##### Table of Contents









UNITED STATES SECURITIES AND EXCHANGE
COMMISSION

Washington, D.C. 20549




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Form 10-K



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FOR ANNUAL AND TRANSITIONAL REPORTS PURSUANT TO
SECTIONS 13 OR 15(d) 
 OF THE SECURITIES EXCHANGE ACT OF 1934

|           |  |                                                                                                 
|---------- |  | ------------------------------------------------------------------------------------------------
|(Mark One)
|          
|þ          |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR
    15(d)
    OF THE SECURITIES EXCHANGE ACT OF 1934    
|          
|           |  | For the fiscal year ended July 31,
    2003                                                     
|          
|or        
|          
|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 number: 000-27597



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NaviSite, Inc.

(Exact name of registrant as specified in its
charter)


|                                                                                          |  |                                         
|----------------------------------------------------------------------------------------- |  | ----------------------------------------
|Delaware                                                                                  |  | 52-2137343                              
|(State or other jurisdiction of
    incorporation)                                        |  | (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




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Securities registered pursuant to
Section 12(b) of the Act:

None


Securities registered pursuant to
Section 12(g) of the Act:

Common Stock, $0.01 par value


(Title of Class)


Indicate by check mark
whether the registrant: (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for
such shorter period than the Registrant was required to file
such reports), and (2) has been subject to such filing
requirements for the past
90 days.     Yes þ         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 the 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.    o

Indicate by check mark
whether the registrant is an accelerated filer (as defined in
Rule 12b-2 of the
Act).    Yes o         No þ

The aggregate market value of the
registrants common stock, $0.01 par value per share, held
by non-affiliates of the registrant was approximately
$7,570,739, based on the last reported sale price of the
registrants common stock on the Nasdaq SmallCap Market as
of the close of business on January 31, 2003.

As of October 15, 2003, there were
24,691,476 shares outstanding of the registrants common
stock, par value $0.01 per share.

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, 2003, which 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.



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TABLE OF CONTENTS



|                                                   |                                                                                                         |  |  |  |  |  |  | 
|-------------------------------------------------- | ------------------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|                                                   | Item 1. Business                                                                                       
|                                                   | Item 2. Properties                                                                                     
|                                                   | Item 3. Legal Proceedings                                                                              
|                                                   | Item 4. Submission of Matters to a Vote of Security Holders                                            
|PART II                                           
|                                                   | Item 5. Market for Registrants Common Equity and Related Stockholder Matters                          
|                                                   | Item 6. Selected Consolidated Financial Data                                                           
|                                                   | Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations          
|                                                   | Item 7A. Quantitative and Qualitative Disclosures About Market Risk                                    
|                                                   | Item 8. Financial Statements and Supplementary Data                                                    
|                                                   | Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure           
|                                                   | Item 9A. Controls And Procedures                                                                       
|PART III                                          
|                                                   | Item 10. Directors and Executive Officers of the Registrant                                            
|                                                   | Item 11. Executive Compensation                                                                        
|                                                   | Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
|                                                   | Item 13. Certain Relationships And Related Transactions                                                
|                                                   | Item 14. Principal Accounting Fees And Services                                                        
|PART IV                                           
|                                                   | Item 15. Exhibits, Financial Statement Schedules And Reports On Form 8-K                               
|SIGNATURES                                        
|INDEX TO EXHIBITS                                 
|                                                   | Item 8. Financial Statements and Supplementary Data                                                    
|Ex-10.47 Offer of Employment                      
|Ex-10.48 2003 Stock Incentive Plan                
|Ex-10.49 Form of Indemnification Agreement        
|Ex-14 Code of Business Conduct                    
|Ex-21 Subsidiaries                                
|Ex-23 Consent of KPMG LLP                         
|Ex-31.1 Certification of CEO & President          
|Ex-31.2 Certification of CFO                      
|Ex-32.1 Certification of CEO & President (Sec 906)
|Ex-32.2 Certification of CFO  (Sec 906)           



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##### Table of Contents



NAVISITE, INC.

2003 ANNUAL REPORT

ON FORM 10-K


TABLE OF CONTENTS

|         |  |                                                                                           |  |        |     | 
|-------- |  | ----------------------------------------------------------------------------------------- |  | ------ | --- | 
|         |  |                                                                                           |  | Page  
|         |  |                                                                                           |  | Number
|         |  |                                                                                           |  |       
|PART I  
|Item 1.  |  | Business                                                                                  |  |        | 3   | 
|Item 2.  |  | Properties                                                                                |  |        | 23  | 
|Item 3.  |  | Legal Proceedings                                                                         |  |        | 24  | 
|Item 4.  |  | Submission of Matters to a Vote of Security
    Holders                                   |  |        | 26  | 
|PART II 
|Item 5.  |  | Market for Registrants Common Equity and
    Related Stockholder Matters                 |  |        | 27  | 
|Item 6.  |  | Selected Consolidated Financial Data                                                      |  |        | 29  | 
|Item 7.  |  | Managements Discussion and Analysis of
    Financial Condition and Results of Operations |  |        | 30  | 
|Item 7A. |  | Quantitative and Qualitative Disclosures about
    Market Risk                            |  |        | 38  | 
|Item 8.  |  | Financial Statements and Supplementary Data                                               |  |        | 38  | 
|Item 9.  |  | Changes in and Disagreements With Accountants on
    Accounting and Financial Disclosure  |  |        | 38  | 
|Item 9A. |  | Controls and Procedures                                                                   |  |        | 38  | 
|PART III
|Item 10. |  | Directors and Executive Officers of the Registrant                                        |  |        | 39  | 
|Item 11. |  | Executive Compensation                                                                    |  |        | 39  | 
|Item 12. |  | Security Ownership of Certain Beneficial Owners
    and Management                        |  |        | 39  | 
|Item 13. |  | Certain Relationships and Related Transactions                                            |  |        | 40  | 
|Item 14. |  | Principal Accounting Fees and Services                                                    |  |        | 40  | 
|PART IV 
|Item 15. |  | Exhibits, Financial Statement Schedules, and
    Reports on Form 8-K                      |  |        | 40  | 
|         |  | Index to Consolidated Financial Statements                                                |  |        | F-1 | 
|         |  | Signatures                                                                                |  |        | 42  | 

2



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##### Table of Contents



PART I

SPECIAL NOTE

All share numbers and share prices provided in
this Annual Report on Form 10-K have been adjusted to
reflect the 1-for-15 reverse stock split of NaviSites
common stock effected on January 7, 2003.

SPECIAL NOTE REGARDING FORWARD-LOOKING
STATEMENTS

This Form 10-K contains forward-looking
statements within the meaning of Section 21E of the
Securities Exchange Act of 1934, as amended, that involve risks
and uncertainties. All statements other than statements of
historical information provided herein are forward-looking
statements and may contain information about financial results,
economic conditions, trends and known uncertainties. Our actual
results could differ materially from those discussed in the
forward-looking statements as a result of a number of factors,
which include those discussed in this section and elsewhere in
this report and the risks discussed in our other filings with
the Securities and Exchange Commission. Readers are cautioned
not to place undue reliance on these forward-looking statements,
which reflect managements analysis, judgment, belief or
expectation only as of the date hereof. Investors are warned
that actual results may differ materially from managements
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.






|        |         
|------- | --------
|Item 1. | Business

Company Overview

NaviSite, Inc. provides outsourced hosting and
managed application services for mid-sized enterprises,
divisions of large multi-national companies, government agencies
and other businesses conducting mission critical business on the
Internet. Our goal is to help customers focus on their core
competencies by outsourcing the hosting and management of their
operations and applications, allowing customers to improve the
efficiency of their operations. Our focus on Managed Application
Services (A-Services), Managed Infrastructure Services
(I-Services) and Managed Messaging Services (M-Services) allows
us to meet the expanding needs of our customers as their
applications become more complex.

NaviSite operates 14 data centers in the
United States and one data center in the United Kingdom. We
combine a highly scalable and developed infrastructure with
expertise, experience, intellectual property, software
platforms, processes and procedures for delivering simple to
complex hosting and application management services. We provide
a combination of high availability infrastructure, high
performance monitoring systems, and proactive problem resolution
and change management processes designed to recognize patterns
and identify and address potentially crippling problems before
they are able to cause downtime in customers operations.
The price for our services varies from customer to customer
based on the number of managed servers and the nature, extent
and level of services provided. Customers typically enter into
agreements with a term of one to three years and monthly payment
installments.

We derive our revenue primarily from hosting
services comprised of a variety of service offerings, including
providing related professional and consulting services, to
mid-sized enterprises, divisions of large multi-national
companies, government agencies and other businesses. These
hosting services include:



| |   |                                                                                                                                                                                                                                               
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Managed Application Services (A-Services): An
    advanced portfolio of collaborative application monitoring and
    management services, managed hosting services and application
    development services;                                  
|
| |  | Managed Infrastructure Services (I-Services): A
    set of infrastructure services consisting of co-location
    hosting, bandwidth, connectivity, content distribution networks
    and electronic software delivery services; and           
|
| |  | Managed Messaging Services (M-Services): A suite
    of outsourced and managed messaging applications built on Lotus
    Domino and Microsoft Exchange software, including fully-managed
    Domino applications and email messaging services.

3



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NaviSite was started in 1996 within CMGI, Inc.,
its former majority stockholder, to support the networks and
host Web sites of CMGI, its subsidiaries and certain of its
affiliated companies. In 1997, we began offering and supplying
Web site hosting and management services to companies not
affiliated with CMGI. NaviSite was incorporated in Delaware in
December 1998. In October 1999, NaviSite completed its initial
public offering of common stock and remained a majority-owned
subsidiary of CMGI until September 11, 2002. On
September 11, 2002, ClearBlue Technologies, Inc. and its
subsidiaries became NaviSites majority stockholder upon
its acquisition from CMGI and Hewlett-Packard Financial Services
Company of all of their shares of NaviSite common stock,
warrants to purchase NaviSite common stock and convertible
promissory notes issued by NaviSite. In August 2003, Atlantic
Investors, LLC, the indirect majority stockholder of ClearBlue
Technologies, Inc., and its subsidiaries, became our majority
stockholder upon ClearBlue Technologies, Inc.s transfer of
its stock ownership interests in NaviSite to its stockholders.
Since January 31, 2000, our corporate headquarters have
been located at 400 Minuteman Road, Andover, Massachusetts.
A description of NaviSites recent developments through
merger and acquisition activities is set forth in Note 6 of
the Notes to the Consolidated Financial Statements included in
Item 8 below and is incorporated herein by reference.

Fiscal Year 2003 Events and
Developments

There have been a number of internal and external
events and developments which impacted NaviSite during and
subsequent to fiscal 2003. Some of the significant events and
developments included:



| |   |                                                                                                                                                                                                                                                                                                                                                                         
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | On September 11, 2002, each of CMGI and
    Hewlett-Packard Financial Services Company sold and transferred
    to ClearBlue Technologies, Inc., a privately-held managed
    service provider based in San Francisco, California, and certain
    subsidiaries, the following equity and debt interests in
    NaviSite, thus becoming NaviSites majority stockholder:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Pursuant to a Note and Stock Purchase Agreement
    by and between CMGI and ClearBlue Technologies, Inc., CMGI sold
    and transferred to ClearBlue Technologies, Inc. approximately
    4.7 million shares of NaviSite common stock, representing
    approximately 76% of the outstanding capital stock of NaviSite,
    warrants to purchase approximately 347,000 shares of
    NaviSite common stock and a convertible note with an aggregate
    principal amount outstanding of $10 million. The
    $10 million convertible note was convertible into
    approximately 2.5 million shares of NaviSite common stock.
|
| |  | Pursuant to a Note and Stock Purchase Agreement
    by and between Hewlett-Packard Financial Services Company and
    ClearBlue Technologies, Inc., Hewlett-Packard Financial Services
    Company sold and transferred to ClearBlue Technologies, Inc.
    approximately 213,000 shares of NaviSite common stock, and
    a convertible note with an aggregate principal amount
    outstanding of approximately $55 million. The
    $55 million convertible notes were convertible into
    approximately 14.1 million shares of NaviSite common stock.                                                                   



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | In connection with: (i) an Assignment
    Agreement dated October 8, 2002 among NaviSite and Fir Tree
    Recovery Master Fund, LP and Fir Tree Value Partners, LDC; and
    (ii) a series of open market transactions from certain
    other third-party holders, NaviSite acquired for
    $2.0 million approximately $36.4 million face value,
    10% convertible senior notes due in 2006 of Interliant, Inc., a
    provider of managed services which filed a petition under
    Chapter 11 of Title 11 of the United States Bankruptcy
    Code (the Bankruptcy Code).                                                                                                                                                                             
|
| |  | On December 12, 2002, ClearBlue Finance,
    Inc., a wholly-owned subsidiary of ClearBlue Technologies, Inc.:
    (i) converted in full the $10 million note formerly
    held by CMGI; and (ii) converted $10 million of the
    $55 million notes formerly held by Hewlett-Packard
    Financial Services Company, including interest and pre-paid
    interest, into an aggregate of approximately
    5,587,000 shares of common stock. A new convertible
    promissory note was issued to ClearBlue Finance, Inc. with
    respect to the portion of the outstanding principal and interest
    due under the promissory note formerly held by Hewlett-Packard
    Financial Services Company that was not converted (approximately
    $45.0 million).

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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   | In addition, ClearBlue Finance, Inc. waived all
    interest for the period from December 15, 2002 through
    December 31, 2003 resulting from the unconverted promissory
    note.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|
| |  | On December 31, 2002, NaviSite completed the
    acquisition of all of the issued and outstanding stock of
    ClearBlue Technologies Management, Inc., a wholly-owned
    subsidiary of ClearBlue Technologies, Inc., which, in June 2002,
    acquired certain assets from the bankrupt estate of
    AppliedTheory, Inc., a provider of complex hosting and
    application management services, in exchange for approximately
    568,000 shares of NaviSite common stock.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|
| |  | Beginning January 1, 2003, NaviSite agreed
    to provide certain management services as well as manage the
    day-to-day operations of data centers owned, directly or
    indirectly, by ClearBlue Technologies, Inc. pursuant to an
    Outsourcing Agreement with ClearBlue Technologies, Inc. In
    connection with the Outsourcing Agreement, NaviSite issued to
    ClearBlue Technologies, Inc. a promissory note pursuant to which
    NaviSite may borrow amounts from ClearBlue Technologies, Inc.
    for working capital needs. In addition, ClearBlue Technologies,
    Inc. issued to NaviSite a promissory note pursuant to which
    ClearBlue Technologies, Inc. may borrow amounts from NaviSite
    for working capital needs. The two notes may be drawn down upon,
    at the sole discretion of the lender, up to a maximum aggregate
    amount of $2.0 million per promissory note.                                                                                                                                                                                                                                                                      
|
| |  | On January 29, 2003, NaviSite entered into a
    $10 million Loan and Security Agreement with Atlantic
    Investors, LLC, an affiliate of ClearBlue Technologies, Inc. The
    loan agreement has a termination date of February 1, 2004
    and bears interest at the rate of 8% per annum. Under the loan
    agreement, NaviSite can require Atlantic Investors, LLC to make
    a loan to it: (i) up to $2.0 million to repay an
    amount due from ClearBlue Technologies Management, Inc. to
    Unicorn Worldwide Holdings Limited, each a related party of
    NaviSite and Atlantic Investors, LLC;
    (ii) $1.0 million for costs associated with our
    acquisition of Avasta, Inc.; and (iii) up to $500,000 for
    the post-acquisition working capital needs of Avasta, Inc.
    Atlantic Investors, LLC, at its sole and absolute discretion,
    may advance other amounts to NaviSite such that the aggregate
    amount borrowed by NaviSite does not exceed the maximum loan
    amount, defined as the lesser of $10.0 million or 65% of
    consolidated NaviSite accounts receivables. The loan is secured
    by all of NaviSites accounts receivables.
|
| |  | On February 5, 2003, NaviSite acquired
    Avasta, Inc., a provider of remote hosting and managed service
    operations located in San Francisco, California, for
    approximately 231,000 shares of NaviSite common stock. The
    acquisition was made to enhance NaviSites ability to be a
    full-service provider of applications management services and
    technology to its customers. An additional 179,353 shares
    of our common stock were issued to the former stockholders of
    Avasta, Inc. in September 2003 as an earnout payment.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|
| |  | On February 19, 2003, the Board of Directors
    elected Arthur P. Becker, a member of NaviSites Board of
    Directors and an officer and director of ClearBlue Technologies,
    Inc., as NaviSites Chief Executive Officer and President,
    effective as of February 21, 2003, to succeed Patricia
    Gilligan.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|
| |  | On April 2, 2003, NaviSite completed the
    acquisition of Conxion Corporation, a provider of software
    distribution services and network/server security expertise. The
    shareholders of Conxion received an aggregate of $1,925,000 in
    cash.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|
| |  | On May 16, 2003, NaviSite, through a
    wholly-owned subsidiary, completed the acquisition of
    substantially all of the assets, other than certain accounts
    receivable, relating to the managed infrastructure solutions
    business, encompassing messaging and collaboration, managed
    hosting, bundled-in managed security, and integrated and related
    professional services in the United States and in Europe, of
    Interliant, Inc. and several of its subsidiaries (the
    Interliant Assets). The aggregate purchase price for
    the Interliant Assets was approximately $7.2 million,
    subject to certain net worth adjustments, comprised of
    approximately $5.8 million in cash, $624,000 in the form of
    a credit of future distributions to be paid on certain
    promissory notes of Interliant held by NaviSite, $550,000 in
    principal amount of a non-interest bearing promissory note due
    December 2003, and approximately $200,000 in acquisition-related
    costs. As part of the transaction, the NaviSite subsidiary
    agreed to                                                                                   

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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   | assume up to $5,766,000 in liabilities relating
    to the Interliant Assets. On June 6, 2003, NaviSite
    acquired certain accounts receivable of Interliant and its
    subsidiaries.                                                                                                                                                                                                                                                                                                                        
|
| |  | On May 27, 2003, NaviSite entered into an
    Accounts Receivable Financing Agreement with Silicon Valley Bank
    whereunder NaviSite may borrow up to a maximum of
    $10.0 million based on eligible accounts receivables. As
    part of the Financing Agreement, on May 27, 2003, NaviSite
    issued warrants to Silicon Valley Bank to purchase up to
    165,000 shares of NaviSite common stock with an exercise
    price of $2.50, which was the trading price of our common stock
    on this date.
|
| |  | On June 16, 2003, NaviSite repaid
    approximately $3.9 million of the $45.0 million of
    outstanding debt payable to ClearBlue Finance, Inc. by
    offsetting amounts due to us by ClearBlue Technologies, Inc. On
    June 17, 2003, NaviSite received written notice from
    ClearBlue Finance, Inc. stating its election to convert the
    remaining approximately $41.2 million of the promissory
    note into 10,559,248 shares of common stock effective
    June 19, 2003.                       
|
| |  | On August 8, 2003, NaviSite completed the
    acquisition of certain assets and the assumption of certain
    liabilities of ClearBlue Technologies, Inc. pursuant to a Stock
    and Asset Acquisition Agreement (the CBT Agreement).
    Pursuant to the CBT Agreement, NaviSite acquired all outstanding
    shares of six (6) wholly-owned subsidiaries of ClearBlue
    Technologies, Inc. with data centers located in Chicago, Las
    Vegas, Los Angeles, Milwaukee, Oakbrook and Vienna.             

In addition, NaviSite assumed the revenue and
expense, as of the date of the CBT Agreement, of four
(4) additional wholly-owned subsidiaries of ClearBlue
Technologies, Inc. with data centers located in Dallas, New
York, San Francisco and Santa Clara. Ownership of these
subsidiaries will automatically be transferred, under certain
conditions, to NaviSite for no additional consideration in
February 2004.

In exchange for these subsidiaries and certain
assets and contracts relating to them, NaviSite: (i) issued
1.1 million shares of NaviSite common stock, to ClearBlue
Technologies, Inc.; (ii) released ClearBlue Technologies,
Inc. from certain inter-company advances in an amount up to
$300,000; (iii) assumed all of ClearBlue Technologies,
Inc.s obligations under certain assets and contracts
relating to the these subsidiaries; and (iv) released
ClearBlue Technologies, Inc. from certain payment obligations
owed to NaviSite pursuant to the Outsourcing Agreement in an
amount not to exceed $263,000.



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | The audit report on our fiscal year 2003
    consolidated financial statements from KPMG LLP, our independent
    auditors, contains an explanatory paragraph that states that our
    recurring losses since inception and accumulated deficit, as
    well as other factors, raise substantial doubt about our ability
    to continue as a going concern. During fiscal year 2003 and
    thereafter, we have undergone a significant transition,
    including all of the acquisitions discussed above and a balance
    sheet restructuring, to position ourselves among the leaders in
    the hosting and managed application services market. While we
    cannot assure you that we will continue as a going concern, as
    part of our transition efforts, we believe that we have
    developed and are implementing an operational plan that will
    bring costs more in line with projected revenue growth.

Industry Background

The dramatic growth in Internet usage and
Internet enabled applications combined with enhanced
functionality, accessibility and security, has made the Internet
increasingly attractive to businesses as a medium for
communication and commerce. Businesses are now deploying
Internet applications on a large scale, to enhance their core
business operations, and such applications have become mission
critical. Such applications now go well beyond Web sites and
e-commerce applications into core enterprise applications such
as financial, enterprise resource management (ERP), supply chain
management (SCM) and customer relationship management (CRM)
applications.

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As business use of the Internet increases, we
believe that businesses utilizing the Internet are seeking, and
will continue to seek, to identify and implement increasingly
sophisticated Internet enabled applications. These applications
permit businesses to:



| |   |                                                                                                                                                       
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | increase operating efficiencies and reduce sales,
    general and administrative costs;                                                               
|
| |  | build and enhance customer relationships by
    providing Internet-based customer service and technical support;                                      
|
| |  | manage vendor and supplier relationships through
    Internet-based technologies such as online training, e-commerce
    enablement and streaming; and
|
| |  | communicate and conduct business more rapidly and
    cost-effectively with customers, suppliers and employees
    worldwide.                         

As a result, the proliferation of business Web
sites and Internet-enabled applications has created a strong
underlying demand for specialized information technology support
and application expertise. Many businesses using the Internet as
part of their business strategies have chosen to outsource the
hosting and management of these enterprise applications.

The outsourced hosting and management services of
Internet-enabled applications are driven by a number of factors,
including:



| |   |                                                                                                                                                                                                
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | the need to improve the reliability, availability
    and overall performance of Internet-enabled applications as
    those applications increase in importance and complexity;                
|
| |  | the need to focus on core competitively
    differentiating activities and not complex IT management
    activities;                                                                           
|
| |  | challenges and costs faced by businesses in
    hiring, training and retaining application engineers and
    information technology employees with the requisite range of IT
    expertise; and
|
| |  | increasing complexity of managing the operations
    of Internet-enabled applications.                                                                                                         

Strategy

Enhancing stockholder value through growth,
obtaining and sustaining profitability and market leadership is
our continued objective. We intend to pursue growth through
expanding our customer base, establishing relationships with new
strategic partners and augmenting penetration within our
established customers, and through the potential acquisition of
companies. Our strategic objective is to build a leadership
position with mid-sized enterprises, divisions of large
multi-national companies, government agencies and other
businesses conducting mission critical business on the Internet.
We believe this can be accomplished by providing an integrated
set of business process outsourcing solutions for target
customers. We believe traditional outsourcers cannot serve these
customers profitably. NaviSite believes it can profitably
customize services for these customers. Key elements of our
strategy include:



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Leverage Existing Operating Platform Through
    Potential Acquisitions.We intend to
    leverage our existing operating platform through the acquisition
    of companies serving mid-sized enterprises, divisions of large
    multi-national companies and government agencies. By acquiring
    companies with a low cost basis, we can leverage fixed costs and
    improve margins by servicing more customers with minimal
    additional administrative and fixed costs.                                                                                              
|
| | Deepen our Relationships With Existing
    Customers by Adding New Service
    Capabilities.We plan to increase our
    services portfolio so that we can service our customers as the
    single point of management across solutions. Acquisitions, such
    as Avasta, Conxion and the Interliant Assets, have provided us
    with strategically important capabilities, such as application
    management, content delivery and managed messaging. New service
    capabilities will allow us to further penetrate existing client
    relationships and increase sales.

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| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Build Partnerships with Key System Integrators
    and Independent Software Vendors.We
    plan to partner with key system integrators to deliver value
    across the full lifecycle of each software solution. This allows
    systems integrators to improve their competitive position and
    revenue opportunities by presenting their customers with a
    hosted and managed solution that meets their customers
    exact requirements. We also plan to partner with independent
    software vendors in order to allow them to quickly create and
    deploy their application software as a service in order to meet
    demand from end-users for subscription-based application
    services.
|
| | Continue Driving Improvements in
    Industry-Leading Operational Metrics.NaviSite plans to continue driving improvements in its operating
    metrics and corresponding improvements in the quality of its
    customer service. NaviSite believes it has developed and
    delivers to its customers consistently high levels of
    operational metrics across the areas that are most critical to
    businesses, including the performance of customer applications,
    network elements and service levels.                                                                                                                                                                                         

The NaviSite Solution

NaviSite provides a range of application,
infrastructure and messaging services that can be deployed in a
cost-effective and rapid manner. We specialize in developing,
deploying and managing dedicated mission-critical Internet-based
solutions for our customers. We serve as the single point of
management for our customers outsourced business
applications and our focus on management of customer business
computing infrastructure allows us to meet an expanding set of
customer needs as customers applications become more
complex. Further, we provide our services across Unix, Windows,
and Linux platforms and in highly secure, highly available and
redundant environments.

The combination of our scalable infrastructure,
the repeatability of our management processes and our extensive
base of expertise allows us to provide our customers with
application hosting and management services on a cost-effective
basis. NaviSite has already deployed state-of-the-art
infrastructure from the industrys leading providers, and,
therefore, our customers can immediately leverage equipment and
services that would typically not be cost effective for them to
purchase and deploy themselves. In addition, we have made
significant investments in our operating platform and our
automation capabilities. Furthermore, we have refined these
processes over time and across a large base of customers. By
leveraging this expertise, we can more efficiently configure,
deploy and manage complex applications and, thus, save our
customers from hiring or developing that same expertise
in-house. By outsourcing these resources and time-intensive
Internet-enabled applications, we allow our customers to focus
on their core businesses. We believe that our customers would
otherwise be required to make significant expenditures to
replicate our performance, reliability and expertise either
internally or by using outside vendors.



| |               
| | --------------
| | Infrastructure

Our infrastructure and technology have been built
by integrating best of breed components and have
been designed specifically to meet the more demanding technical
requirements of providing managed application hosting. Our
high-performance infrastructure, together with our trained and
experienced staff, enables us to offer levels of service that
are backed by high service level guarantees.

Network Operations Centers.We monitor the operations of our
infrastructure and customer Internet applications from our own
state-of-the-art network operations centers. Our primary network
operations center in Andover, Massachusetts is staffed
24 hours per day, seven days per week with Network,
Security, Windows NT, Linux and UNIX personnel. We run a
fully operational real-time backup network operations center in
San Jose, California. Our network operations centers perform
first-level problem identification, validation and resolution.
The design of our network operations centers allows network
engineers and support personnel to be promptly alerted to
problems and we have established procedures for rapidly
resolving any technical issues that arise. Network management
and monitoring tools continuously monitor the network and server
performance.

Data Centers.We
currently serve customers from 14 data centers located in the
United States and one data center located in the United Kingdom.
These data centers incorporate technically sophisticated

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components which are designed to be
fault-tolerant. The components used in our data centers include
redundant core routers, redundant core switching hubs and secure
virtual local area networks. We utilize the equipment and tools
necessary for our data center operations, including our
infrastructure hardware, networking and software products, from
industry leaders such as BMC, Cisco, Hewlett-Packard, Dell, EMC,
Microsoft, Oracle and Sun Microsystems.


Internet Connectivity.Our use of direct private transit
Internet connections to major Internet backbone providers
differentiates our network infrastructure from those of our
competitors. We have redundant high-capacity Internet
connections to Level3, InterNap and Wiltel on the east coast and
Level3, XO Communications and Wiltel on the west coast. We have
deployed direct private transit Internet connections to utilize
the providers peering capabilities and to enhance routes
via their networks to improve global performance. Our private
transit system enables us to provide fast, reliable access for
our customers Internet-based applications.



| |         
| | --------
| | Services

In fiscal 2003, NaviSite expanded its service
offerings and its customer base. NaviSites acquisitions of
ClearBlue Technologies Management, Inc., Avasta, Conxion, the
Interliant Assets and, subsequent to the end of fiscal 2003, the
data centers owned by ClearBlue Technologies, Inc. provided
NaviSite with an increase in, and significant diversification
of, its customer base from approximately 145 to over 800 and the
ability to increase and improve its suite of service offerings
to its new and existing customers. The universe of offerings is
provided to customers a la carte, enabling customers to design
configurations to meet their particular needs for availability,
security and performance. NaviSite also has developed a number
of ready made, yet customizable, configurations that
are based on best practices and on field-proven architectures.
The services provided to NaviSites customers range from
simple co-location to application managed services.

NaviSites services consist of:



| |   |                                                  
| | - | -------------------------------------------------
| |  | Managed Application Services (A-Services);       
|
| |  | Managed Infrastructure Services (I-Services); and
|
| |  | Managed Messaging Services (M-Services).         

A-Services

A-Services consist of:



| |   |                                               
| | - | ----------------------------------------------
| |  | Application Development;                      
|
| |  | Application Hosting; and                      
|
| |  | Collaborative Application Management Platform.

Application
Development These services
combine NaviSites skill and experience in designing
attractive and effective Web brands and interfaces.
NaviSites tailored Web site workflow systems improve
timeliness of Web site content, empower multiple content
administrators and improve Web site control. NaviSite customizes
back-end and user interface designs to enable the customer to
share Web-based information.

Application
Hosting NaviSite provides
fully managed hosting for mid-sized enterprises, divisions of
large multi-national companies, government agencies and other
businesses conducting mission-critical business on the Internet.
NaviSite manages data centers, Internet connectivity, servers
and networking, security (including firewall, virtual private
networks and intrusion detection), storage, load balancers,
database clusters and operating system and Web and application
servers. NaviSite also provides more advanced management
services for leading databases and applications. Most
application hosting services are available in one of
NaviSites data centers or via remote management on a
customers own premises.

Collaborative Application Management
(CAM) The CAM platform
enables NaviSite, IT teams and systems integrator partners to
work together to provide seamless, integrated application
management to end

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customers. The CAM platform helps ensure full
transparency and seamless operations of: (i) hardware,
operating system, database and application monitoring;
(ii) event management; (iii) problem resolution
management; and (iv) integrated change and configuration
management tools. CAM includes:




| |   |                                                                                                                                                                                                                                                                                                                                                                                                    
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | NaviSite Event Detection
    System This NaviSite
    custom-developed technology allows NaviSites operations
    personnel to efficiently process alerts across heterogeneous
    environments. This system collects and aggregates data from all
    of the major enterprise systems management software packages
    utilized by an IT organization.                                          
|
| |  | Synthetic Transaction
    Monitoring These
    NaviSite-developed synthetic transaction methods emulate the
    end-user experience and monitor for application latency or
    malfunctions that affect user productivity.                                                                                                                                                                        
|
| |  | Automated
    Remediation NaviSite
    automatically applies domain expertise to address predicted
    issues raised by automated monitoring. These automated fixes
    help ensure availability and reliability by remediating known
    issues in real time, keeping applications up and running while
    underlying problems or potential problems are diagnosed.                             
|
| |  | Component Information
    Manager This central
    repository for network, database, application and device
    information allows NaviSite to consolidate, present and track
    disparate sources of critical system device information in a
    unified view.                                                                                                                                  
|
| |  | Escalation
    Manager This unique
    workflow automation technology allows NaviSite to streamline
    routine tasks and escalate critical issues in a fraction of the
    time that manual procedures require. Escalation Manager
    initiates specific orders and tasks based on pre-defined
    conditions, ensuring clear, consistent communications between
    NaviSite and its customers.

An integral part of CAM is its customer portal
that provides customers with a real-time view into systems and
application operations, including access to metrics and reports,
incidents, service requests, customer knowledge base, standard
remediation procedures and change control management. This
portal provides NaviSites customers with the transparency
and control that customers and strategic partners rely on to
manage critical systems and applications.



| |           
| | ----------
| | I-Services

I-Services consist of NaviSites
infrastructure services, which provide the building blocks for
all Internet-enabled services. I-Services consist of:



| |   |                               
| | - | ------------------------------
| |  | Co-location hosting;          
|
| |  | Bandwidth;                    
|
| |  | Security;                     
|
| |  | Disaster recovery; and        
|
| |  | Content distribution networks.

Co-location
NaviSites co-location data centers provide customers with
a secure place to gain rapid access to the Internet, without
having to build their own environments. NaviSites data
centers include multiple levels of security with camera
surveillance, redundant uninterruptible power supply and power,
data grade heating ventilation and air conditioning, 24/7
customer access which is constantly monitored and advanced fire
suppression.

Bandwidth
NaviSites data centers are carrier-neutral facilities,
providing connectivity via a wide range of separate carriers,
and offering competitive Internet access and bandwidth pricing.

Security
NaviSite offers industry standard security service offerings,
including managed firewalls, intrusion detection, denial of
service attack prevention and exposure analysis. We utilize
commercial equipment products such as Netscreen, Checkpoint and
Cisco PIX.

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Disaster
Recovery Features of
NaviSites disaster recovery program include a spare
cabinet of equipment, redundant data centers for physical
separation, tape back-up and archiving off-site, storage
on-demand, load balancing, fully mirrored content, remote access
and professional consulting services.

NaviSites Content Distribution
Network(CDN) business allows
customers to accelerate the distribution of all types of
Internet-based data to users while reducing costs typically
associated with this function. Currently, there are two primary
areas of focus within this business, our caching services, Cache
on Demand and Delta Edge, and our enterprise software
distribution services, Conxion FTL.

NaviSites caching services are specifically
designed to bring (or cache) Web content, both static and
dynamic, closer to the end user, which results in a decrease in
overall bandwidth usage for the customer as well as an increase
in overall performance regardless of the access type or
connection the user is using.

NaviSites software distribution services
allow software manufacturers to securely and reliably distribute
patches, updates, and even large new versions of their software
products to its user base. This service allows them to largely
bypass traditional distribution processes of physical compact
disc (CD) creation, packaging and shipping resulting in a
dramatic decrease in their software distribution costs as well
as an increase in their ability to distribute updates quickly
and accurately to their user base.



| |           
| | ----------
| | M-Services

NaviSites M-Services manage messaging
applications such as Microsoft Exchange, Lotus Domino and other
collaborative technologies.

M-Services consist of:



| |   |                                                                                                                                                 
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Messaging Application Management: NaviSite
    provides fully managed Lotus Notes and Microsoft Exchange
    services;                          
|
| |  | IM and Collaboration: NaviSites instant
    messaging service provides turnkey access to all of the benefits
    of secure, real-time chat; and
|
| |  | Spam Filtering: NaviSite provides services that
    allow customers to keep spam and viruses out of email systems.                              

Sales and Marketing

NaviSites sales and marketing strategy is
to cost effectively penetrate mid-sized enterprises, divisions
of large multi-national companies, government agencies and other
businesses through a combination of direct sales and channel
partnerships.



| |      
| | -----
| | Sales

Direct
Sales Our direct sales
professionals are organized geographically into groups located
in Massachusetts, New York, California, Virginia and the United
Kingdom. We utilize a sales model that consists of meetings with
customers to understand and identify their individual business
requirements. Our sales teams then translate those requirements
into tailored business solutions. There is significant, ongoing
revenue opportunity with customers as they grow and change their
networks and we believe our sales model is designed to
capitalize on that opportunity. To date, most of our sales have
been realized through our direct sales force.

Channel
Partnerships Our current
partners include IBM, Progress Software and Accenture. In fiscal
2003, we worked to increase the number of channel partners that
match our market vision, including establishing key
relationships with independent software vendors and system
integrators. For systems integrators, NaviSites
flexibility and cost-effectiveness bolsters their application
development and management service. For independent software
vendors, NaviSite provides the ability and easy means to offer
their software as a managed service.

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| |          
| | ---------
| | Marketing

NaviSites marketing organization is
responsible for defining the overall market strategy for
NaviSite. A primary focus is on identifying key market
opportunities and customer segments which will best match the
NaviSite service portfolio and creating marketing programs which
target those segments. We are actively building general
awareness of NaviSite and its strategy through public relations,
marketing communications and product marketing. The marketing
organization supports direct sales and business development, as
well as defines and enhances channel partner relationships.

Customers

Our customers range from small, privately-held
companies to mid-sized enterprises, divisions of large
multi-national companies and government agencies. Our customers
operate in a wide variety of industries, such as technology,
manufacturing, retail, business services and government agencies.

Through a combination of factors, including
acquisitions, an increase in our product offering portfolio and
market demand, we had approximately 700 customers as of
July 31, 2003. This represents a significant increase from
145 customers as of July 31, 2002.

We derived approximately 2%, 31% and 35% of our
revenue from CMGI and CMGI affiliates for the fiscal years ended
July 31, 2003, 2002 and 2001, respectively. We derived
approximately 26%, 0% and 0% of our revenue from the New York
State Department of Labor for the fiscal years ended
July 31, 2003, 2002 and 2001, respectively. The contract
with the New York State Department of Labor is scheduled to
expire in June 2005, provided, however, the New York State
Department of Labor has the right to terminate the contract at
any time by providing us with 60 days notice. Other than
CMGI, CMGI affiliates and the New York State Department of
Labor, no other customer represented 10% or more of our revenue
for the fiscal years ended July 31, 2003, 2002 and 2001.
Substantially all of our revenues are derived from, and
substantially all of our plant, property and equipment are
located in, the United States. Our customers include the
following companies for each type of service offered by us:

|                   |  |                |  |                 
|------------------ |  | -------------- |  | ----------------
|A-Services         |  | I-Services     |  | M-Services      
|                   |  |                |  |                 
|Cabelas            |  | Broderbund     |  | Aguirre         
|Ross Stores        |  | Forbes.com     |  | Daimler Chrysler
|Wolters Kluwer     |  | Install Shield |  | Fleetwood       
|XM Satellite Radio |  | Symantec       |  |                 

Competition

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

We believe that NaviSite is the only provider
that is able to offer a comprehensive set of services to
customers who purchase outsourced services that enable them to
increase efficiency, reduce or stabilize operational expenses,
and better manage their businesses by focusing on their core
competency rather than their IT requirements. We also believe
that we can offer these services at a competitive price point
due to our internal operational efficiencies, scale of
operations, and the significantly reduced cost of acquisition
for our infrastructure assets.

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



| |   |                                                                              
| | - | -----------------------------------------------------------------------------
| |  | Quality of service delivered;                                                
|
| |  | Ability to consistently measure, track and report
    on operational metrics;
|
| |  | Application hosting, infrastructure and messaging
    management expertise;  

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| |   |                                                                                                                                 
| | - | --------------------------------------------------------------------------------------------------------------------------------
| |  | Fast, redundant and reliable Internet
    connectivity;                                                                         
|
| |  | A robust infrastructure providing availability,
    speed, scalability and security;                                            
|
| |  | Comprehensive and diverse service offerings and
    timely addition of value-added services;                                    
|
| |  | Brand recognition;                                                                                                              
|
| |  | Leveraging strategic relationships;                                                                                             
|
| |  | Competitive pricing; and                                                                                                        
|
| |  | Adequate capital to permit continued investment
    in infrastructure, customer service and support and sales and
    marketing.

Our current and prospective competitors include:



| |   |                                                                                                                                                                                                                                  
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Other providers of complex hosting and related
    services, including Digex, Inc., Globix Corp., Computer Sciences
    Corporation, Totality Corp., Inflow, Inc. and a large number of
    local and regional hosting providers;
|
| |  | Large system integrators and information
    technology outsourcing firms, including Electronic Data Systems
    Corporation, IBM and Accenture;                                                                                 
|
| |  | CDN providers, such as Akamai, Inc. and Speedera
    Networks, Inc.;                                                                                                                                                             
|
| |  | Global telecommunications companies, including
    AT&T and Sprint;                                                                                                                                                              
|
| |  | National and regional messaging providers,
    including Connectria Corp., Internoded, Inc. and USA.net, Inc.;
    and                                                                                                           
|
| |  | National and regional co-location providers,
    including NTT/ Verio, Rackspace, Interland, Inc. and XO
    Communications.                                                                                                     

Many of our competitors may be able to develop
and expand their network infrastructures 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, devote
greater resources to the marketing and sale of their services
and adopt more aggressive pricing policies than we can. Because
of these competitive factors and due to our comparatively small
size and our lack of financial resources, we may be unable to
successfully compete in the hosting and application management
services market.

In addition, we believe that there will be
continued consolidation within the market in which we compete.
Our competitors may consolidate with one another or acquire
software application vendors or technology providers, enabling
them to more effectively compete with us. This consolidation
could affect prices and other competitive factors in ways that
would impede our ability to compete successfully in the hosting
and application management services market.

Intellectual Property

We rely on a combination of trademark, service
mark, copyright and trade secret laws and contractual
restrictions to establish and protect our proprietary rights and
promote our reputation and the growth of our business. We do not
have any patents that would prevent or inhibit competitors from
using technology similar to ours or entering our market. While
it is our practice to require our employees, consultants and
independent contractors to enter into agreements containing
non-disclosure, non-competition (for employees only) and
non-solicitation restrictions and covenants, and while our
agreements with some of our customers and suppliers include
provisions prohibiting or restricting the disclosure of
proprietary information, we can not assure you that these
contractual arrangements or the other steps taken by us to
protect our proprietary rights will prove sufficient to prevent
misappropriation of our proprietary rights or to deter
independent, third-party development of similar proprietary
assets. In addition, we offer our services in other countries
where the laws may not afford adequate protection for our
proprietary rights.

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We license or lease most technologies used in our
hosting and application management services. Our technology
suppliers may become subject to third-party infringement claims,
or other claims or assertions, which could result in their
inability or unwillingness to continue to license their
technology to us. The loss of certain of our technologies could
impair our ability to provide services to our customers or
require us to obtain substitute technologies that may be of
lower quality or performance standards or at greater cost. We
expect that NaviSite and its customers increasingly will be
subject to third-party infringement claims as the number of Web
sites and third-party service providers for Internet-based
businesses grows. We cannot assure you that third parties will
not assert claims alleging the infringement of service marks and
trademarks against us in the future or that these claims will
not be successful. Any infringement claim as to our technologies
or services, regardless of its merit, could be time-consuming,
result in costly litigation, cause delays in service,
installation or upgrades, adversely impact our relationships
with suppliers or customers or require us to enter into costly
royalty or licensing agreements.

Government Regulation

While there currently are few laws or regulations
directly applicable to the Internet or to managed application
hosting service providers, due to the increasing popularity of
the Internet and Internet-based applications, such laws and
regulations are being considered and may be adopted. These laws
may cover a variety of issues including, for example, 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 future growth of our business or expose
us to unanticipated liabilities. Moreover, the applicability of
existing laws to the Internet and managed application hosting
service providers is uncertain. These existing laws could expose
us to substantial liability if they are found to be applicable
to our business. For example, we offer services over the
Internet in many states in the United States and internationally
and we facilitate the activities of our customers in those
jurisdictions. As a result, we may be required to qualify to do
business, be subject to taxation or be subject to other laws and
regulations in these jurisdictions, even if we do not have a
physical presence or employees or property there. The
application of existing laws and regulations to the Internet or
our business, or the adoption of any new legislation or
regulations applicable to the Internet or our business, could
materially adversely affect our financial condition and
operating results.

Employees

As of July 31, 2003, we had 367 employees.
Of these employees, 270 were principally engaged in
operations, 50 were principally engaged in sales and
marketing, 14 were principally engaged in product
development and 33 were principally engaged in finance and
administration. None of our employees is party to a collective
bargaining agreement and we believe our relationship with our
employees is good. We also retain consultants and independent
contractors on a regular basis to assist in the completion of
projects.

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 Web site, free of charge, as soon as reasonably practicable
after we file such material with, or furnish it to the
Securities and Exchange Commission. Our Internet address is
http://www.navisite.com. The contents of our Web site are not
part of this annual report on Form 10-K, and our Internet
address is included in this document as an inactive textual
reference only.

Certain Risk Factors That May Affect Future
Results

The risks and uncertainties described below
are not the only risks we face. Additional risks and
uncertainties not presently known to us or currently deemed
immaterial may also impair our business operations. If any of
the following risks actually occurs, our financial condition and
operating results could be materially adversely
affected.

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We have a history of losses and may never
achieve profitability and may not continue as a going
concern.Since our incorporation
in 1998, we have experienced operating losses and negative cash
flows for each quarterly and annual period. As of July 31,
2003, we had approximately $3.9 million of cash and cash
equivalents, a working capital deficit of approximately
$15.2 million and had incurred losses since our
incorporation resulting in an accumulated deficit of
approximately $407 million. During the fiscal year ended
July 31, 2003, we had a net loss of approximately
$69.5 million. We anticipate that we will continue to incur
net losses in the future. We also have significant fixed
commitments, including with respect to real estate, machinery
and equipment leases. As a result, we can give no assurance that
we will achieve profitability or be capable of sustaining
profitable operations. If we are unable to reach and sustain
profitability, we risk depleting our working capital balances
and our business will be materially adversely affected.

Our available cash, combined with the funds
available to us under the Silicon Valley Bank financing
agreement, may not be sufficient to meet our needs through the
end of fiscal year 2004. In addition, the financing agreement
with Silicon Valley Bank includes various covenants and
restrictions that may affect our ability to operate our
business. To the extent that we are not able to comply with the
covenants and restrictions, we may be unable to borrow
additional amounts and outstanding amounts may become due on an
accelerated basis, which would adversely affect our liquidity.
Further, we will more than likely need to raise additional funds
to remain a going concern. Our projections for cash usage are
based on a number of assumptions, including: (i) our
ability to retain customers in light of market uncertainties and
our uncertain future; (ii) our ability to collect accounts
receivables in a timely manner; (iii) our ability to
effectively integrate recent acquisitions and realize forecasted
cash savings synergies; and (iv) our ability to achieve
expected other cash expense reductions. Further, our projected
use of cash and business results could be affected by continued
market uncertainties, including delays or restrictions in IT
spending and any merger or acquisition activity. Accordingly, we
will more than likely need to raise additional funds to continue
as a going concern and such funds may not be available or may
not be available on favorable terms.

In recent years, we have generally financed our
operations with proceeds from selling shares of our stock and
borrowing funds. There can be no assurance that we will be able
to sell any such securities or borrow funds in the future at
favorable terms or at all. In addition, even if we find outside
funding sources, we may be required to issue to such outside
sources securities with greater rights than those currently
possessed by holders of our common stock. We may also be
required to take other actions, which may lessen the value of
our common stock or dilute our common stockholders, including
borrowing money on terms that are not favorable to us or issuing
additional equity securities. If we are required to raise money
in the future and we experience difficulties doing so, our
business will be materially adversely affected.

A significant portion of our revenue comes
from one customer and, if we lost this customer, it would have a
significant adverse impact to our business results and cash
flow.The New York State
Department of Labor, a customer of ClearBlue Technologies
Management, Inc. (CBTM), one of our wholly-owned
subsidiaries which, in June 2002, acquired certain assets from
the bankrupt estate of AppliedTheory, Inc., represented
approximately 26% of our consolidated revenue for the fiscal
year ended July 31, 2003. Although the New York State
Department of Labor has been a long-term customer of CBTM, we
cannot guarantee that we will be able to retain this customer or
to maintain the same level of services to or revenue from such
customer. This contract with the New York State Department of
Labor expires in June 2005, provided, however, the New York
State Department of Labor has the right to terminate the
contract at any time by providing us with 60 days notice.
If we were to lose this customer or suffer a material reduction
in the revenue generated from this customer, it would have a
significant adverse impact on our business results and cash
flows. The loss of a significant amount of business with this
customer, or any other key customer, would have a material
adverse effect on our business, financial condition and results
of operations. We believe that we will continue to derive the
vast majority of our operating revenue from sales to a small
number of customers.

Atlantic Investors and its affiliates,
collectively, own a majority of our outstanding common stock and
may have interests that conflict with the interests of our other
stockholders.At
September 30, 2003, Atlantic Investors and its affiliates
owned, directly or indirectly, approximately 73% of the
outstanding capital stock of NaviSite, as reported on
Schedule 13D/A by Atlantic Investors, LLC on
August 28, 2003. In addition, Atlantic Investors holds a
promissory note issued by NaviSite in the principal amount of
$3.0 million. In

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addition, Atlantic Investors has the power,
acting alone, to elect a majority of our Board of Directors and
has the ability to determine the outcome of any corporate action
requiring stockholder approval, regardless of how our other
stockholders may vote. Under Delaware law, Atlantic Investors is
able to exercise its voting power by written consent, without
convening a meeting of the stockholders, which means that
Atlantic Investors could effect a sale or merger of NaviSite
without the consent of our other stockholders. Atlantic
Investors ownership of a majority of our outstanding
common stock may have the effect of delaying, deterring or
preventing a change in control of NaviSite or discouraging a
potential acquiror from attempting to obtain control of us,
which in turn could adversely affect the market price of our
common stock.


Some of the members of our management group also
serve as members of the management group of Atlantic Investors
and its affiliates. As a result, these NaviSite officers and
directors may face potential conflicts of interest.
Specifically, these NaviSite officers and directors may be
presented with situations in their capacity as officers or
directors of NaviSite that conflict with their fiduciary
obligations to Atlantic Investors or to another subsidiary or
affiliate. Atlantic Investors may have interests that conflict
with the interests of our other stockholders.

Integration of acquisitions may result in
disruptions to our business or distractions of our management
due to difficulties in integrating and assimilating acquired
personnel and operation, and such integrations may not proceed
as planned.On December 31,
2002, we acquired CBTM. On February 4, 2003, we acquired
Avasta. On April 2, 2003, we acquired Conxion. On
May 16, 2003, we acquired the Interliant Assets. On
August 8, 2003, we acquired all of the shares of six
(6) wholly-owned subsidiaries of ClearBlue Technologies and
the revenues and expenses of four (4) additional
wholly-owned subsidiaries. In order to successfully integrate
the operations, products and people of CBTM, Avasta, Conxion,
certain former wholly-owned subsidiaries of ClearBlue
Technologies and the Interliant Assets, we will have to devote a
significant amount of management resources. Integrating and
assimilating acquired operations, technologies and personnel and
changes in management or other key personnel may prove difficult
and may harm relationships with our customers and employees. We
cannot assure you that the combined businesses, assets or
technologies will generate sufficient revenue to offset the
associated costs or other adverse effects. In addition, these
businesses may not produce the revenues, cash savings, earnings
or business synergies that we anticipated, and an acquired
product, service or technology might not perform as we expected.
As a result, we may incur higher costs, and realize lower
revenues than we had anticipated.

Our strategy of expanding our business
through acquisitions of other businesses and technologies
presents special risks.We intend
to continue to expand our business through the acquisition of
businesses, technologies, products and services from other
businesses. Acquisitions involve a number of special problems
and risks, including:



| |   |                                                                                                                                                                                                                           
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | difficulty integrating acquired technologies,
    operations and personnel with the existing businesses;                                                                                                                  
|
| |  | diversion of managements attention in
    connection with both negotiating the acquisitions and
    integrating the businesses;                                                                                          
|
| |  | strain on managerial and operational resources as
    management tries to oversee larger operations;                                                                                                                      
|
| |  | inability to retain management and other key
    personnel of the acquired businesses;                                                                                                                                    
|
| |  | changes in management and key personnel of
    acquired businesses may harm relationships with the acquired
    businesses customers and employees;                                                                      
|
| |  | exposure to unforeseen liabilities of acquired
    companies;                                                                                                                                                             
|
| |  | increased risk of costly and time-consuming
    litigation, including stockholder lawsuits;                                                                                                                               
|
| |  | potential issuance of securities in connection
    with an acquisition with rights that are superior to the rights
    of holders of our common stock, or which may have a dilutive
    effect on the common stockholders;
|
| |  | the need to incur additional debt or use cash; and                                                                                                                                                                        

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| |   |                                                                                                                                       
| | - | --------------------------------------------------------------------------------------------------------------------------------------
| |  | the requirement to record potentially significant
    additional future operating costs for the amortization of
    intangible assets.

We may not be able to successfully address these
problems. Moreover, our future operating results will depend to
a significant degree on our ability to successfully integrate
acquisitions and manage operations and cross-sell our service
offerings while also controlling expenses and cash burn. We
cannot assure you that the acquisitions will be successfully
identified and completed or that, if one or more acquisitions
are completed, the acquired business, assets or technologies
will generate sufficient revenue to offset the associated costs
or other adverse effects.

If the market for Internet commerce and
communication does not continue, or it decreases, there may be
insufficient demand for our services and, as a result, our
business strategy and objectives may
fail.The increased use of the
Internet for retrieving, sharing and transferring information
among businesses and consumers has developed only recently, and
the market for the purchase of products and services over the
Internet is still relatively new and emerging. If acceptance and
growth of the Internet as a medium for commerce and
communication does not continue or decreases, our business
strategy and objectives may fail because there may not be
sufficient market demand for our hosting and application
management services. Our growth will be substantially impaired
if the market for hosting and application management services
fails to continue to develop or if we cannot continue to achieve
broad market acceptance.

Our customer base includes a significant
number of small start-up businesses that face increased risk of
loss of funding depending upon the availability of private
and/or public funding.Many of our
customers are small start-up businesses that have traditionally
been initially funded by venture capital firms and then through
public securities offerings. If the market for small start-up
businesses is not supported by the private investors who have
funded these customers, we face the risk that these customers
may cease, curtail or limit operations hosted by us. We have
experienced and may continue to experience a loss of revenue
associated with these customers and will then have to increase
sales to other businesses using the Internet in order to
preserve and grow our revenue.

A failure to meet customer expectations
could result in lost revenues, increased expenses, negative
publicity and claims for damages.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 or no charge;                                                                                                                                                                
|
| |  | negative publicity about NaviSite, which could
    adversely affect our ability to attract or retain customers; and                                                                                                                                   
|
| |  | claims by customers for substantial damages
    against NaviSite, regardless of our responsibility for such
    failure, which may not be covered by insurance policies and
    which may not be limited by contractual terms of their
    engagement.

Our ability to successfully market our
services could be substantially impaired if we are unable to
deploy new Internet applications or if new Internet applications
deployed by us prove to be unreliable, defective or
incompatible.We 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 Internet applications suffer from reliability,
quality or compatibility problems, market acceptance of our
services could be greatly hindered and our ability to attract
new customers could be adversely affected. We cannot assure you
that new applications deployed by us will be free from any
reliability, quality or compatibility problems. If we incur
increased costs or are unable, for technical or other reasons,
to host and manage new Internet applications or enhancements of
existing applications, our ability to successfully market our
services could be substantially impaired.

To succeed, we must respond to the rapid
changes in the technology sector.The markets for the technology-related products and services we
offer are characterized by rapidly changing technology, evolving
industry standards, frequent new service introductions, shifting
distribution channels and changing customer

17



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demands. Our success will depend on our ability
to adapt to this rapidly evolving marketplace. We may not be
able to adequately adapt our services or to acquire new services
that can compete successfully. In addition, we may not be able
to establish and maintain effective distribution channels.


The market in which we operate is highly
competitive, and we may lack the financial and other resources,
expertise or capability needed to capture increased market share
or maintain market share.We
compete in the hosting and application management services
market. This market is rapidly evolving, highly competitive and
likely to be characterized by over capacity and industry
consolidation. We believe that participants in this market must
grow rapidly and achieve a significant presence to compete
effectively. 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.
We may lack the financial and other resources, expertise or
capability needed to capture increased market share in this
environment in the future.

Any interruptions in, or degradation of,
our private transit Internet connections could result in the
loss of customers or hinder our ability to attract new
customers.Our customers rely on
our ability to move their digital content as efficiently as
possible to the people accessing their Web sites and Internet
applications. We utilize our direct private transit Internet
connections to major network providers as a means of avoiding
congestion and resulting performance degradation at public
Internet exchange points. We rely on these telecommunications
network suppliers to maintain the operational integrity of their
networks so that our private transit Internet connections
operate effectively.

Increased costs associated with our private
transit Internet connections could result in the loss of
customers or significant increases in operating
costs.Our private transit
Internet connections are already more costly than alternative
arrangements commonly utilized to move Internet traffic. If
providers increase the pricing associated with utilizing their
bandwidth, we may be required to identify alternative methods to
distribute our customers digital content. We cannot assure
you that our customers will continue to be willing to pay the
higher costs associated with direct private transit or that we
could effectively move to another network approach. If we were
unable to access alternative networks to distribute our
customers digital content on a cost-effective basis or to
pass any additional costs on to our customers, our operating
costs would increase significantly.

If we are unable to maintain existing and
develop additional relationships with Internet application
software vendors, the sales and marketing of our service
offerings may be unsuccessful.We
believe that to penetrate the market for hosting and application
management services we must maintain existing and develop
additional relationships with industry-leading Internet
application software vendors and other third parties. We license
or lease select software applications from Internet application
software vendors. The loss of our ability to continually obtain
and utilize any of these applications could materially impair
our ability to provide services to our customers or require us
to obtain substitute software applications that may be of lower
quality or performance standards or at greater cost. In
addition, because we generally license applications on a
non-exclusive basis, our competitors may license and utilize the
same software applications. In fact, many of the companies with
which we have strategic relationships currently have, or could
enter into, similar license agreements with our competitors or
prospective competitors. We cannot assure you that software
applications will continue to be available to us from Internet
application 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.

We depend on third-party software, systems
and services.We rely on products
and services of third-party providers in our business
operations. There can be no assurance that we will not
experience operational problems attributable to the
installation, implementation, integration, performance, features
or functionality of such third-party software, systems and
services. Any interruption in the availability or usage of the
products and services provided by third parties could have a
material adverse effect on our business, financial condition or
results of operations.

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We purchase key components of our
infrastructure from a limited number of suppliers, including
networking equipment.We cannot
assure you that we will have the necessary hardware or parts on
hand or that our suppliers will be able to provide them in a
timely manner in the event of equipment failure. Our ability to
obtain and continue to maintain the necessary hardware or parts
on a timely basis could result in sustained equipment failure
and a loss of revenue due to customer loss or claims for service
credits under our service level guarantees. Our ability to meet
the needs of a substantial number of customers while maintaining
superior performance is largely unproven. If our network
infrastructure is not scalable, we may not be able to provide
our services to additional customers, which would result in no
increase in, and may decrease, revenue.

Our decision to discontinue our practice,
on a prospective basis, of obtaining equipment under leases and
subsequently renting the equipment to our customers may have a
material adverse effect on our business, future condition and
business operations.New customers
and current customers seeking to renew their agreements will
have to obtain equipment directly from equipment vendors. We may
not be successful in attracting new customers who prefer to
obtain equipment from their service providers. Current customers
may not renew their agreements, but rather, may seek a hosting
provider who would also rent equipment directly to them to
satisfy their equipment needs. If we are unable to keep our
current customers and attract new customers due to our
discontinuation of obtaining equipment, our business, financial
condition and results of operations could be materially
adversely affected.

Our network infrastructure could fail,
which would impair our ability to provide guaranteed levels of
service and could result in significant operating
losses.To provide our customers
with guaranteed levels of service, we must operate our network
infrastructure 24 hours per day, seven days per week
without interruption. In order to operate in this manner, we
must protect our network infrastructure, equipment and customer
files against damage from human error, natural disasters,
unexpected equipment failure, power loss or telecommunications
failures, 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 such a disaster. We have experienced service interruptions in
the past, and any future service interruptions could require us
to spend substantial amounts of money to replace equipment or
facilities, entitle customers to claim service credits under our
service level guarantees, cause customers to seek damages for
losses incurred, cause customers to seek alternate providers, or
make it more difficult for us to attract new customers, retain
current customers or enter into additional strategic
relationships. Any of these occurrences could result in
significant operating losses.

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

The misappropriation of our proprietary
rights could result in the loss of our competitive advantage in
the market.We rely on a
combination of trademark, service mark, copyright and trade
secret laws and contractual restrictions to establish and
protect our proprietary rights. We do not own any patents that
would prevent or inhibit competitors from using our technology
or entering our market. We cannot assure you that the
contractual arrangements or other steps taken by us to protect
our proprietary rights will prove sufficient to

19



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prevent misappropriation of our proprietary
rights or to deter independent, third-party development of
similar proprietary assets. In addition, we provide our services
in other countries where the laws may not afford adequate
protection for our proprietary rights.


Third-party infringement claims against our
technology suppliers, customers or us could result in
disruptions in service, the loss of customers or costly and
time-consuming litigation.We
license or lease most technologies used in the Internet
application services that we offer. Our technology suppliers may
become subject to third-party infringement or other claims and
assertions, which could result in their inability or
unwillingness to continue to license their technology to us. We
expect that our customers and we increasingly will be subject to
third-party infringement claims as the number of Web sites and
third-party service providers for Internet-based businesses
grows. We cannot assure you that third parties will not assert
claims against us in the future or that these claims will not be
successful. Any infringement claim as to our technologies or
services, regardless of its merit, could result in delays in
service, installation or upgrades, the loss of customers or
costly and time-consuming litigation, or require us to enter
into royalty or licensing agreements.

We may be subject to legal claims in
connection with the information disseminated through our
network, which could have the effect of diverting
managements attention and requires us to expend
significant financial resources.We may face potential direct and indirect liability for claims
of defamation, negligence, copyright, patent or trademark
infringement, violation of securities laws and other claims
based on the nature and content of the materials disseminated
through our network. For example, lawsuits may be brought
against us claiming that content distributed by some of our
current or future customers may be regulated or banned. In these
and other instances, we may be required to engage in protracted
and expensive litigation 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 complaints against service
providers that enable such activities, particularly where
recipients view the materials received as offensive. We have in
the past received, and may in the future receive, letters from
recipients of information transmitted by our customers objecting
to such transmission. Although we prohibit our customers by
contract from spamming, we cannot assure you that our customers
will not engage in this practice, which could subject us to
claims for damages.

The emergence and growth of a market for
our Internet application services will be impaired if third
parties do not continue to develop and improve the Internet
infrastructure.The recent growth
in the use of the Internet has caused frequent periods of
performance degradation, requiring the upgrade of routers and
switches, telecommunications links and other components forming
the infrastructure of the Internet-by-Internet service providers
and other organizations with links to the Internet. Any
perceived degradation in the performance of the Internet as a
means to transact business and communicate could undermine the
benefits and market acceptance of our services. Our services are
ultimately limited by, and dependent upon, the speed and
reliability of hardware, communications services and networks
operated by third parties. Consequently, the market for our
services will be impaired if improvements are not made to the
entire Internet infrastructure to alleviate overloading and
congestion.

We must develop and maintain positive brand
name awareness.We believe that
establishing and maintaining our brand name is essential to
expanding our business and attracting new customers. We also
believe that the importance of brand name recognition will
increase in the future as technology-related companies continue
to differentiate themselves. Promotion and enhancement of our
brand name will depend largely on our ability to provide
consistently high-quality services. If we are unable to provide
high-quality services, the value of our brand names will suffer
and our business prospects would be adversely affected.

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

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that the continued service of key personnel is a
key component of the future success of our business. The
familiarity of these individuals with the hosting and
application management industry in which we operate makes them
especially critical to our success. In addition, our success is
dependent on our ability to attract, train, retain and motivate
high quality personnel. The loss of the services of any of our
executive officers or key employees may harm our business,
particularly the loss of key members of our sales and marketing
teams or key technical service personnel could adversely affect
relations with our customers. Our success also depends on our
continuing ability to attract, train, retain and motivate other
highly qualified technical and managerial personnel. Competition
for such personnel is intense. The departure of Arthur P.
Becker, as our Chief Executive Officer and President, would have
negative ramifications on our customer relations and operations.
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 key personnel. Any loss of key technical personnel
could adversely affect the stability of our infrastructure and
our ability to provide the guaranteed service levels our
customers expect. Over the past year, we have had significant
reductions-in-force and a number of departures of key
management. In the event that future reductions or departures of
employees occur, our ability to successfully execute our
business strategy, or to continue to provide services to our
customers, could be adversely affected. Our business requires
individuals with significant levels of Internet application
expertise to win consumer confidence in outsourcing the hosting
and management of mission-critical applications. Qualified
technical personnel are likely to remain a limited resource for
the foreseeable future. We may not be able to retain or hire the
necessary personnel to implement our business strategy or may
need to provide higher compensation to such personnel than we
currently anticipate.


Our common stockholders have experienced
dilution because of conversions of convertible notes by Atlantic
Investors and its affiliates and the issuance of new shares of
common stock in connection with acquisition of companies or
businesses. You may experience additional dilution in the
future.On December 12, 2002,
ClearBlue Technologies, Inc. and its affiliates converted
$20 million of the $65 million of convertible notes
obtained from CMGI and Hewlett-Packard Financial Services
Company into 5,128,205 shares of our common stock. In
February 2003 and September 2003, we issued an
aggregate of 410,353 shares of our common stock in
connection with our acquisition of Avasta, Inc. On June 17,
2003, ClearBlue Technologies and its affiliates converted
$41.2 million of the then outstanding $45 million
convertible note into 10,559,248 shares of our common stock
at a conversion price of $3.90 per share. On August 8,
2003, we issued 1,100,000 shares of our common stock to
ClearBlue Technologies in connection with the acquisition of all
of the shares of six (6) wholly-owned subsidiaries of
ClearBlue Technologies and the revenues and expenses of
four (4) of its other wholly-owned subsidiaries. Although
no convertible promissory notes are presently outstanding, if
additional funds are raised through the issuance of additional
equity or convertible debt securities or additional securities
are issued in connection with future acquisitions and option
exercises, our stockholders percentage of ownership will
be reduced and they may experience additional dilution.

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



| |   |                                                                                 
| | - | --------------------------------------------------------------------------------
| |  | reduction of market demand and/or acceptance from
    our services;             
|
| |  | oversupply of data center space in the industry;                                
|
| |  | our ability to develop, market and introduce new
    services on a timely basis;
|
| |  | the length of the sales cycle for our services;                                 
|
| |  | the timing and size of sales of our services;                                   
|
| |  | the budgeting cycles of our customers and
    potential customers;              
|
| |  | downward price adjustments by our competitors;                                  
|
| |  | changes in the mix of services provided by our
    competitors;                 

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| |   |                                                                                                                           
| | - | --------------------------------------------------------------------------------------------------------------------------
| |  | technical difficulties or system downtime
    affecting the Internet generally or our hosting operations
    specifically;
|
| |  | our ability to meet any increased technological
    demands of our customers;                                             
|
| |  | the amount and timing of costs related to our
    marketing efforts and service introductions; and                        
|
| |  | economic conditions specific to our industry.                                                                             

Due to the above factors, we believe that
quarter-to-quarter or period-to-period comparisons of our
operating results are not a good indication 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 market price of our
common stock would likely fall.

The price of our common stock has been
volatile and our common stock could be delisted from the Nasdaq
SmallCap Market.The market price
of our common stock has been, and is likely to continue to be,
volatile, experiencing wide fluctuations. In recent years, the
stock market has experienced significant price and volume
fluctuations, which have particularly impacted the market prices
of equity securities of many companies providing
technology-related products and services. The volatility in the
stock market often has been unrelated to the operating
performance of particular companies. In the past, securities
class action litigation often has been brought against companies
that experience volatility in the market price of their
securities. Whether or not meritorious, litigation brought
against us could result in substantial costs and a diversion of
managements attention and resources. The market price of
our common stock may also fluctuate substantially due to a
variety of other factors, including: public announcements
concerning us, our competitors, or our industry; the
introduction or market acceptance of new service offerings by us
or our competitors; changes in accounting principles; sales of
our common stock by existing stockholders; and the loss of any
of our key personnel.

Our common stock currently trades on the Nasdaq
SmallCap Market. If we fail to meet the Nasdaq SmallCap Market
maintenance standards, such as by having the market price of our
common stock trade below $1.00 per share for an extended period
of time, our common stock could be delisted from Nasdaq. Such
delisting would have an adverse effect on our business and our
stock price. We could be delisted from the Nasdaq SmallCap
Market and may be traded on the over-the-counter electronic
bulletin board, which is operated by the National Association of
Securities Dealers, Inc. If our common stock is delisted from
the Nasdaq SmallCap Market, this could result in a number of
negative implications, including continued reduced liquidity in
our common stock, as well as the potential loss of confidence by
suppliers, customers and employees, fewer business development
and acquisition opportunities and greater difficulty in
obtaining financing.

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

Difficulties presented by international
economic, political, legal, accounting and business factors
could harm our business in international
markets.We operate a data center
in the United Kingdom. In furtherance of our international
activities, we may enter into joint ventures or outsourcing
agreements with

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third parties, acquire complementary businesses
or operations, or establish and maintain new operations outside
of the United States. Some risks inherent in conducting business
internationally include:




| |   |                                                                                                                      
| | - | ---------------------------------------------------------------------------------------------------------------------
| |  | unexpected changes in regulatory, tax and
    political environments;                                                
|
| |  | longer payment cycles and problems collecting
    accounts receivable;                                               
|
| |  | geopolitical risks such as political and economic
    instability and the possibility of hostilities among countries;
|
| |  | reduced protection of intellectual property
    rights;                                                              
|
| |  | fluctuations in currency exchange rates;                                                                             
|
| |  | ability to secure and maintain the necessary
    physical and telecommunications infrastructure;                     
|
| |  | challenges in staffing and managing foreign
    operations; and                                                      
|
| |  | employment laws and practices in foreign
    countries.                                                              

Furthermore, some foreign governments have
enforced laws and regulations on content distributed over the
Internet that are more restrictive than those currently in place
in the United States. Any one or more of these factors could
adversely affect our contemplated future international
operations and consequently, our business.






|        |           
|------- | ----------
|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 center in the United Kingdom.
The table below sets forth a list of our offices and data
centers:

|                  |  |                        |  |                |        |                  |  |  |                | 
|----------------- |  | ---------------------- |  | -------------- | ------ | ---------------- |  |  | -------------- | 
|                  |  |                        |  | Square Footage |        |                 
|                  |  |                        |  | Leased         |        |                 
|Location          |  | Type                   |  | (Approximate)  |        | Lease Expiration
|                  |  |                        |  |                |        |                 
|Andover, MA       |  | Office                 |  |                | 16,500 |                  |  |  | March 2006     | 
|Andover, MA       |  | Data Center and Office |  |                | 90,000 |                  |  |  | January 2012   | 
|San Jose, CA      |  | Data Center and Office |  |                | 66,350 |                  |  |  | November 2006  | 
|La Jolla, CA      |  | Office                 |  |                | 16,810 |                  |  |  | December 2006  | 
|Los Angeles, CA   |  | Data Center            |  |                | 34,711 |                  |  |  | February 2009  | 
|San Francisco, CA |  | Office                 |  |                | 6,905  |                  |  |  | January 2006   | 
|Syracuse, NY      |  | Data Center            |  |                | 21,246 |                  |  |  | November 2008  | 
|Syracuse, NY      |  | Office                 |  |                | 44,002 |                  |  |  | December 2007  | 
|Syracuse, NY      |  | Office                 |  |                | 5,016  |                  |  |  | May 2009       | 
|New York, NY      |  | Office                 |  |                | 1,500  |                  |  |  | October 2003   | 
|Chicago, IL       |  | Office                 |  |                | 22,413 |                  |  |  | February 2008  | 
|Chicago, IL       |  | Data Center            |  |                | 6,800  |                  |  |  | January 2009   | 
|Oak Brook, IL     |  | Data Center            |  |                | 16,780 |                  |  |  | September 2009 | 
|Herndon, VA       |  | Office                 |  |                | 16,611 |                  |  |  | July 2005      | 
|Vienna, VA        |  | Office                 |  |                | 22,270 |                  |  |  | July 2005      | 
|Vienna, VA        |  | Data Center and Office |  |                | 23,715 |                  |  |  | February 2010  | 
|Houston, TX       |  | Data Center and Office |  |                | 14,772 |                  |  |  | October 2005   | 
|Las Vegas, NV     |  | Data Center            |  |                | 28,560 |                  |  |  | February 2010  | 
|Milwaukee, WI     |  | Data Center            |  |                | 5,200  |                  |  |  | March 2010     | 

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We believe that these offices and data centers
are adequate to meet our foreseeable requirements or that
suitable additional or substitute space will be available on
commercially reasonable terms. We currently sublease a portion
of our premises, approximately 9,100 square feet in Vienna,
Virginia and approximately 8,400 square feet in La Jolla,
California. We also operate, but are not the lessees of,
additional data centers in Dallas, Santa Clara, New York, San
Francisco and the United Kingdom.






|        |                  
|------- | -----------------
|Item 3. | Legal Proceedings

On or about June 13, 2001, Stuart Werman and
Lynn McFarlane filed a lawsuit against us, BancBoston Robertson
Stephens, an underwriter of our initial public offering in
October 1999, Joel B. Rosen, our then chief executive officer,
and Kenneth W. Hale, our then chief financial officer. The suit
was filed in the United States District Court for the Southern
District of New York. The suit generally alleges that the
defendants violated federal securities laws by not disclosing
certain actions allegedly taken by Robertson Stephens in
connection with our initial public offering. The suit alleges
specifically that Robertson Stephens, in exchange for the
allocation to its customers of shares of our common stock sold
in our initial public offering, solicited and received from its
customers agreements to purchase additional shares of our
common stock in the aftermarket at pre-determined prices. The
suit seeks unspecified monetary damages and certification of a
plaintiff class consisting of all persons who acquired shares of
our common stock between October 22, 1999 and
December 6, 2000.Three other substantially similar
lawsuits were filed between June 15, 2001 and July 10,
2001 by Moses Mayer (filed June 15, 2001), Barry Feldman
(filed June 19, 2001), and Binh Nguyen (filed July 10,
2001). Robert E. Eisenberg, our president at the time of the
initial public offering in 1999, also was named as a defendant
in the Nguyen lawsuit.

On or about June 21, 2001, David Federico
filed in the United States District Court for the Southern
District of New York a lawsuit against us, Mr. Rosen,
Mr. Hale, Robertson Stephens and other underwriter
defendants including J.P. Morgan Chase, First Albany Companies,
Inc., Bank of America Securities, LLC, Bear Stearns &
Co., Inc., B.T. Alex. Brown, Inc., Chase Securities, Inc., CIBC
World Markets, Credit Suisse First Boston Corp., Dain Rauscher,
Inc., Deutsche Bank Securities, Inc., The Goldman Sachs Group,
Inc., J.P. Morgan & Co., J.P. Morgan Securities, Lehman
Brothers, Inc., Merrill Lynch, Pierce, Fenner & Smith, Inc.,
Morgan Stanley Dean Witter & Co., Robert Fleming, Inc.
and Salomon Smith Barney, Inc. The suit generally alleges that
the defendants violated the anti-trust laws and the federal
securities laws by conspiring and agreeing to raise and increase
the compensation received by the underwriter defendants by
requiring those who received allocation of initial public
offering stock to agree to purchase shares of manipulated
securities in the after-market of the initial public offering at
escalating price levels designed to inflate the price of the
manipulated stock, thus artificially creating an appearance of
demand and high prices for that stock, and initial public
offering stock in general, leading to further stock offerings.
The suit also alleges that the defendants arranged for the
underwriter defendants to receive undisclosed and excessive
brokerage commissions and that, as a consequence, the
underwriter defendants successfully increased investor interest
in the manipulated initial public offering of securities and
increased the underwriter defendants individual and
collective underwritings, compensation, and revenues. The suit
further alleges that the defendants violated the federal
securities laws by issuing and selling securities pursuant to
the initial public offering without disclosing to investors that
the underwriter defendants in the offering, including the lead
underwriters, had solicited and received excessive and
undisclosed commissions from certain investors. The suit seeks
unspecified monetary damages and certification of a plaintiff
class consisting of all persons who acquired shares of our
common stock between October 22, 1999 and June 12,
2001.

Those five cases, along with lawsuits naming more
than 300 other issuers and over 50 investment banks which have
been sued in substantially similar lawsuits, have been assigned
to the Honorable Shira A. Scheindlin (the Court) for
all pretrial purposes (the IPO Securities
Litigation). On September 6, 2001, the Court entered
an order consolidating the five individual cases involving us
and designating Werman v. NaviSite, Inc., et al., Civil
Action No. 01-CV-5374 as the lead case. A consolidated,
amended complaint was filed thereafter on April 19, 2002
(the Class Action Litigation) on behalf of
plaintiffs Arvid Brandstrom and Tony Tse against 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

24



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##### Table of Contents



Albany and against us and Messrs. Rosen,
Hale and Eisenberg (collectively, the NaviSite
Defendants). Plaintiffs uniformly allege that all
defendants, including the NaviSite Defendants, violated the
federal securities laws (i.e., Sections 11 and 15 of the
Securities Act, Sections 10(b) and 20(a) of the Exchange
Act and Rule 10b-5) by issuing and selling our common stock
pursuant to the October 22, 1999, initial public offering,
without disclosing to investors that some of the underwriters of
the offering, including the lead underwriters, had solicited and
received extensive and undisclosed agreements from certain
investors to purchase aftermarket shares at pre-arranged,
escalating prices and also to receive additional commissions
and/or other compensation from those investors. At this time,
plaintiffs have not specified the amount of damages they are
seeking in the Class Action Litigation.


Between July and September 2002, the parties to
the IPO Securities Litigation briefed motions to dismiss filed
by the underwriter defendants and the issuer defendants,
including NaviSite. On November 1, 2002, the Court held
oral argument on the motions to dismiss. The plaintiffs have
since agreed to dismiss the claims against Messrs. Rosen,
Hale and Eisenberg without prejudice, in return for their
agreement to toll any statute of limitations applicable to those
claims. By stipulation entered by the Court on November 18,
2002, Messrs. Rosen, Hale and Eisenberg were dismissed
without prejudice from the Class Action Litigation. On
February 19, 2003, an opinion and order was issued on
defendants motion to dismiss the IPO Securities
Litigation, essentially denying the motions to dismiss of all 55
underwriter defendants and of 185 of the 301 issuer defendants.

We believe that the allegations against us are
without merit and we intend to vigorously defend against the
plaintiffs claims. We are not able to predict the possible
outcome of the suits and their ultimate effect, if any, on our
financial condition.

In March 2001, we engaged Goldman
Sachs & Co. to serve as our financial advisor in
connection with the possible sale of all or a portion of
NaviSite. On September 17, 2002, Goldman made a written
demand for payment of a $3 million success fee in
connection with the September 2002 acquisition by ClearBlue of
the stock and convertible debt of NaviSite from CMGI and
Hewlett-Packard Financial Services Company. We have rejected
Goldmans demands, as we believe they are without merit. No
legal actions have been filed concerning the Goldman claim. As
this matter is in the initial stage, we are not able to predict
the possible outcome of this matter and the effect, if any, on
our financial condition.

On or about September 27, 2002, we received
a demand for a wage payment of $850,000 from our former
Procurement Director, Joseph Cloonan. We rejected the demand,
alleging that Mr. Cloonans claim is based, among
other things, on a potentially fraudulent contract.
Mr. Cloonan also claimed $40,300 for allegedly unpaid
accrued vacation and bonuses and that he may be statutorily
entitled to treble damages and legal fees. On October 11,
2002, NaviSite filed a civil complaint with the Massachusetts
Superior Court, Essex County, seeking a declaratory judgment and
asserting claims against Mr. Cloonan for civil fraud,
misrepresentation, unjust enrichment and breach of duty of
loyalty. We believe the allegations are without merit and intend
to vigorously defend against Mr. Cloonans claims. As
the litigation is in the initial discovery stage, we are not
able to predict the possible outcome of this matter and the
effect, if any, on our financial condition.

On October 28, 2002, ClearBlue Technologies
Management, Inc., one of our subsidiaries, filed a complaint in
United States District Court for the Southern District of New
York against Lighthouse International, alleging six causes of
action for copyright infringement, breach of contract, account
stated, unjust enrichment, unfair competition, and
misappropriation and/or conversion. The total claimed damages
are in the amount of $1,866,450. On or about January 16, 2003,
Lighthouse filed and served its answer and counterclaimed
against ClearBlue Technologies Management, Inc. claiming
$3,130,000 in damages and $5,000,000 in punitive relief.

On June 17, 2003, the U.S. Bankruptcy Court
for the Southern District of New York heard oral argument on
Lighthouses Motion for an Order Compelling the Debtor
(AppliedTheory) to Assume or Reject an Agreement, filed in
response to ClearBlue Technologies Management, Inc.s.
complaint, and the objections to Lighthouses motion filed
by ClearBlue Technologies Management and AppliedTheory.
Lighthouse made this motion on the basis that it never received
notice of ClearBlue Technologies Management assuming the
AppliedTheory contract for the LighthouseLink Web site. The
Bankruptcy Court declined to grant Light-

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##### Table of Contents



houses motion, and instead ordered that an
evidentiary hearing be conducted to determine whether Lighthouse
received appropriate notice of the proposed assignment of the
contract by AppliedTheory to ClearBlue Technologies Management.
The Bankruptcy Court ordered that the parties first conduct
discovery, and upon completion of discovery, which is expected
to be completed on or about the end of November 2003, the
Bankruptcy Court would schedule an evidentiary hearing on the
issue of notice.


As to the U.S. District Court matter, the
exchange of written discovery is near completion, with a number
of discovery disputes to be resolved by the Court in October
2003 at a discovery status conference. All depositions of
witnesses have been stayed pending completion of the Bankruptcy
Court evidentiary hearing. Because of the continuing discovery,
and the uncertain outcome of the evidentiary hearing before the
Bankruptcy Court, we are not able to predict the possible
outcome of this matter, if any, on our financial condition.

On December 12, 2002, our Board of
Directors, pursuant to authority previously granted by our
stockholders at the annual meeting of stockholders held on
December 19, 2001, approved a reverse stock split of our
common stock at a ratio of one-for-fifteen (1:15) (the
Reverse Split). The Reverse Split was effective on
January 7, 2003. On May 28, 2003 we received a letter
from Mr. Edward W. Roberts, as trustee of The Roberts
Family Trust, stating that in June 2002 the trust had purchased
13,000 shares of our common stock and due to the Reverse Split,
the trust now owns 866 shares of common stock (i.e. 13,000
shares divided by 15). As a result of the Reverse Split,
Mr. Roberts states an intention to institute a derivative
action requesting $7.5 million in damages. On
October 20, 2003, we received a letter dated
October 13, 2003, from Mr. Robertson, as trustee on
behalf of The Roberts Family Trust, stating his intention to
prove conspiracy and collusion relating to the
September 11, 2002 transactions between ClearBlue
Technologies, Inc. and Hewlett-Packard Financial Services
Company and relating to the later Reverse Split. No legal
actions have been filed concerning this matter. This matter is
in its initial stages and we are not able to predict the
possible outcome of this matter, and the effect, if any, on our
financial condition. We believe the claim is without merit and
intend to vigorously defend any action that may be brought
against us.

On October 14, 2003, we received a letter
purportedly on behalf of the former stockholders of Avasta
relating to the issuance of additional shares of common stock
pursuant to the earnout calculations pursuant to the Agreement
and Plan of Merger and Reorganization dated as of
January 29, 2003 among Avasta Corp., Avasta, Inc. and
NaviSite. No legal actions have been filed concerning this
matter. As this matter is in the initial stage, we are not able
to predict the possible outcome of this matter and the effect,
if any, on our financial condition.

We are also subject to other legal proceedings
and claims which arise in the ordinary course of our business.
In the opinion of management, the amount of ultimate liability
with respect to these actions will not materially affect our
consolidated financial position or results from our operations.






|        |                                                        
|------- | -------------------------------------------------------
|Item 4. | Submission of Matters to a Vote of Security
    Holders

No matters were submitted to a vote of security
holders during the fourth quarter of the fiscal year ended
July 31, 2003.

Executive Officers of NaviSite

Andrew Ruhan, age
41, has served as Chairman of the Board of NaviSite since
September 11, 2002. Since 2000, Mr. Ruhan has served
as Chief Executive Officer of ClearBlue Technologies, Inc., a
managed service provider based in San Francisco, California.
From 1998 to 2002, Mr. Ruhan was the co-founder and Chief
Executive Officer of GlobalSwitch Group, a data center company
in the United Kingdom. Prior to 1998, Mr. Ruhan was a
private investor. Mr. Ruhan and Gabriel Ruhan, also a
member of the Board of Directors and the Chief Operating Officer
of NaviSite, are brothers.

Arthur P. Becker,
age 53, has served as a director of NaviSite since
September 11, 2002 and its Chief Executive Officer and
President since February 2003. Since 2000, Mr. Becker has
served as Vice Chairman and a director of ClearBlue
Technologies, Inc. Mr. Becker is also a co-founder of
Atlantic Investors, LLC. For

26



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##### Table of Contents



the past five years, Mr. Becker has been a
private investor and since 1999, he has been a Managing Member
of Madison Technologies LLC, an investment fund that is focused
on technology and telecommunications companies, which is a
managing member of Atlantic Investors, LLC.


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

James W. Pluntze,
age 42, has served as Chief Financial Officer of NaviSite since
April 2003. From January 2003 to April 2003, Mr. Pluntze
served as a member of NaviSites Board of Directors and as
the chairman of its Audit Committee. From August 2002 until
April 2003, Mr. Pluntze served as Chief Financial Officer
of Lanthorn Technologies Inc., an energy technology company.
From May 2000 to June 2002, Mr. Pluntze served as Chief
Financial Officer of Guardent, Inc., a managed security services
provider. From August 1999 to May 2000, Mr. Pluntze was
Vice President of Finance of Razorfish, a global professional
services company engaged in the design, development and
implementation of e-business systems, and from April 1996 to
August 1999, Mr. Pluntze served in the same role at
International Integration Incorporated (i-Cube), a global
professional services company engaged in the design, development
and implementation of e-business systems which was acquired by
Razorfish.

Kenneth Drake, age
36, has served as General Counsel of NaviSite since September
2003 and Secretary since October 2003. From July 2001 to
September 2003, Mr. Drake served as a senior corporate
associate with the law firm of Heller Ehrman White and McAuliffe
LLP. From March 2000 to November 2000, Mr. Drake served as
General Counsel and Secretary of Phlair, Inc., an application
software company. Mr. Drake served as a legal consultant
from February 1999 to February 2000 and from January 2001 to
June 2001. From September 1992 to January 1999, Mr. Drake
served as a corporate associate with the law firm Sonnenschein
Nath & Rosenthal.




PART II






|        |                                                                          
|------- | -------------------------------------------------------------------------
|Item 5. | Market for Registrants Common Equity
    and Related Stockholder Matters

Price Range of Common Stock

Our common stock is currently traded on the
Nasdaq SmallCap Market under the symbol NAVI. As of
September 30, 2003, there were 121 holders of record of our
common stock. Because brokers and other institutions on behalf
of stockholders hold many of such shares, we are unable to
estimate the total number of stockholders represented by these
record holders. The following table sets forth for the periods
indicated the high and low sales prices for our common stock as
reported on the Nasdaq SmallCap Market and on The

27



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##### Table of Contents



Nasdaq National Market, and is adjusted to
reflect the effect of the January 7, 2003 one-for-fifteen
reverse stock split.


|                                     |                                               |               |   |       |  |  |   |      | 
|------------------------------------ | --------------------------------------------- | ------------- | - | ----- |  |  | - | ---- | 
|                                     |                                               |              
|                                     |                                               | Closing Price
|                                     |                                               |              
|                                     |                                               | High          |   | Low  
|                                     |                                               |               |   |      
|Fiscal Year Ended July 31,
    2003: |                                               |               |   |       |  |  |   |     
|                                     | May 1, 2003 through July 31, 2003             |               | $ | 3.60  |  |  | $ | 1.26 | 
|                                     | February 1, 2003 through April 30, 2003       |               |   | 1.78  |  |  |   | 1.02 | 
|                                     | November 1, 2002 through January 31,
    2003 |               |   | 4.35  |  |  |   | 1.78 | 
|                                     | August 1, 2002 through October 31, 2002       |               |   | 3.30  |  |  |   | 1.50 | 
|Fiscal Year Ended July 31,
    2002: |                                               |               |   |       |  |  |   |     
|                                     | May 1, 2002 through July 31, 2002             |               | $ | 3.90  |  |  | $ | 1.80 | 
|                                     | February 1, 2002 through April 30, 2002       |               |   | 5.40  |  |  |   | 3.15 | 
|                                     | November 1, 2001 through January 31,
    2002 |               |   | 9.15  |  |  |   | 3.90 | 
|                                     | August 1, 2001 through October 31, 2001       |               |   | 12.30 |  |  |   | 2.25 | 

We believe that a number of factors may cause the
market price of our common stock to fluctuate significantly. See
Item 1. Business  Certain Factors That May
Affect Future Results.

We have never paid cash dividends on our capital
stock. We currently anticipate retaining all available funds, if
any, to finance internal growth and product 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 Accounts Receivable
Financing Agreement dated May 27, 2003 with Silicon Valley
Bank prohibits the payment of cash dividends on our capital
stock.

Recent Sales of Unregistered
Securities

On May 27, 2003, NaviSite entered into an
Accounts Receivable Financing Agreement with Silicon Valley Bank
whereby NaviSite can finance up to a maximum of
$10.0 million based on eligible accounts receivables. As
part of the financing, on May 27, 2003, we issued warrants
to Silicon Valley Bank to purchase up to 165,000 shares of our
common stock with an exercise price of $2.50. The offers and
sales of these securities were effected without registration in
reliance on the exemption afforded by Section 4(2) of the
Securities Act of 1933, as amended, as a sale by NaviSite not
involving a public offering. No underwriters were involved in
the issuance and sale of these securities.

On June 17, 2003, ClearBlue Technologies,
Inc. and its affiliates converted $41.2 million of the then
outstanding $45 million of convertible notes into
10,559,248 shares of our common stock at a rate of $3.90 per
share. The shares of common stock were issued in reliance on
Section 3(a)(9) of the Securities Act of 1933, as amended,
as a security exchanged by the issuer with its existing security
holders exclusively where no commission or other remuneration is
paid or given directly or indirectly for soliciting such
exchange. No underwriters were involved with the issuance and
sale of the shares of common stock.

On August 8, 2003, we acquired all
outstanding shares of six (6) wholly-owned subsidiaries of
ClearBlue Technologies, Inc. and assumed the revenues and
expenses of four (4) of its additional wholly-owned
subsidiaries. Pursuant to the terms of the Stock and Asset
Purchase Agreement between NaviSite and ClearBlue Technologies,
Inc. dated August 8, 2003, we issued 1,100,000 shares of
our common stock on August 8, 2003 to ClearBlue
Technologies, Inc. The offers and sales of these securities were
effected without registration in reliance on the exemption
afforded by Section 4(2) of the Securities Act of 1933, as
amended, and Regulation D promulgated thereunder, as a sale
by NaviSite not involving a public offering. No underwriters
were involved in the issuance and sale of these shares of common
stock.

In September 2003, an additional 179,353 shares
of our common stock were issued to the former stockholders of
Avasta, Inc. as an earnout payment relating to the acquisition
of Avasta. The offers and sales of these securities were
effected without registration in reliance on the exemption
afforded by Section 4(2) of

28



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##### Table of Contents



the Securities Act of 1933, as amended, as a sale
by NaviSite not involving a public offering. No underwriters
were involved in the issuance and sale of these shares of common
stock.







|        |                                         
|------- | ----------------------------------------
|Item 6. | Selected Consolidated 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 Form 10-K. Historical results are not necessarily
indicative of results of any future period.

|                                                                           |                                                                      |                                            |        |         |         |      |        |         |          |      |         |        |          |   |        |        |         |   |        |       |         |  
|-------------------------------------------------------------------------- | -------------------------------------------------------------------- | ------------------------------------------ | ------ | ------- | ------- | ---- | ------ | ------- | -------- | ---- | ------- | ------ | -------- | - | ------ | ------ | ------- | - | ------ | ----- | ------- | -
|                                                                           |                                                                      |                                           
|                                                                           |                                                                      | Year Ended July 31,                       
|                                                                           |                                                                      |                                           
|                                                                           |                                                                      | 2003                                       |        | 2002    |         | 2001 |        | 2000    |          | 1999
|                                                                           |                                                                      |                                            |        |         |         |      |        |         |          |     
|                                                                           |                                                                      |                                           
|                                                                           |                                                                      | (In thousands, except per share data)     
|Revenue:                                                                   |                                                                      |                                            |        |         |         |      |        |         |          |      |         |        |          |   |        |        |         |   |        |      
|                                                                           | Revenue                                                              |                                            | $      | 61,445  |         |      | $      | 40,968  |          |      | $       | 66,358 |          |   | $      | 24,870 |         |   | $      | 3,461 |        
|                                                                           | Revenue, related parties                                             |                                            |        | 1,310   |         |      |        | 18,453  |          |      |         | 36,368 |          |   |        | 24,893 |         |   |        | 7,058 |        
|                                                                           |                                                                      |                                            |        |         |         |      |        |         |          |      |         |        |          |   |        |        |         |   |        |      
|                                                                           |                                                                      | Total revenue                              |        |         | 62,755  |      |        |         | 59,421   |      |         |        | 102,726  |   |        |        | 49,763  |   |        |       | 10,519  |  
|Cost of revenue                                                            |                                                                      |                                            | 56,585 |         |         |      | 67,000 |         |          |      | 127,155 |        |          |   | 68,496 |        |         |   | 20,338 |      
|Impairment of long lived assets                                            |                                                                      |                                            |       |         |         |      | 68,317 |         |          |      | 1,930   |        |          |   |       |        |         |   |       |      
|                                                                           |                                                                      |                                            |        |         |         |      |        |         |          |      |         |        |          |   |        |        |         |   |        |      
|                                                                           |                                                                      | Total cost of revenue                      |        |         | 56,585  |      |        |         | 135,317  |      |         |        | 129,085  |   |        |        | 68,496  |   |        |       | 20,338  |  
|                                                                           |                                                                      |                                            |        |         |         |      |        |         |          |      |         |        |          |   |        |        |         |   |        |      
|                                                                           |                                                                      | Gross profit (deficit)                     |        |         | 6,170   |      |        |         | (75,896  | )    |         |        | (26,359  | ) |        |        | (18,733 | ) |        |       | (9,819  | )
|Operating expenses:                                                        |                                                                      |                                            |        |         |         |      |        |         |          |      |         |        |          |   |        |        |         |   |        |      
|                                                                           | Product development                                                  |                                            |        | 950     |         |      |        | 5,281   |          |      |         | 14,072 |          |   |        | 5,197  |         |   |        | 2,620 |        
|                                                                           | Selling and marketing                                                |                                            |        | 5,829   |         |      |        | 9,703   |          |      |         | 32,251 |          |   |        | 22,805 |         |   |        | 6,888 |        
|                                                                           | General and administrative                                           |                                            |        | 18,785  |         |      |        | 19,272  |          |      |         | 33,011 |          |   |        | 12,270 |         |   |        | 4,823 |        
|                                                                           | Impairment and restructuring                                         |                                            |        | 6,903   |         |      |        | (2,633  | )        |      |         | 8,011  |          |   |        |       |         |   |        |      |        
|                                                                           |                                                                      |                                            |        |         |         |      |        |         |          |      |         |        |          |   |        |        |         |   |        |      
|                                                                           |                                                                      | Total operating expenses                   |        |         | 32,467  |      |        |         | 31,623   |      |         |        | 87,345   |   |        |        | 40,272  |   |        |       | 14,331  |  
|                                                                           |                                                                      |                                            |        |         |         |      |        |         |          |      |         |        |          |   |        |        |         |   |        |      
|                                                                           |                                                                      | Loss from operations                       |        |         | (26,297 | )    |        |         | (107,519 | )    |         |        | (113,704 | ) |        |        | (59,005 | ) |        |       | (24,150 | )
|Other income (expense):                                                    |                                                                      |                                            |        |         |         |      |        |         |          |      |         |        |          |   |        |        |         |   |        |      
|                                                                           | Interest income                                                      |                                            |        | 785     |         |      |        | 1,060   |          |      |         | 2,753  |          |   |        | 2,027  |         |   |        | 4     |        
|                                                                           | Interest expense                                                     |                                            |        | (43,289 | )       |      |        | (14,718 | )        |      |         | (8,042 | )        |   |        | (1,001 | )       |   |        | (347  | )      
|                                                                           | Other income (expense), net                                          |                                            |        | (719    | )       |      |        | (516    | )        |      |         | 292    |          |   |        | 9      |         |   |        | (39   | )      
|                                                                           |                                                                      |                                            |        |         |         |      |        |         |          |      |         |        |          |   |        |        |         |   |        |      
|                                                                           |                                                                      | Loss before income taxes                   |        |         | (69,520 | )    |        |         | (121,693 | )    |         |        | (118,701 | ) |        |        | (57,970 | ) |        |       | (24,532 | )
|                                                                           | Cumulative effect of change in accounting
    principle              |                                            |        |        |         |      |        |        |          |      |         | (4,295 | )        |   |        |       |         |   |        |      |        
|                                                                           |                                                                      |                                            |        |         |         |      |        |         |          |      |         |        |          |   |        |        |         |   |        |      
|                                                                           |                                                                      | Net Loss                                   |        |         | (69,520 | )    |        |         | (121,693 | )    |         |        | (122,996 | ) |        |        | (57,970 | ) |        |       | (24,532 | )
|                                                                           | Accretion of dividends on convertible redeemable
    preferred stock |                                            |        |         |         |      |        |         |          |      |         |        |          |   |        |        |         |   |        | (172  | )      
|                                                                           |                                                                      |                                            |        |         |         |      |        |         |          |      |         |        |          |   |        |        |         |   |        |      
|                                                                           |                                                                      | Net loss applicable to common stockholders |        | $       | (69,520 | )    |        | $       | (121,693 | )    |         | $      | (122,996 | ) |        | $      | (57,970 | ) |        | $     | (24,704 | )
|                                                                           |                                                                      |                                            |        |         |         |      |        |         |          |      |         |        |          |   |        |        |         |   |        |      
|Basic and diluted net loss per common share                                |                                                                      | $                                          | (5.97  | )       |         | $    | (22.30 | )       |          | $    | 31.27   |        |          | $ | (20.57 | )      |         | $ | (55.64 | )    
|                                                                           |                                                                      |                                            |        |         |         |      |        |         |          |      |         |        |          |   |        |        |         |   |        |      
|Basic and diluted weighted average number of
    common shares outstanding |                                                                      |                                            | 11,654 |         |         |      | 5,457  |         |          |      | 3,933   |        |          |   | 2,818  |        |         |   | 444    |      
|                                                                           |                                                                      |                                            |        |         |         |      |        |         |          |      |         |        |          |   |        |        |         |   |        |      

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|                               |  |                                       |         |      |  |      |        |      |  |      |         |   |  |   |         |  |  |   |        |  
|------------------------------ |  | ------------------------------------- | ------- | ---- |  | ---- | ------ | ---- |  | ---- | ------- | - |  | - | ------- |  |  | - | ------ | -
|                               |  |                                      
|                               |  | Year Ended July 31,                  
|                               |  |                                      
|                               |  | 2003                                  |         | 2002 |  | 2001 |        | 2000 |  | 1999
|                               |  |                                       |         |      |  |      |        |      |  |     
|                               |  |                                      
|                               |  | (In thousands, except per share data)
|BALANCE SHEET DATA:            |  |                                       |         |      |  |      |        |      |  |      |         |   |  |   |         |  |  |   |        |  
|Working capital (deficit)      |  | $                                     | (15,214 | )    |  | $    | 16,516 |      |  | $    | (9,683  | ) |  | $ | 48,159  |  |  | $ | (1,355 | )
|                               |  |                                       |         |      |  |      |        |      |  |      |         |   |  |   |         |  |  |   |        |  
|Total assets                   |  | $                                     | 55,379  |      |  | $    | 53,534 |      |  | $    | 112,266 |   |  | $ | 175,461 |  |  | $ | 21,111 |  
|                               |  |                                       |         |      |  |      |        |      |  |      |         |   |  |   |         |  |  |   |        |  
|Long term obligations          |  | $                                     | 11,383  |      |  | $    | 28,073 |      |  | $    | 69,852  |   |  | $ | 24,988  |  |  | $ | 1,935  |  
|                               |  |                                       |         |      |  |      |        |      |  |      |         |   |  |   |         |  |  |   |        |  
|Stockholders equity (deficit) |  | $                                     | 8,581   |      |  | $    | 8,544  |      |  | $    | (6,962  | ) |  | $ | 97,474  |  |  | $ | (4,369 | )
|                               |  |                                       |         |      |  |      |        |      |  |      |         |   |  |   |         |  |  |   |        |  






|        |                                                                                          
|------- | -----------------------------------------------------------------------------------------
|Item 7. | Managements Discussion and Analysis
    of Financial Condition and Results of Operations

Overview

NaviSite, Inc. provides outsourced hosting and
managed application services for mid-sized enterprises,
divisions of large multi-national companies, government agencies
and other businesses conducting mission critical business on the
Internet. Our goal is to help customers focus on their core
competencies by outsourcing the hosting and management of their
operations and applications, allowing customers to improve the
efficiency of their operations. Our focus on Managed Application
Services (A-Services), Managed Infrastructure Services
(I-Services) and Managed Messaging Services (M-Services) allows
us to meet the expanding needs of our customers as their
applications become more complex.

NaviSite operates 14 data centers in the United
States and one data center in the United Kingdom. We combine a
highly scalable and developed infrastructure with expertise,
experience, intellectual property, software platforms, processes
and procedures for delivering simple to complex hosting and
application management services. We provide a combination of
high availability infrastructure, high performance monitoring
systems, and proactive problem resolution and change management
processes designed to recognize patterns and identify and
address potentially crippling problems before they are able to
cause downtime in customers operations. The price for our
services varies from customer to customer based on the number of
managed servers and the nature, extent and level of services
provided. Customers typically enter into agreements with a term
of one to three years and monthly payment installments.

On September 11, 2002, each of CMGI and
Hewlett-Packard Financial Services Company sold and transferred
to ClearBlue Technologies, Inc., a privately-held managed
service provider based in San Francisco, California, and certain
affiliated entities, all of their equity and debt interests in
NaviSite, resulting in ClearBlue Technologies becoming
NaviSites majority stockholder.

The audit report on our fiscal year 2003
consolidated financial statements from KPMG LLP, our independent
auditors, contains an explanatory paragraph that states that our
recurring losses since inception and accumulated deficit, as
well as other factors, raise substantial doubt about our ability
to continue as a going concern. During fiscal year 2003 and
thereafter, we have undergone a significant transition,
including all of the acquisitions that are described in this
report and a balance sheet restructuring, to position ourselves
among the leaders in the hosting and managed applications
services market. Included in this transition was a complete
turnover of our senior management team and our Board of
Directors. While we cannot assure you that we will continue as a
going concern, as part of our transition efforts we believe that
we have developed and are implementing an operational plan that
will bring costs more in line with projected revenue growth.

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Results of Operations

The following table sets forth the consolidated
statements of operations data for the periods indicated as a
percentage of revenues:

|                                                        |                              |                                                                     |      |       |        |      |       |       |        |    |       |      |        |   
|------------------------------------------------------- | ---------------------------- | ------------------------------------------------------------------- | ---- | ----- | ------ | ---- | ----- | ----- | ------ | -- | ----- | ---- | ------ | --
|                                                        |                              |                                                                    
|                                                        |                              | Year Ended July 31,                                                
|                                                        |                              |                                                                    
|                                                        |                              | 2003                                                                |      | 2002  |        | 2001
|                                                        |                              |                                                                     |      |       |        |     
|Revenue:                                                |                              |                                                                     |      |       |        |      |       |       |        |    |       |     
|                                                        | Revenue                      |                                                                     |      | 97.9  | %      |      |       | 68.9  | %      |    |       | 64.6 | %     
|                                                        | Revenue, related parties     |                                                                     |      | 2.1   | %      |      |       | 31.1  | %      |    |       | 35.4 | %     
|                                                        |                              |                                                                     |      |       |        |      |       |       |        |    |       |     
|                                                        |                              | Total revenue                                                       |      |       | 100.0  | %    |       |       | 100.0  | %  |       |      | 100.0  | % 
|Cost of revenue                                         |                              |                                                                     | 90.2 | %     |        |      | 112.8 | %     |        |    | 123.8 | %   
|Impairment of long lived assets                         |                              |                                                                     | 0.0  | %     |        |      | 115.0 | %     |        |    | 1.9   | %   
|                                                        |                              |                                                                     |      |       |        |      |       |       |        |    |       |     
|                                                        |                              | Total cost of revenue                                               |      |       | 90.2   | %    |       |       | 227.7  | %  |       |      | 125.7  | % 
|                                                        |                              |                                                                     |      |       |        |      |       |       |        |    |       |     
|                                                        |                              | Gross margin (deficit)                                              |      |       | 9.8    | %    |       |       | (127.7 | )% |       |      | (25.7  | )%
|Operating expenses:                                     |                              |                                                                     |      |       |        |      |       |       |        |    |       |     
|                                                        | Product development          |                                                                     |      | 1.5   | %      |      |       | 8.9   | %      |    |       | 13.7 | %     
|                                                        | Selling and marketing        |                                                                     |      | 9.3   | %      |      |       | 16.3  | %      |    |       | 31.4 | %     
|                                                        | General and administrative   |                                                                     |      | 29.9  | %      |      |       | 32.4  | %      |    |       | 32.1 | %     
|                                                        | Impairment and restructuring |                                                                     |      | 11.0  | %      |      |       | (4.4  | )%     |    |       | 7.8  | %     
|                                                        |                              |                                                                     |      |       |        |      |       |       |        |    |       |     
|                                                        |                              | Total operating expenses                                            |      |       | 51.7   | %    |       |       | 53.2   | %  |       |      | 85.0   | % 
|                                                        |                              |                                                                     |      |       |        |      |       |       |        |    |       |     
|                                                        |                              | Loss from operations                                                |      |       | (41.9  | )%   |       |       | (180.9 | )% |       |      | (110.7 | )%
|Other income (expense):                                 |                              |                                                                     |      |       |        |      |       |       |        |    |       |     
|                                                        | Interest income              |                                                                     |      | 1.3   | %      |      |       | 1.8   | %      |    |       | 2.7  | %     
|                                                        | Interest expense             |                                                                     |      | (69.0 | )%     |      |       | (24.8 | )%     |    |       | (7.8 | )%    
|                                                        | Other income (expense), net  |                                                                     |      | (1.1  | )%     |      |       | (0.9  | )%     |    |       | 0.3  | %     
|                                                        |                              |                                                                     |      |       |        |      |       |       |        |    |       |     
|                                                        |                              | Loss before cumulative effect of change in
    accounting principle |      |       | (110.7 | )%   |       |       | (204.8 | )% |       |      | (115.6 | )%
|Cumulative effect of change in accounting
    principle |                              |                                                                     | 0.0  | %     |        |      | 0.0   | %     |        |    | (4.2  | )%  
|                                                        |                              |                                                                     |      |       |        |      |       |       |        |    |       |     
|                                                        |                              | Net Loss                                                            |      |       | (110.7 | )%   |       |       | (204.8 | )% |       |      | (119.7 | )%
|                                                        |                              |                                                                     |      |       |        |      |       |       |        |    |       |     



| |                                                
| | -----------------------------------------------
| | Comparison of the Years 2003, 2002 and
    2001

Revenue

We derive our revenue primarily from outsourced
managed hosting and application services comprised of a variety
of service offerings, including providing related professional
and consulting services, to mid-sized enterprises, divisions of
large multi-national companies and government agencies.

Total revenue for fiscal year 2003 increased 6%
to approximately $62.8 million from approximately
$59.4 million in fiscal year 2002. The overall growth in
revenue was mainly due to revenue resulting from our
acquisitions, which contributed $34.8 million in revenue
during fiscal year 2003 offset by lost customer revenue of
$31.5 million. Revenue from non-related parties increased
by 50% to approximately $61.4 million in fiscal year 2003
from approximately $41.0 million in fiscal year 2002 but
was offset by a decline in revenue from related parties. Revenue
from related parties decreased by 92.9% to approximately
$1.3 million in fiscal year 2003 from approximately
$18.5 million in 2002. Revenue from related parties
principally consisted of sales of services to CMGI and its
affiliates until September 11, 2002 when CMGI sold its
equity and debt interests in NaviSite. The decrease in related
party revenue was primarily attributable to CMGI and its
affiliates terminating their relationships with NaviSite upon
the completion of their contracts.

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

In fiscal year 2003, one non-related customer
accounted for 26% of our revenue as compared to fiscal year 2002
where one CMGI affiliate accounted for approximately 11% of our
revenue and fiscal year 2001 where four CMGI affiliates
accounted for approximately 25%, 17%, 15% and 14% of our
revenue, respectively.

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

Cost of Revenue

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

Cost of revenue, excluding impairment charges,
decreased 16% to approximately $56.6 million in fiscal year
2003 from approximately $67.0 million in fiscal year 2002.
The reduction in cost of revenue of $10.4 million, net of
impairment charges, resulted primarily from reductions in
depreciation of $11.1 million, equipment lease and related
costs of $6.4 million due to restructuring that took place
in fiscal year 2002 partially offset by increases in labor costs
of $4.0 million, bandwidth costs of $1.6 million and
software licenses of $1.4 million related to acquisitions
made in fiscal year 2003.

Cost of revenue, excluding impairment charges,
decreased 47% to approximately $67.0 million in fiscal year
2002, from approximately $127.2 million in fiscal year
2001. The reduction in cost of revenue of $60.2 million,
net of impairment charges, resulted from a $34.7 million
reduction in equipment lease and related costs, a
$10.0 million reduction in labor costs due to head count
reductions, a $9.1 million reduction in consulting fees, a
$5.9 million reduction in bandwidth and bandwidth related
costs, a $2.9 million reduction in rent costs related to
the shut down of our original data centers on July 31,
2001, and a $2.9 million reduction in other facility and
equipment related costs offset by a $5.2 million increase
in depreciation resulting from the purchase of certain equipment
formerly held under operating lease. Included in cost of revenue
for fiscal years 2002 and 2001 are impairment charges of
$68.3 million and $1.9 million, respectively.

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



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | As a result of a physical inventory of its
    customer-dedicated equipment, NaviSite recorded an impairment
    charge of $1.5 million for obsolete equipment and for
    equipment no longer on hand and identified certain excess assets
    not in use.                                                                                                                                                                                                                                                                                                                                                                                                                   
|
| |  | NaviSite modified the payment amounts and terms
    of certain operating leases with three equipment vendors such
    that the modified leases qualify as capital leases. One of the
    resulting capital leases is payable in 24 monthly payments
    of $38,000, starting in December 2001. The second capital lease
    has total payments of $2.6 million, of which
    $1.0 million was paid in the second quarter of fiscal year
    2002 and $1.6 million was paid in fiscal year 2003. The
    third capital lease is payable in 28 monthly payments of
    $4,700 for the first four months and $20,400 for the remaining
    24 months, starting in April 2002. The

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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   | equipment under all resulting capital leases was
    capitalized at the fair market value of the equipment at the
    time of the modification, $1.1 million, which was lower
    than the present value of the future minimum lease payments
    based on NaviSites estimated incremental borrowing rate of
    12%. Since the fair market value of the equipment was less than
    the consideration given, based on a third-party appraisal,
    NaviSite recorded an asset impairment charge of approximately
    $1.0 million. In addition, NaviSite returned certain
    equipment held under certain operating leases with one of the
    above lessors and incurred and paid a breakage fee of $397,000.
|
| |  | NaviSite recorded a net $1.9 million charge
    representing the future estimated remaining minimum lease
    payments related to certain idle equipment held under various
    operating leases. The equipment had previously been rented to
    former customers under operating leases, and upon the loss of
    the customer, the equipment became idle. Based on our then
    forecasts, the equipment would not be utilized before the
    related operating leases expired and/or the equipment became
    obsolete.                                                                                                                                                                                      
|
| |  | NaviSite evaluated the current and forecasted
    utilization of its purchased software licenses. As a result of
    this evaluation, during the second quarter of fiscal year 2002,
    we recorded a $365,000 impairment for software licenses that
    would not be utilized before the licenses expired and/or became
    obsolete.                                                                                                                                                                                                                                                                                                                                                                          
|
| |  | NaviSite finalized agreements with various
    equipment lessors whereby we purchased equipment previously held
    under operating leases for approximately $42.0 million. The
    fair market value of the equipment at the time of purchase,
    based on third-party appraisal, was approximately
    $14.3 million. As the aggregate fair market value of the
    equipment, based on third-party appraisal, was less than the
    aggregate consideration given, we recorded an asset impairment
    charge of approximately $25.4 million, as a separate
    component of cost of revenue, in fiscal year 2002.                                                                                           
|
| |  | A number of factors occurring during the fourth
    quarter of fiscal year 2002 impacted our long-lived assets
    including both our expected future cash flow generation and our
    expected utilization of the assets within revised operating
    plans. These factors included the further deterioration of
    market conditions within our industry, excess capacity in the
    industry and in our two data centers, our anticipated data
    center utilization and our revised business model.                                                                                                                                                                                                        

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

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

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

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Product Development

Product development expenses consist primarily of
salaries and related costs.

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

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

Selling and Marketing

Selling and marketing expenses consist primarily
of salaries and related benefits, commissions and marketing
expenses such as advertising, product literature, trade shows,
marketing and direct mail programs.

Selling and marketing expense decreased 40% to
approximately $5.8 million in fiscal year 2003 from
approximately $9.7 million in fiscal year 2002. The
decrease of approximately $3.9 million resulted primarily
from a reduction in salary and related costs of approximately
$2.8 million, a reduction of allocated rent of
approximately $800,000 and a reduction in marketing program
costs of approximately $300,000.

Selling and marketing expenses decreased 70% to
approximately $9.7 million in fiscal year 2002 from
approximately $32.3 million in fiscal year 2001. The
$22.6 million decrease resulted primarily from a
$8.1 million reduction in headcount expenses related to a
decrease in sales and marketing personnel at July 31, 2002
to 18 from 65 at July 31, 2001, a $6.6 million
reduction in marketing programs, advertising and product
literature, a $5.2 million reduction in commission expense
driven by decreased revenue levels, and a $765,000 reduction in
consulting fees.

General and Administrative

General and administrative expenses include the
costs of financial, leasing, human resources, IT and
administrative personnel, professional services, bad debt and
corporate overhead. Also included are intercompany charges from
CMGI for facilities and shared back office and business
development support. These costs were eliminated upon the
termination of the Facilities and Administrative Agreement
between CMGI and us in September 2002.

General and administrative expenses decreased 3%
to approximately $18.8 million in fiscal year 2003 from
approximately $19.3 million in fiscal year 2002. The
reduction of approximately $500,000 was mainly the result of a
reduction in bad debt expense of $2.6 million partially
offset by increases in headcount related expenses of
$1.2 million, increased accounting and legal fees of
$800,000 and increased expense for amortization of intangibles
related to the ClearBlue Technologies Management, Inc.
acquisition during the fiscal year.

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

Impairment and Restructuring

Costs associated with impairment, restructuring
and abandonment of lease facilities increased to approximately
$6.9 million in fiscal year 2003 compared to approximately
($2.6 million) in fiscal year 2002.

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The increase is due primarily to abandonment of
administrative space at our 400 Minuteman Road, Andover, MA
facility and the abandonment of administrative space at our
La Jolla, CA office. We recorded a charge equal to the
amount of rent and other direct costs for the period and time
the space is expected to remain unoccupied plus the present
value of the amount by which the rent paid by us to the landlord
exceeds any rent paid to us by a subtenant under a sublease over
the remainder of the lease term.


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

Interest Income

Interest income decreased 26% to approximately
$785,000 in fiscal year 2003 from approximately
$1.1 million in fiscal year 2002. The decrease is due
primarily to the reduced levels of average cash on hand.

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

Interest Expense

Interest expense increased 194% to approximately
$43.3 million in fiscal year 2003 from approximately
$14.7 million in fiscal year 2002. The increase of
$28.6 million is due mainly to the non-cash write-off of
the unamortized beneficial conversion feature related to the
conversion of the $65 million of convertible notes during
fiscal year 2003.

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

Other Income (expense), net

Other expense increased 39% to approximately
($719,000) in fiscal year 2003 from ($516,000) in fiscal year
2002. This increase is mainly due to increase fees related to
the accounts receivable financing line with Silicon Valley Bank.

Other income (expense) decreased 276% to
($516,000) in fiscal year 2002 from $292,000 in fiscal year
2001. The decrease is due to the loss on the sale of certain
assets offset by the gain realized on the sale of certain of our
Streaming Media assets.

Liquidity and Capital Resources

Our cash and cash equivalents decreased to
approximately $3.9 million at July 31, 2003 from
approximately $21.8 million at July 31, 2002. Net cash
used in operating activities was approximately
$16.2 million for the year ended July 31, 2003,
resulting primarily from net losses, decreases in accrued
expenses and accounts payables, and a decrease in amounts due to
CMGI, partially offset by non-cash charges for the write-off and
amortization of the beneficial conversion feature of the
convertible debt, interest paid in

35



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stock, costs related to abandoned leases,
impairment of assets, depreciation and amortization, and
provision for bad debt. Net cash used in investing activities
was approximately $1.4 million for the year ended
July 31, 2003, resulting primarily from purchases of
property and equipment, the purchase of certain assets of
Interliant, the purchase of convertible notes of Interliant, a
loan made to a related party, partially offset by cash acquired
in acquisitions and the release of restricted cash. Net cash
used for financing activities was approximately $359,000 for the
fiscal year ended July 31, 2003, resulting primarily from
repayment of debt to the estate of AppliedTheory, repayment of
notes to affiliates, the payment of capital lease obligations,
partially offset by borrowings from affiliates and borrowings
from our accounts receivable financing line.


At July 31, 2003, we had a working capital
deficit of $15.2 million, an accumulated deficit of
$407 million, and have reported losses from operations
since incorporation. We have used cash from continuing
operations of $16.2 million, $27.0 million and
$88.8 million in the years ended July 31, 2003, 2002,
and 2001, respectively. We anticipate incurring additional
losses throughout our next fiscal year. NaviSite has taken
several actions it believes will allow us to continue as a going
concern through July 31, 2004, including the closing and
integration of strategic acquisitions, the change in our Board
of Directors and senior management and bringing costs more in
line with projected revenues. Based upon our cash flow estimates
we believe that we will more than likely need to raise funds to
meet our anticipated needs for working capital and capital
expenditures for at least the next twelve months. Our cash flow
estimates are based upon attaining certain levels of sales,
maintaining budgeted levels of operating expenses, collections
of accounts receivable and maintaining our current borrowing
line with Silicon Valley Bank among other assumptions, including
the improvement in the overall macroeconomic environment. Our
sales estimate includes revenue from new and existing customers
which may not be realized and we may be required to further
reduce expenses if budgeted sales are not attained. We may be
unsuccessful in reducing expenses in proportion to any shortfall
in projected sales and our estimate of collections of accounts
receivable may be hindered by our customers ability to pay.

We believe that we will more than likely need to
raise funds through the issuance of equity or convertible debt
securities, or through credit arrangements with financial
institutions. We cannot assure that we will be able to obtain
financing on commercially reasonable terms, or at all. If funds
are raised through the issuance of equity or convertible debt
securities, the percentage ownership of our stockholders will be
reduced and our stockholders may experience dilution of their
interest in us. If adequate funds are not available or are not
available on acceptable terms, we may not be able to continue as
a going concern.

Contractual Obligations and Commercial
Commitments

In the normal course of our business, we enter
into contracts related to the leasing of facilities and
equipment and the purchase of minimum bandwidth. Future payments
required under these long-term obligations are as follows:

|                                  |  |       |        |           |  |           |        |           |  |         |        |  |  |   |       |  |  |   |       | 
|--------------------------------- |  | ----- | ------ | --------- |  | --------- | ------ | --------- |  | ------- | ------ |  |  | - | ----- |  |  | - | ----- | 
|                                  |  |       |        | Less than |  |           |        |           |  | After  
|Description                       |  | Total |        | 1 Year    |  | 1-3 Years |        | 4-5 Years |  | 5 Years
|                                  |  |       |        |           |  |           |        |           |  |        
|Short/Long-term debt              |  | $     | 9,550  |           |  | $         | 3,550  |           |  | $       | 6,000  |  |  | $ |      |  |  | $ |      | 
|Interest on debt                  |  |       | 1,610  |           |  |           | 650    |           |  |         | 960    |  |  |   |      |  |  |   |      | 
|Capital leases                    |  |       | 5,492  |           |  |           | 3,590  |           |  |         | 1,902  |  |  |   |      |  |  |   |      | 
|Operating leases                  |  |       | 1,337  |           |  |           | 1,008  |           |  |         | 328    |  |  |   |      |  |  |   |      | 
|Bandwidth commitments             |  |       | 6,716  |           |  |           | 3,542  |           |  |         | 2,384  |  |  |   | 791   |  |  |   |      | 
|Maintenance for hardware/software |  |       | 1,405  |           |  |           | 1,405  |           |  |         |       |  |  |   |      |  |  |   |      | 
|Property leases                   |  |       | 38,937 |           |  |           | 8,271  |           |  |         | 14,383 |  |  |   | 7,666 |  |  |   | 8,616 | 
|                                  |  |       |        |           |  |           |        |           |  |         |        |  |  |   |       |  |  |   |       | 
|                                  |  | $     | 65,047 |           |  | $         | 22,016 |           |  | $       | 25,957 |  |  | $ | 8,457 |  |  | $ | 8,616 | 
|                                  |  |       |        |           |  |           |        |           |  |         |        |  |  |   |       |  |  |   |       | 

Critical Accounting Policies

We prepare our consolidated financial statements
in accordance with accounting principles generally accepted in
the United States of America. As such, management is required to
make certain estimates,

36



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##### Table of Contents



judgments and assumptions that they 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 financial statements and the
reported amounts of revenues and expenses for the periods
presented. The significant accounting policies which management
believes are the most critical to aid in fully understanding and
evaluating our reported financial results include revenue
recognition, allowance for doubtful accounts and impairment of
long-lived assets.


Revenue Recognition.We provide outsourced hosting and managed application services
and related professional and consulting services. Revenue
consists of monthly fees for Web site and Internet application
management, application rentals, and hosting. Revenues related
to monthly fees for Web site and Internet application
management, application rentals and hosting are recognized over
the term of the customer contract based on actual usage and
services. Revenue from professional services is recognized on a
time-and-materials basis as the services are performed or under
the percentage-of-completion method for revenue related to
fixed-price contracts. Revenue and profits on long-term Internet
solutions contracts, performed over extended periods, are
recognized under the percentage-of-completion method of
accounting, principally based on direct labor dollars. Revenues
and profits on long-term contracts are based on our estimates to
complete and are reviewed periodically, with adjustments
recorded in the period in which the revisions are made. Any
anticipated losses on contracts are charged to operations as
soon as they are determinable. Fees charged for the installation
of customer equipment are generally received in advance and are
deferred and recognized as revenue over the life of the related
customer contract, typically 12 to 36 months. In the event
a customer terminates the agreement prior to its stated
maturity, all deferred revenue related to installation services
is automatically recognized upon the effective date of the
termination, and we generally charge cancellation or termination
fees that are also recognized upon the effective date of the
termination. Cancellation fees are calculated as the
customers remaining base monthly fees obligation times the
number of months remaining in the contract term. Existing
customers are subject to ongoing credit evaluations based on
payment history and other factors. If it is determined
subsequent to our initial evaluation and at any time during the
arrangement that collectability is not reasonably assured,
revenue is recognized as cash is received. Due to the nature of
our service arrangements, we provide written notice of
termination of services, typically 10 days in advance of
disconnecting a customer. Revenue for services rendered during
this notification period is recognized on a cash basis as
collectability is not considered probable at the time the
services are provided.

Allowance for Doubtful Accounts.We perform periodic credit evaluations
of our customers financial conditions and generally do not
require collateral or other security against trade receivables.
We make estimates of the uncollectability of our accounts
receivables and maintain an allowance for doubtful accounts for
potential credit losses. We specifically analyze accounts
receivable and consider historical bad debts, customer and
industry concentrations, customer credit-worthiness, current
economic trends and changes in our customer payment patterns
when evaluating the adequacy of the allowance for doubtful
accounts. We specifically reserve for 100% of the balance of
customer accounts deemed uncollectible. For all other customer
accounts, we reserve for 50% of the balance over 90 days
old and 3% of all other customer balances. This method
historically approximated actual write off experience. Changes
in economic conditions or the financial viability of our
customers may result in additional provisions for doubtful
accounts in excess of our current estimate.

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



| |   |                                                                                                                 
| | - | ----------------------------------------------------------------------------------------------------------------
| |  | Significant underperformance relative to expected
    historical or projected future operating results;         
|
| |  | Significant changes in the manner of our use of
    the acquired assets or the strategy of our overall business;
|
| |  | Significant negative industry or economic trends;                                                               

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| |   |                                                                        
| | - | -----------------------------------------------------------------------
| |  | Significant declines in our stock price for a
    sustained period; and
|
| |  | Our market capitalization relative to net book
    value.              

Recoverability is measured by a comparison of the
carrying amount of an asset to future undiscounted cash flows
expected to be generated by the asset. If such assets were
considered to be impaired, the impairment to be recognized would
be measured by the amount by which the carrying value of the
assets exceeds their fair value. Fair value is determined based
on discounted cash flows or appraised values, depending on the
nature of the asset. Assets to be disposed of are valued at the
lower of the carrying amount or their fair value less disposal
costs. Property and equipment is primarily comprised of
leasehold improvements, computer and office equipment and
software licenses. During the fourth quarter of fiscal year
2002, due to significant industry and economic trends affecting
both our current and future operations as well as a significant
decline in our stock price, we completed an impairment review of
our property and equipment. This review included a comparison of
the carrying amount of such assets to the estimated fair values
of the specific assets. Management determined that the best
measure of fair value for the property and equipment was a
combination of the market and cost approaches. The cost approach
was utilized to determine the fair value of certain computer
hardware, leasehold improvements, office furniture and equipment
and construction in progress. The cost approach utilizes
estimated replacement/reproduction costs, with allowances for
physical depreciation and functional obsolescence (i.e., asset
utilization). For certain equipment and leasehold improvements,
the market approach was used. The market approach typically
includes comparing recent sales of similar assets and adjusting
these comparable transactions based on factors such as age,
condition, and types of sale to determine fair value. Based on
the appraised fair value of the property and equipment, we
recorded an impairment charge of $38.1 million during the
fourth quarter of fiscal year 2002. The selection of valuation
methodologies and approaches, as well as assumptions of future
asset utilization, requires judgments and estimates. The use of
different valuation methodologies or assumptions could have
increased or decreased the impairment charge.






|         |                                                               
|-------- | --------------------------------------------------------------
|Item 7A. | Quantitative and Qualitative Disclosures
    About Market Risk

Our exposure to market rate risk for changes in
interest rates relates primarily to our cash equivalents. From
time to time, we invest our excess cash in money market funds.
We do not currently have any significant foreign operations and
thus are not materially exposed to foreign currency fluctuations.






|        |                                                
|------- | -----------------------------------------------
|Item 8. | Financial Statements and Supplementary
    Data

Our consolidated Financial Statements and
Schedule and the Report of the Independent Accountants appear
beginning on page F-1 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 managements
evaluation (with the participation of NaviSites principal
executive officer and principal financial officer) as of the end
of the period covered by this report, NaviSites principal
executive officer and principal financial officer have concluded
that NaviSites disclosure controls and procedures (as
defined in Rules 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934, as amended, (the Exchange
Act)) are effective to ensure that information required to
be disclosed by NaviSite in reports that it files or submits
under the Exchange Act is recorded, processed, summarized and
reported within the time periods specified in Securities and
Exchange Commission rules and forms.

Changes in Internal Control Over Financial
Reporting.There was no change in
NaviSites internal control over financial reporting during
the fourth fiscal quarter that has materially affected, or is
reasonably likely to materially affect, NaviSites internal
control over financial reporting.

38



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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 and Executive Officers of the
    Registrant

Incorporated by reference to the portions of the
Definitive Proxy Statement entitled
Proposal 1  Election of Directors,
Additional Information  Management,
Additional Information  Section 16(a)
Beneficial Ownership Reporting Compliance and
Additional Information  Audit Committee
Financial Expert. The information required by this item
relating to our executive officers is included in Part I of
this Form 10-K under the section captioned Executive
Officers of NaviSite and is incorporated by reference into
this item.

Code of Ethics.NaviSite has adopted a Code of
Business Conduct and Ethics that applies to all directors,
officers and employees of NaviSite, including NaviSites
principal executive officer, and its senior financial officers
(principal financial officer and controller or principal
accounting officer, or persons performing similar functions). A
copy of NaviSites Code of Business Conduct and Ethics is
filed with this report.






|         |                       
|-------- | ----------------------
|Item 11. | Executive Compensation

Incorporated by reference to the portions of the
Proxy Statement entitled Additional
Information  Executive Compensation,
Additional Information  Director
Compensation, Additional Information 
Compensation Committee Report, Additional
Information  Stock Performance Graph, and
Additional Information  Employment Agreements
and Severance and Change of Control Arrangements. The
information specified in Item 402(k) and (l) of
Regulation S-K and set forth in our Proxy Statement is not
incorporated by reference.






|         |                                                                                                       
|-------- | ------------------------------------------------------------------------------------------------------
|Item 12. | Security Ownership of Certain Beneficial
    Owners and Management and Related Stockholder
    Matters

Information regarding the security ownership of
certain beneficial owners and management is 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, 2003

The following table sets forth certain
information regarding NaviSites equity compensation plans
as of July 31, 2003.

|                                                                  |  |                         |           |                      |  |                               |       |  |  |  |           | 
|----------------------------------------------------------------- |  | ----------------------- | --------- | -------------------- |  | ----------------------------- | ----- |  |  |  | --------- | 
|                                                                  |  |                         |           |                      |  | (c)                          
|                                                                  |  | (a)                     |           | (b)                  |  | Number of Securities         
|                                                                  |  | Number of Securities to |           | Weighted-average     |  | Available for Future 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        |  |                         | 273,506   |                      |  | $                             | 67.93 |  |  |  | 683,464   | 
|Equity compensation plans not approved by
    security holders(1) |  |                         | 2,272,000 |                      |  | $                             | 2.55  |  |  |  | 328,000   | 
|Total                                                             |  |                         | 2,545,506 |                      |  | $                             | 9.57  |  |  |  | 1,011,464 | 



---



|    |                                                                                                                                                                                                                                                                                                                                        
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | The 2003 Stock Incentive Plan (the 2003
    Plan) was approved by the Board of Directors on
    July 10, 2003. The 2003 Plan has not yet been approved by
    NaviSites stockholders. The 2003 Plan provides that stock
    options or restricted stock awards may be granted to employees,
    officers, directors, consultants and

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##### Table of Contents



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | advisors of NaviSite (or any present or future
    parent or subsidiary corporations and any other business venture
    (including, without limitation, joint venture or limited
    liability company) in which NaviSite has a controlling interest,
    as determined by the Board of Directors of NaviSite). The Board
    of Directors has authorized 2,600,000 shares of common stock for
    issuance under the 2003 Plan. As of September 30, 2003,
    stock options to purchase 2,272,000 shares of common stock
    at an average exercise price of $2.55 per share were outstanding
    under the 2003 Plan, of which none had been exercised and no
    grants of restricted shares had been made. Grants made to date
    under the 2003 Plan are not effective until such time as
    NaviSites stockholders approve the plan. It is currently
    expected that the 2003 Plan will be presented to NaviSites
    stockholders for approval at NaviSites 2003 annual meeting
    of stockholders.






|         |                                                   
|-------- | --------------------------------------------------
|Item 13. | Certain Relationships And Related
    Transactions

Incorporated by reference to the portion of the
Proxy Statement entitled Additional
Information  Certain Relationships and Related
Transactions.






|         |                                           
|-------- | ------------------------------------------
|Item 14. | Principal Accounting Fees And
    Services

Incorporated by reference to the portion of the
Proxy Statement entitled Additional
Information  Independent Auditors Fees.




PART IV






|         |                                                                    
|-------- | -------------------------------------------------------------------
|Item 15. | Exhibits, Financial Statement Schedules And
    Reports On Form 8-K

(A) Financial Statements, Financial
Statement Schedule and Exhibits.



| |                                 
| | --------------------------------
| | 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.



| |                                                                                                                                                                                                                                                                                                                                            
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Financial Statement Schedule II of NaviSite
    and the corresponding Report of Independent Auditors on
    Financial Statement Schedule are filed as part of this report.
    All other financial statement schedules have been omitted as
    they are either not required, 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.

(B) Reports on Form 8-K

|             |  |            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|------------ |  | ---------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Date Filed   |  |            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|or Furnished |  | Item No.   |  | Description                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|             |  |            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|June 2, 2003 |  | Items 2, 7 |  | On June 2, 2003, NaviSite filed a Current
    Report on Form 8-K dated May 16, 2003 to report that
    it completed the acquisition of substantially all of the assets
    relating to the managed infrastructure solutions business,
    encompassing messaging and collaboration, managed hosting,
    bundled-in managed security, and integrated and related
    professional services in the United States and in Europe
    (Interliant Assets), of Interliant, Inc., a Delaware
    corporation, and several of its subsidiaries (the
    Debtors) in the bankruptcy proceedings of the
    Debtors under Chapter 11 of Title 11 of the United States
    Bankruptcy Code. No financial statements were filed with such
    report.

40



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##### Table of Contents



|                |  |            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|--------------- |  | ---------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Date Filed      |  |            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|or Furnished    |  | Item No.   |  | Description                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|                |  |            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|June 3, 2003    |  | Items 2, 7 |  | On June 3, 2003, NaviSite filed a Current
    Report on Form 8-K/ A dated May 16, 2003 to amend its
    Current Report on Form 8-K filed on June 2, 2003 to
    report that it completed the acquisition of substantially all of
    the Interliant Assets, and several of Interliants
    subsidiaries in the bankruptcy proceedings of the Debtors under
    Chapter 11 of Title 11 of the United States Bankruptcy
    Code. No financial statements were filed with such report.                                                                                                                                                                                                            
|June 16, 2003   |  | Items 2, 7 |  | On June 16, 2003, NaviSite filed a Current
    Report on Form 8-K dated December 31, 2002 to amend
    NaviSites Current Report on Form 8-K filed
    April 17, 2003 to report that it completed the acquisition
    of Conxion Corporation (Conxion) and to include
    certain financial statements of Conxion and pro forma financial
    information, including to give effect to the December 31,
    2002 acquisition by NaviSite of ClearBlue Technologies
    Management, Inc. as a combination of entities under common
    control and to the Conxion acquisition. The following financial
    statements were filed with such report:                                              
|                |  |            |  | Audited
    consolidated financial statements of Conxion and subsidiaries as
    of December 31, 2002 and March 31, 2003 (unaudited);
    and                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|                |  |            |  | NaviSites pro
    forma condensed consolidated statement of operations for the
    year ended July 31, 2002 and the nine months ended
    April 30, 2003 (unaudited).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|June 17, 2003   |  | Item 9*    |  | On June 17, 2003, NaviSite furnished a copy
    of its earnings release for the fiscal quarter ended
    April 30, 2003. Unaudited consolidated financial statements
    for such period were furnished with such report.                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|July 31, 2003   |  | Items 2, 7 |  | On July 31, 2003, NaviSite filed a Current
    Report on Form 8-K/ A dated May 16, 2003 to amend and
    restate Items 7(a) and (b) of NaviSites Current
    Report on Form 8-K filed June 2, 2003 and
    NaviSites Current Report on Form 8-K/ A filed
    June 3, 2003 to report that it was not necessary to file
    financial statements and pro forma financial information
    relating to the acquisition of substantially all of the
    Interliant Assets, and several of Interliants subsidiaries
    in the bankruptcy proceedings of the Debtors under
    Chapter 11 of Title 11 of the United States Bankruptcy
    Code. No financial statements were filed with such report.
|August 22, 2003 |  | Items 2, 7 |  | On August 22, 2003, NaviSite filed a Current
    Report on Form 8-K dated August 8, 2003 to report
    that, among other things, it completed the acquisition of
    certain assets and the assumption of certain liabilities of
    ClearBlue Technologies, Inc. No financial statements were filed
    with such report.                                                                                                                                                                                                                                                                                                                                                                       



---



|  |                                                                                                                            
|- | ---------------------------------------------------------------------------------------------------------------------------
|* | Pursuant to SEC Release 33-8216, the information
    required to be furnished under Item 12 was furnished under
    Item 9.

41



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##### Table of Contents






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, 2003

| |     |                     
| | --- | --------------------
| | By: | /s/ ARTHUR P. BECKER

| |                        
| | -----------------------
| |                        
| | Arthur P. Becker       
| | 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 RUHANAndrew Ruhan           |  | Chairman of the Board                                                                      |  | October 22, 2003
|                                      
|/s/ ARTHUR P. BECKERArthur P. Becker   |  | Chief Executive Officer, President and Director
    (Principal Executive Officer)          |  | October 22, 2003
|                                      
|/s/ JAMES W. PLUNTZEJames W. Pluntze   |  | Chief Financial Officer (Principal Financial
    Officer and Principal Accounting Officer) |  | October 22, 2003
|                                      
|/s/ GABRIEL RUHANGabriel Ruhan         |  | Chief Operating Officer and Director                                                       |  | October 22, 2003
|                                      
|/s/ JAMES H. DENNEDYJames H. Dennedy   |  | Director                                                                                   |  | October 22, 2003
|                                      
|/s/ LARRY W. SCHWARTZLarry W. Schwartz |  | Director                                                                                   |  | October 22, 2003
|                                      
|/s/ THOMAS R. EVANSThomas R. Evans     |  | Director                                                                                   |  | October 22, 2003

42



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##### Table of Contents






INDEX TO EXHIBITS

|            |    |                        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|----------- | -- | ---------------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |    | Description of Exhibit
|            |    |                       
|            | 2  | .1                     |  | Stock Purchase Agreement, dated as of
    December 31, 2002, by and between ClearBlue Technologies,
    Inc. and the Registrant, is incorporated herein by reference to
    Exhibits to the Registrants Current Report on
    Form 8-K dated December 31, 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|            | 2  | .2                     |  | Agreement and Plan of Merger and Reorganization,
    dated as of January 29, 2003, among Avasta Corp., Avasta,
    Inc. 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            | 2  | .3                     |  | Agreement and Plan of Merger, dated as of
    March 26, 2003, by and between the Registrant and Conxion
    Corporation and Union Acquisition, Corp., a Delaware corporation
    and wholly-owned subsidiary of the Registrant, is incorporated
    herein by reference to Exhibits to the Registrants Current
    Report on Form 8-K dated April 2, 2003.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|            | 2  | .4                     |  | Sale Order pursuant to 11 U.S.C.
    Sections 105, 363, and 1146(c) and Bankruptcy
    Rules 2002, 6004 and 6006 approving (i) Asset Purchase
    Agreement, (ii) Sale of Substantially All of Debtors
    Assets Free and Clear of All Liens, Claims, Encumbrances and
    Interests, (iii) Waiver of Stay Provisions under Bankruptcy
    Rule Section 6004 and 6006 and (iv) Granting Related
    Relief entered by the Bankruptcy Court for the Southern District
    of New York (White Plains) on May 15, 2003; together with
    the Asset Purchase Agreement, dated as of May 15, 2003, by
    and among Interliant, Inc. and certain of its subsidiaries, and
    Intrepid Acquisition Corp., a Delaware corporation and
    wholly-owned subsidiary of the Registrant, annexed thereto, is
    incorporated herein by reference to Exhibits to the
    Registrants Current Report on Form 8-K dated
    May 16, 2003.
|            | 2  | .5                     |  | Stock and Asset Acquisition Agreement, dated as
    of August 8, 2003, by and between the Registrant and
    ClearBlue Technologies, Inc., is incorporated herein by
    reference to the Registrants Current Report on
    Form 8-K dated August 8, 2003.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|            | 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|            | 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            | 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            | 3  | .4                     |  | 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|            | 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
    (File No. 333-83501).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|            | 4  | .2                     |  | Series C Convertible Preferred Stock
    Purchase Agreement, dated as of June 3, 1999, by and
    between Dell USA L.P. and the Registrant is incorporated herein
    by reference to Exhibits to the Registrants Registration
    Statement on Form S-1 (File No. 333-83501).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|            | 4  | .3                     |  | Series D Convertible Preferred Stock
    Purchase Agreement, dated as of June 3, 1999, by and
    between Microsoft 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 | .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                     |  | 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).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  

43



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##### Table of Contents



|            |    |                        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|----------- | -- | ---------------------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |    | Description of Exhibit
|            |    |                       
|            | 10 | .3(*)                  |  | 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.                                                                                                                                                                                                                                                                                         
|            | 10 | .4(*)                  |  | 1999 Employee Stock Purchase 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.                                                                                                                                                                                                                                                                                                       
|            | 10 | .5(*)                  |  | 1999 Stock Option Plan for Non-Employee Directors
    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.                                                                                                                                                                                                                                                                                       
|            | 10 | .6(*)                  |  | Deferred Compensation 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.                                                                                                                                                                                                                                                                                                              
|            | 10 | .7(*)                  |  | Form of Director Indemnification Agreement, as
    executed by former Directors 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.                                                                                                                                                                                                                                                         
|            | 10 | .8                     |  | Facilities and Administrative Agreement, dated as
    of October 27, 1999, between CMGI, Inc. 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 October 31, 1999.                                                                                                                                                                                                                        
|            | 10 | .9                     |  | Tax Allocation Agreement, dated as of
    October 27, 1999, between CMGI, Inc. 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 October 31, 1999.                                                                                                                                                                                                                                       
|            | 10 | .10                    |  | Irrevocable Standby Letter of Credit, dated as of
    December 3, 1999, between BankBoston, N.A. 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, 2000.                                                                                                                                                                                                                     
|            | 10 | .11                    |  | Security Agreement and Assignment of Account,
    dated December 3, 1999, between BankBoston, N.A. 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, 2000.                                                                                                                                                                                                                   
|            | 10 | .12(*)                 |  | Amended and Restated Director Indemnification
    Agreement, dated February 23, 2001, by and between the
    Registrant and James F. Moore, Ph.D. is incorporated herein by
    reference to Exhibits to the Registrants Quarterly Report
    on Form 10-Q for the fiscal quarter ended April 30,
    2001.                                                                                                                                                                                         
|            | 10 | .13(*)                 |  | Amended and Restated Director Indemnification
    Agreement, dated February 23, 2001, by and between the
    Registrant and Stephen D.R. Moore is incorporated herein by
    reference to Exhibits to the Registrants Quarterly Report
    on Form 10-Q for the fiscal quarter ended April 30,
    2001.                                                                                                                                                                                            
|            | 10 | .14(*)                 |  | Form of Executive Retention Agreement by and
    between the Registrant and each of Patricia Gilligan and Kevin
    Lo is incorporated herein by reference to Exhibits to the
    Registrants Quarterly Report on Form 10-Q for the
    fiscal quarter ended April 30, 2001.                                                                                                                                                                                                                        
|            | 10 | .15(*)                 |  | Form of Indemnification Agreement by and between
    the Registrant and each of Patricia Gilligan, Kenneth Hale and
    Kevin Lo is incorporated herein by reference to Exhibits to the
    Registrants Quarterly Report on Form 10-Q for the
    fiscal quarter ended April 30, 2001.                                                                                                                                                                                                              
|            | 10 | .16(*)                 |  | Form of Amended and Restated Director
    Indemnification Agreement by and between the Registrant and each
    of Joel Rosen and David Wetherell is incorporated herein by
    reference to Exhibits to the Registrants Quarterly Report
    on Form 10-Q for the fiscal quarter ended April 30,
    2001.                                                                                                                                                                                          
|            | 10 | .17(*)                 |  | Form of Executive Non-Statutory Stock Option
    Agreement by and between the Registrant and each of Patricia
    Gilligan and Kevin Lo is incorporated herein by reference to
    Exhibits to the Registrants Quarterly Report on
    Form 10-Q for the fiscal quarter ended April 30, 2001.                                                                                                                                                                                                       
|            | 10 | .18(*)                 |  | Form of Executive Retention Agreement by and
    between the Registrant and each of Kevin Lo and Wayne Whitcomb,
    dated October 17, 2001, is incorporated herein by reference
    to Exhibits to the Registrants Quarterly Report on
    Form 10-Q for the fiscal quarter ended October 31,
    2001.                                                                                                                                                                                            
|            | 10 | .19                    |  | Letter Amendment, dated November 8, 2001, to
    Transaction Agreement, dated as of October 29, 2001, by and
    among CMGI, Inc., AltaVista Company, Compaