revenue, expenses, applicable interest expense and income taxes have been broken out separately for these assets to determine the loss from discontinued operations from these sales. Operating results related to these discontinued operations for the fiscal years ended July 31, 2010, 2009 and 2008 were as follows (in thousands):
 
                         
    July 31,
    July 31,
    July 31,
 
    2010     2009     2008  
 
Revenue
  $ 14,334     $ 27,293     $ 22,745  
Cost of revenue
    12,501       21,223       16,086  
                         
Gross profit
    1,833       6,070       6,659  
Operating expenses
    1,069       1,325       1,446  
Interest expense
    3,427       5,523       4,273  
                         
Income (loss) from discontinued operations before income taxes
    (2,663 )     (778 )     940  
Income taxes
    (941 )     (654 )     (682 )
                         
Income (loss) from discontinued operations, as reported
  $ (3,604 )   $ (1,432 )   $ 258  
                         


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NAVISITE, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Interest expense has been allocated to discontinued operations based upon the net amount of debt repaid as a result of the asset sales using the interest rate in effect during the reported periods.
 
The Company has elected not to reflect the discontinued operations separately within the consolidated statements of cash flows. As of July 31, 2010, all assets and liabilities related to these discontinued operations were eliminated from our balance sheet. The following is a summary of the financial position of these discontinued operations as of July 31, 2009:
 
         
    July 31,
 
    2009  
    (In thousands)  
 
Current assets
  $ 3,860  
Property and equipment, net
    3,851  
Other long term assets
    31,636  
         
Total assets
  $ 39,347  
         
Current liabilities
    2,872  
Non-current liabilities
    1,661  
         
Total liabilities
  $ 4,533  
         
Net assets of discontinued operations
  $ 34,814  
         
 
(6)   Property and Equipment
 
Property and equipment consisted of the following:
 
                 
    July 31,  
    2010     2009  
    (In thousands)  
 
Office furniture and equipment
  $ 4,085     $ 4,208  
Computer equipment
    89,969       75,766  
Software licenses
    17,289       15,798  
Leasehold improvements
    14,068       25,838  
                 
      125,411       121,610  
Less: Accumulated depreciation and amortization
    (95,497 )     (89,562 )
                 
Property and equipment, net
  $ 29,914     $ 32,048  
                 
 
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 the life of the license; and leasehold improvements, the lesser of the lease term and the asset’s estimated useful life.


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NAVISITE, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Property and equipment held under capital leases, which are classified primarily as computer equipment and leasehold improvements above, was as follows:
 
                 
    July 31,  
    2010     2009  
    (In thousands)  
 
Computer equipment
  $ 29,699     $ 20,637  
Leasehold improvements
          12,119  
                 
Total cost
  $ 29,699     $ 32,756  
Accumulated depreciation and amortization
    (16,466 )     (15,324 )
                 
    $ 13,233     $ 17,432  
                 
 
The estimated useful lives of assets held under capital leases in circumstances in which the lease does not transfer ownership of the property by the end of the lease term or contains a bargain purchase option are determined in a manner consistent with our normal depreciation policy except that the period of amortization is the lease term.
 
During fiscal year ended July 31, 2010, we signed a lease amendment to shorten the lease term on one of our data centers from 10-years to 7-years which resulted in a change in the accounting treatment for this lease from a capital lease to an operating lease. As a result of this lease amendment, our capital lease obligations were reduced by $10.5 million and the corresponding leasehold improvement balances declined $9.4 million from the reported balances as of July 31, 2009. See additional discussion regarding this matter in footnote 17, Related-Party Transactions.
 
During fiscal year ended July 31, 2010, we sold assets associated with three data centers thereby reducing property and equipment, net by $3.6 million. See additional discussion regarding the sale of these data centers in footnote 5, Discontinued Operations.
 
(7)   Intangible Assets
 
Intangible assets, net, consist of the following:
 
                         
    July 31, 2010  
    Gross Carrying
    Accumulated
    Net Carrying
 
    Amount     Amortization     Amount  
    (In thousands)  
 
Customer lists
  $ 29,812     $ (24,667 )   $ 5,145  
Customer-contract backlog
    3,400       (3,400 )      
Developed technology
    3,140       (2,046 )     1,094  
Vendor contracts
    700       (700 )      
Trademarks
    670       (332 )     338  
Non-compete agreements
    206       (204 )     2  
                         
Intangible assets, net
  $ 37,928     $ (31,349 )   $ 6,579  
                         
 


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NAVISITE, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
                         
    July 31, 2009  
    Gross Carrying
    Accumulated
    Net Carrying
 
    Amount     Amortization     Amount  
    (In thousands)  
 
Customer lists
  $ 39,392     $ (26,498 )   $ 12,894  
Customer-contract backlog
    14,600       (7,619 )     6,981  
Developed technology
    3,140       (1,506 )     1,634  
Vendor contracts
    700       (637 )     63  
Trademarks
    670       (220 )     450  
Non-compete agreements
    206       (135 )     71  
                         
Intangible assets, net
  $ 58,708     $ (36,615 )   $ 22,093  
                         
 
Intangible-asset amortization expense for the years ended July 31, 2010, 2009 and 2008, aggregated $4.6 million, $7.2 million and $7.9 million, respectively. During fiscal years 2010 and 2009, we adjusted the intangible assets and accumulated amortization by $1.6 million and $0.3 million, respectively, to reflect the disposal of acquired intangibles in each year. Excluding the intangible-asset amortization expense related to discontinued operation, intangible-asset amortization expense for the years ended July 31, 2010, 2009 and 2008 aggregated $2.7 million, $3.8 million and $4.9 million, respectively. In February 2010, we sold substantially all of the assets related to our netASPx business, which resulted in an adjustment to our reported intangibles assets of approximately $10.9 million. Intangible assets are being amortized over estimated useful lives ranging from two to eight years.
 
Amortization expense related to intangible assets for the next five years is as follows:
 
         
Year Ending July 31,
   
    (In thousands)
 
2011
  $ 2,538  
2012
  $ 2,393  
2013
  $ 903  
2014
  $ 726  
2015
  $ 19  
 
(8)   Goodwill
 
The following table details the carrying amount of goodwill for the fiscal years ended July 31:
 
                         
    2010     2009     2008  
    (In thousands)  
 
Goodwill as of August 1
  $ 66,566     $ 66,683     $ 43,159  
Acquired goodwill
                23,524  
Adjustments to goodwill
    (20,377 )     (117 )      
                         
Goodwill as of July 31
  $ 46,189     $ 66,566     $ 66,683  
                         
 
Goodwill acquired during the fiscal year ended July 31, 2008, was related to our acquisitions of Jupiter, Alabanza, netASPx and iCommerce. Goodwill was adjusted during fiscal year 2009, reflecting the finalization of purchase-accounting reserves made within one year of the acquisition date. During the fiscal year ended July 31, 2010, we sold substantially all of the assets related to our netASPx business and two co-location data centers, which resulted in a reduction of our reported goodwill of approximately $17.6 million and $2.8 million, respectively.

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NAVISITE, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
(9)   Accrued Expenses
 
Accrued expenses consist of the following:
 
                 
    July 31,  
    2010     2009  
    (In thousands)  
 
Accrued payroll, benefits and commissions
  $ 4,359     $ 4,086  
Accrued legal
    151       636  
Accrued accounts payable
    4,965       2,408  
Accrued sales, use, property and miscellaneous taxes
    990       421  
Accrued other
    1,748       2,271  
                 
    $ 12,213     $ 9,822  
                 
 
(10)   Debt
 
Debt consists of the following:
 
                 
    July 31,
    July 31,
 
    2010     2009  
    (In thousands)  
 
Total term loan
  $ 49,152     $ 106,700  
Other debt
    4,024       10,057  
                 
Total debt
    53,176       116,757  
Less current portion, term loan, revolver and other debt
    4,150       10,603  
                 
Long-term term loan
  $ 49,026     $ 106,154  
                 
 
(a)  Senior Secured Credit Facility
 
In June 2007 we entered into a senior secured credit agreement (the “Credit Agreement”) with a syndicated lending group. The Credit Agreement consisted of a six-year single-draw term loan (the “Term Loan”) totaling $90.0 million and a five-year $10.0 million revolving-credit facility (the “Revolver”). Proceeds from the Term Loan were used to pay our obligations under the Silver Point Debt (which we describe in subsection (b) below), to pay fees and expenses totaling approximately $1.5 million related to the closing of the Credit Agreement, to provide financing for data-center expansion (totaling approximately $8.7 million) and for general corporate purposes. Borrowings under the Credit Agreement were guaranteed by the Company and certain of its subsidiaries.
 
Under the Term Loan we are required to make principal amortization payments during the six-year term of the loan in amounts totaling $0.9 million per annum, paid quarterly on the first day of our fiscal quarters. In June 2013 the balance of the Term Loan becomes due and payable. The outstanding principal under the Credit Agreement is subject to prepayment in the case of an Event of Default, as defined in the Credit Agreement. In addition, amounts outstanding under the Credit Agreement are subject to mandatory prepayment in certain cases, including, among others, a change in control of the Company, the incurrence of new debt and the issuance of equity of the Company. In the case of a mandatory prepayment resulting from a debt issuance, 100% of the proceeds must be used to prepay amounts owed under the Credit Agreement. In the case of an equity offering, we are entitled to retain the first $5.0 million raised and must prepay amounts owed under the Credit Agreement with 100% of any equity-offering proceeds that exceed $5.0 million.
 
Amounts outstanding under the initial Credit Agreement bore interest at either (a) the LIBOR rate plus 3.5% or, at our option, (b) the Base Rate, as defined in the Credit Agreement, plus the Federal Funds Effective


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Table of Contents

NAVISITE, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Rate plus 0.5%. Upon the attainment of a Consolidated Leverage Ratio, as defined, of no greater than 3:1, the interest rate under the LIBOR option can decrease to LIBOR plus 3.0%. Interest becomes due and is payable quarterly in arrears. The Credit Agreement requires us to maintain interest-rate cap to minimize exposure to interest-rate fluctuations on an aggregate notional principal amount of 50% of amounts borrowed under the Term Loan. See Note 11.
 
The Credit Agreement requires us to maintain certain financial and non-financial covenants. Financial covenants include a minimum fixed-charge-coverage ratio, a maximum total-leverage ratio and an annual capital-expenditure limitation. At July 31, 2007, we had exceeded the maximum allowable annual capital expenditures under the terms of the Credit Agreement for the fiscal year ended July 31, 2007. In September 2007, in connection with an amendment to the Credit Agreement that waived the violation as of July 31, 2007, we received an increase in the maximum allowable annual capital expenditures for the fiscal year ended July 31, 2007. Non-financial covenants include restrictions on our ability to pay dividends, to make investments, to sell assets, to enter into merger or acquisition transactions, to incur indebtedness or liens, to enter into leasing transactions, to alter our capital structure and to issue equity. In addition, under the Credit Agreement, we are allowed to borrow, through one or more of our foreign subsidiaries, up to $10.0 million to finance data-center expansion in the United Kingdom.
 
With very limited exceptions, the Credit Agreement does not allow the Company to authorize, pay or declare any dividends to any person. Under the Credit Agreement, as amended, the only dividends the Company is allowed to declare or pay are: (i) to a wholly-owned subsidiary; (ii) to the Company to repurchase or redeem certain capital stock of the Company held by officers, directors or employees upon their death, disability, retirement or termination; (iii) to redeem or repurchase our Series A Convertible Preferred Stock in accordance with the terms thereof and subject to certain exceptions; and (iv) to issue payment-in-kind dividends on the Series A Convertible Preferred Stock in accordance with the terms thereof.
 
In August 2007 we entered into Amendment, Waiver and Consent Agreement No. 1 to the Credit Agreement (the “Amendment”). The Amendment permitted us (a) to use approximately $8.7 million of cash originally borrowed under the Credit Agreement, which amount was restricted for data-center expansion to partially fund the acquisition of Jupiter and Alabanza, and (b) to issue up to $75.0 million of indebtedness, so long as such indebtedness is unsecured, requires no amortization payment and becomes due or payable no earlier than 180 days after the maturity date of the Credit Agreement in June 2013.
 
In September 2007 we entered into an Amended and Restated Credit Agreement (the “Amended Credit Agreement”). The Amended Credit Agreement provided us with an incremental $20.0 million in term-loan borrowings and amended the rate of interest to LIBOR plus 4.0%, with a step-down to LIBOR plus 3.5% upon attainment of a 3:1 leverage ratio. All other terms of the Credit Agreement remained substantially the same. We recorded a loss on debt extinguishment of approximately $1.7 million for the six months ended January 31, 2008, to reflect this extinguishment of the Credit Agreement, in accordance with FASB ASC 470-50 “Debt — Modifications and Extinguishments.”
 
In January 2008 we entered into Amendment, Waiver and Consent Agreement No. 3 to the Amended Credit Agreement (the “January Amendment”). The January Amendment amended the definition of Permitted UK Datasite Buildout Indebtedness (as that term is defined in the Amended Credit Agreement) to total $16.5 million, as compared to $10.0 million, and requires the reduction of the $16.5 million to no less than $10.0 million as such indebtedness is repaid as to principal.
 
In June 2008 we entered into Amendment and Consent Agreement No. 4 to the Amended Credit Agreement (the “June Amendment”). The June Amendment (i) amended the definition of Permitted UK Datasite Buildout Indebtedness (as that term is defined in the Amended Credit Agreement) to total $33 million, as compared to $16.5 million, (ii) increased to $20 million the maximum amount of contingent obligations


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NAVISITE, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
relating to all leases for any period of 12 months and (iii) increased the rate of interest to either (x) LIBOR plus 5.0% or (y) the Base Rate, as defined in the Amended Credit Agreement, plus 4.0%.
 
At July 31, 2008, we were not in compliance with our financial covenants of leverage, fixed charges and annual capital expenditures. In October 2008 we entered into Amendment, Waiver and Consent Agreement No. 5 to the Amended Credit Agreement (the “October Amendment”), which waived these violations as of July 31, 2008. In addition, the October Amendment (i) increased the rate of interest to either (x) LIBOR plus 6% or (y) the Base Rate, as defined in the Amended Credit Agreement, plus 5%, (ii) added a 2% accruing PIK interest until the leverage ratio has been lowered to 3:1, (iii) changed the excess cash flow sweep to 75% to be performed quarterly, (iv) required certain settlement and asset sale proceeds to be used for debt repayment, (v) modified certain financial covenants for future periods, and (vi) required a payment to the lenders of 3% the outstanding term and revolving loans if a leverage ratio of 3:1 is not achieved by January 31, 2010.
 
In February 2010 we entered into Amendment, Waiver and Consent Agreement No. 7 (“Amendment No. 7”). Amendment No. 7 provided for certain required waivers with respect to the security interest in the assets of netASPx transferred post sale and modified the definition of fixed charges to exclude certain prior capital expenditures related to the netASPx business and other contemplated asset sales as well as excluded from our third quarter fixed charge covenant calculation and the purchase of capital equipment to support a recent new customer contract.
 
In April 2010, we entered into Amendment and Consent Agreement No. 8 (“Amendment No. 8”). Amendment No. 8, among other things, (i) reduced the Revolver to $9.0 million and provides for a further reduction of the Revolver to $8.0 million upon the occurrence of certain asset sales, (ii) increased the commitment fee from 0.50% to 0.75%, (iii) changed the excess cash flow sweep to be performed on a semi-annual basis, (iv) modified the amount of asset-sale proceeds to be used for debt repayment, (v) added a prepayment premium to be paid in connection with certain mandatory prepayments in an amount equal to (x) 0.75% (if prepayment is made on or prior to September 30, 2010) and (y) 0.50% (if prepayment is made after September 30, 2010 and on or prior to April 30, 2011) of the aggregate principal amount of the loans repaid plus the amount of the revolving commitments terminated, (vi) modified certain financial covenants for future periods and (vii) added two new financial covenants related to minimum EBITDA and minimum liquidity.
 
At July 31, 2010, $53.2 million was outstanding under the Amended Credit Agreement, of which $4.0 million was outstanding under the Revolver. We were in compliance with the covenants under the Credit Agreement, as amended, as of July 31, 2010.
 
(b)  Term Loans and Revolving Credit Facilities
 
In April 2006 we entered into a senior secured term loan and senior secured revolving-credit facility, (the “Silver Point Debt”) with Silver Point Finance, LLC and its affiliates (“Silver Point”). The term loan consisted of a five-year single-draw term loan in the aggregate amount of $70 million.
 
In connection with the Silver Point borrowing, we issued two warrants to purchase an aggregate amount of 3,514,933 shares of our common stock at an exercise price of $0.01 per share. These warrants will expire on April 11, 2016. The warrants were valued using the Black-Scholes Model and were recorded in our consolidated balance sheet as a discount to the loan amount of $9.1 million at inception and were being amortized into interest expense over the five-year term of the credit facility.
 
In February 2007 we entered into Amendment No. 4 and Waiver to Credit and Guaranty Agreement (the “SP Amendment”) with Silver Point. In February 2007, in connection with the SP Amendment, we 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 Model, recorded in our consolidated


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NAVISITE, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
balance sheet at inception as a discount to the loan amount of $2.2 million and were being amortized, as an interest expense, over the five-year term of the credit facility.
 
The fair value of the warrants issued in connection with the issuance of the debt to Silver Point Debt (noted above) was determined using the Black-Scholes Model with the following assumptions:
 
                 
    Warrant Issue Date:
    April 2006   February 2007
 
Expected life (in years)
    10       10  
Expected volatility
    101.21 %     105.96 %
Expected dividend rate
    0.00 %     0.00 %
Risk-free interest rate
    4.44 %     4.58 %
 
The proceeds of the borrowings from Silver Point in April 2006 and February 2007 were allocated to the debt and the warrants by measuring each component’s relative fair value. The debt agreements were entered into at market value, and, as such, the difference between the total proceeds received and the fair value of the warrants represented both the residual and relative fair value of the debt. Therefore, the debt and equity components of the arrangement were recorded at their relative fair values.
 
The fair values of $9.1 million and $2.2 million for the warrants issued in April 2006 and February 2007, respectively, were recorded as additional paid-in capital and as discounts to the loan amount in our consolidated balance sheets upon issuance. The loan-discount amounts were being amortized into interest expense over the five-year term of the credit facility.
 
The Silver Point Debt was paid in full in June 2007, as discussed above in clause (a).
 
(c)  Notes Payable to the AppliedTheory Estate
 
As part of Clearblue Technologies Management, Inc.’s acquisition of certain AppliedTheory assets, Clearblue Technologies Management, Inc. made and issued two unsecured promissory notes totaling $6.0 million (the “Estate Liability”) due to the AppliedTheory estate in June 2006. The Estate Liability bore interest at 8% per annum, which is due and payable annually. In July 2006 we 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. At July 31, 2007, we had approximately $0.5 million in accrued interest related to these notes. In June 2008 the settlement agreement was approved by the bankruptcy court, the $5.0 million was released from escrow and we recognized a gain on the settlement of $1.6 million. Clearblue Technologies Management, Inc., a former subsidiary of CBT, was purchased by Navisite, Inc. in December 2002.
 
(11)   Fair Value Measures and Derivative Instruments
 
In October 2007, in connection with the execution of the Amended Credit Agreement in September 2007, (see Note 10), we purchased an interest-rate cap, totaling $10.0 million of notional amount, as the Amended Credit Agreement required that we hedge a minimum notional amount of 50% of all Indebtedness, as defined in the Amended Credit Agreement. In March and July 2009, we amended the interest-rate cap previously purchased to increase the notional amount by $3.0 million and $3.0 million, respectively, to a total of $16.0 million. As of July 31, 2010 and 2009, the fair value of these interest-rate derivatives (representing a notional amount of approximately $47.8 million and $55.8 million at July 31, 2010 and 2009, respectively) was approximately $8,000 and $93,000, respectively, which is included in “Other Assets” in our consolidated balance sheets. The change in fair value during fiscal year 2010 of approximately $85,000 was charged to Other income, net, during the fiscal year ended July 31, 2010.


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Table of Contents

NAVISITE, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Fair value of 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. We have utilized interest-rate derivatives to mitigate the risk of rising interest rates on a portion of our floating-rate debt and have not qualified for 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 is recognized over the life of the agreements as Other income (expense), net. The principal objectives of the derivative instruments are to minimize the risks associated with financing activities. We do not use derivative financial instruments for trading purposes.
 
Effective August 1, 2008, we adopted SFAS 157 “Fair Value Measurements,” which establishes a framework for measuring fair value and requires enhanced disclosures about fair-value measurements. SFAS 157 requires disclosure about how fair value is determined for assets and liabilities and establishes a hierarchy for which these assets and liabilities must be grouped, based on significant levels of inputs as follows:
 
Level 1  quoted prices in active markets for identical assets or liabilities;
 
Level 2  quoted prices in active markets for similar assets and liabilities and inputs that are observable for the asset or liability; and
 
Level 3  unobservable inputs, such as discounted-cash-flow models or valuations.
 
The determination of where assets and liabilities fall within this hierarchy is based upon the lowest level of input that is significant to the fair-value measurement. Our interest-rate derivatives are required to be measured at fair value on a recurring basis, and where they are classified within the hierarchy, as of July 31, 2010 and 2009 are as follows:
 
                                 
    Level 1     Level 2     Level 3     Total  
 
Interest-rate derivatives as of July 31, 2010
        $ 8,000           $ 8,000  
                                 
Interest-rate derivatives as of July 31, 2009
        $ 93,000           $ 93,000  
                                 
 
Interest-rate derivatives.  The initial fair values of these instruments were determined by our counterparties, and we continue to value these securities based on quotes from our counterparties. Our interest-rate derivative is classified within Level 2, as the valuation inputs are based on quoted prices and market-observable data. The change in fair value for the fiscal years ended July 31, 2010, 2009 and 2008, was a loss of approximately $85,000, $73,000 and $91,000, respectively.
 
Fair value of non-derivative financial instruments.  Long-term debt is carried at amortized cost. However, we are required to estimate the fair value of long-term debt under FASB ASC 820, “Fair Value Measurements and Disclosures.” The fair value of the term loan was determined using current trading prices obtained from indicative market data on the term debt.
 
A summary of the estimated fair value of our financial instruments as of July 31, 2010 and 2009 follows (in thousands):
 
                                 
    2010     2009  
    Carrying Value     Fair Value     Carrying Value     Fair Value  
 
Term loan — short term
  $ 126     $ 121     $ 546     $ 368  
Term loan — long term
    49,026       47,065       106,154       71,654  
                                 
Total term loan
  $ 49,152     $ 47,186     $ 106,700     $ 72,022  
Revolver
  $ 4,024     $ 3,742     $ 10,018     $ 6,261  


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NAVISITE, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
(12)   Commitments and Contingencies
 
Minimum annual rental commitments under operating leases and other commitments are, as of July 31, 2010, as follows:
 
                                                         
          Less than
                            After
 
Description
  Total     1 Year     Year 2     Year 3     Year 4     Year 5     Year 5  
    (In thousands)  
 
Short/long-term debt
  $ 53,176     $ 4,150     $ 505     $ 48,521     $     $     $  
Interest on debt(a)
    13,032       4,562       4,533       3,937                    
Capital leases
    9,194       5,484       3,340       370                    
Operating leases(b)
    9,692       2,046       2,107       2,170       2,235       1,134        
Bandwidth commitments
    1,135       684       318       122       11              
Property leases(b)(c)
    60,058       7,802       7,651       7,616       7,611       7,688       21,690  
                                                         
    $ 146,287     $ 24,728     $ 18,454     $ 62,736     $ 9,857     $ 8,822     $ 21,690  
                                                         
 
 
(a) Interest on debt assumes that LIBOR is fixed at 3.15%, as this is the minimum interest required under our credit agreement.
 
(b) Future commitments denominated in foreign currency are fixed at the exchange rates as of July 31, 2010.
 
(c) Amounts exclude certain common area maintenance and other property charges that are not included within the lease payment.
 
Total bandwidth expense for bandwidth commitments was $4.2 million, $4.4 million, and $5.6 million for the fiscal years ended July 31, 2010, 2009 and 2008, respectively.
 
Total rent expense for property leases was $10.8 million, $11.2 million and $11.1 million for the fiscal years ended July 31, 2010, 2009 and 2008, respectively.
 
With respect to the property-lease commitments listed above, certain cash amounts are restricted pursuant to terms of lease agreements with landlords. At July 31, 2010, restricted cash of approximately $1.4 million related to these lease agreements consisted of certificates of deposit and a treasury note and are recorded at cost, which approximates fair value.
 
(b)  Legal Matters
 
IPO Securities Litigation
 
In 2001, lawsuits naming more than 300 issuers and over 50 investment banks were filed in the U.S. District Court for the Southern District of New York (the “Court”) for all pretrial purposes (the “IPO Securities Litigation”). Between June 13, 2001, and July 10, 2001, five purported class-action lawsuits seeking monetary damages were filed against us; Joel B. Rosen, our then-chief executive officer; Kenneth W. Hale, our then-chief financial officer; Robert E. Eisenberg, our then president; and the underwriters of our initial public offering of October 22, 1999. On September 6, 2001, the Court consolidated the five similar cases and a consolidated, amended complaint was filed on April 19, 2002 on behalf of all persons who acquired shares of our common stock between October 22, 1999, and December 6, 2000 (the “Class-Action Litigation”), 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. The plaintiffs uniformly alleged that all defendants, including the NaviSite Defendants, violated 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 in the offering without disclosing to investors that some of the underwriters, including the


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NAVISITE, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
lead underwriters, allegedly had solicited and received 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. Plaintiffs did not specify the amount of damages they sought in the Class-Action Litigation. On April 2, 2009, a stipulation and agreement of settlement among the plaintiffs, issuer defendants (including any present or former officers and directors) and underwriters was submitted to the Court for preliminary approval (the “Global Settlement”). Pursuant to the Global Settlement, all claims against the NaviSite Defendants would be dismissed with prejudice and our pro-rata share of the settlement consideration would be fully funded by insurance. By Opinion and Order dated October 5, 2009, after conducting a settlement fairness hearing on September 10, 2009, the Court granted final approval to the Global Settlement and directed the clerk to close each of the actions comprising the IPO Securities Litigation, including the Class-Action Litigation. A proposed final judgment in the Class-Action Litigation was filed on November 23, 2009, and was signed by the Court on November 24, 2009 and entered on the docket on December 29, 2009.
 
The settlement remains subject to numerous conditions, including the resolution of several appeals that have been filed, in the United States Court of Appeals for the Second Circuit (the “Court of Appeals”), and there can be no assurance that the Court’s approval of the Global Settlement will be upheld in all respects upon appeal. The deadline for appellants to submit their papers to the Court of Appeals was October 6, 2010. Two appellants filed opening briefs, and the remaining appellants filed a stipulation of dismissal of their appeals pursuant to Fed. R. App. P. 42(d). Appellees’ responding brief is due to be filed no later than February 3, 2011. We believe that the allegations against us are without merit, and, if the litigation continues, we intend to vigorously defend against the plaintiffs’ claims. Because of the inherent uncertainty of litigation, and because the settlement remains subject to numerous conditions and appeals, 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.
 
On October 12, 2007, a purported NaviSite stockholder filed a complaint for violation of Section 16(b) of the Exchange Act, which provision prohibits short-swing trading, against two of the underwriters of the public offering at issue in the Class-Action Litigation. The complaint is pending in the U.S. District Court for the Western District of Washington (the “District Court”) and is captioned Vanessa Simmonds v. Bank of America Corp., et al. Plaintiff seeks the recovery of short-swing profits from the underwriters on behalf of the Company, which is named only as a nominal defendant and from which no recovery is sought. Simmonds’ complaint was dismissed without prejudice by the District Court on the grounds that she had failed to make an adequate demand on us before filing her complaint. Because the District Court dismissed the case on the grounds that it lacked subject-matter jurisdiction, it did not specifically reach the issue of whether the plaintiff’s claims were barred by the applicable statute of limitations. However, the District Court also granted the underwriter defendants’ joint motion to dismiss with respect to cases involving other issuers, holding that the cases were time-barred because the issuers’ stockholders had notice of the potential claims more than five years before filing suit.
 
The plaintiff filed a notice of appeal with the Ninth Circuit Court of Appeals on April 10, 2009, and the underwriter defendants filed a cross-appeal, asserting that the dismissal should have been with prejudice. The appeal and cross-appeal are fully briefed. On October 5, 2010, oral argument was held before the Ninth Circuit Court of Appeals. We do not expect that this claim will have a material impact on our financial position or results of operations.


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NAVISITE, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
(13)   Income Taxes
 
Total income tax expense (benefit) from continuing operations for the years ended July 31, 2010, July 31, 2009, and July 31, 2008, consisted of the following:
 
                                                                         
    2010     2009     2008  
    Current     Deferred     Total     Current     Deferred     Total     Current     Deferred     Total  
                            (In thousands)                          
 
Federal
  $ (406 )   $ 915     $ 509     $     $ 920     $ 920     $     $ 912     $ 912  
Foreign
    111       (109 )     2                               (78 )     (78 )
State
    (76 )     320       244             321       321             318       318  
                                                                         
    $ (371 )   $ 1,126     $ 755     $     $ 1,241     $ 1,241     $     $ 1,152     $ 1,152  
                                                                         
 
The actual tax expense from continuing operations for the years ended July 31, 2010, July 31, 2009, and July 31, 2008, differs from the expected tax expense for the three years as follows:
 
                         
    2010     2009     2008  
    (In thousands)  
 
Computed “expected” tax expense (benefit)
  $ (905 )   $ (4,229 )   $ (2,649 )
State taxes, net of federal income tax benefit
    160       212       210  
Losses not benefited
    1,500       5,258       3,591  
                         
Total
  $ 755     $ 1,241     $ 1,152  
                         
 
Total income tax expense (benefit) from discontinued operations for the year 2010 consists of $2.2 million in current tax expenses and a $1.3 million deferred tax benefit. The tax expenses primarily relate to state tax liabilities for the gain-on-sale of netASPx, Inc., CBT/San Francisco, Inc., and CBT/Vienna, Inc. in 2010. The tax benefit results from the reversal of the deferred tax liability that had been recorded for the tax amortization of netASPx goodwill. Deferred tax expense of $0.7 million which relates to tax goodwill amortization from the acquisition of netASPx was recorded in both fiscal 2009 and 2008.
 
Temporary differences between the financial statement carrying and tax bases of assets and liabilities that give rise to significant portions of deferred tax assets (liabilities) are comprised of the following:
 
                 
    2010     2009  
    (In thousands)  
 
Deferred tax assets:
               
Accruals and reserves
  $ 14,014     $ 12,960  
Loss carryforwards
    61,072       73,116  
Depreciation and amortization
    12,524       12,021  
Tax Credits
    109        
                 
Total deferred tax assets
  $ 87,719     $ 98,097  
Less: Valuation allowance
    (87,610 )     (98,097 )
                 
    $ 109        
                 
Deferred tax liabilities: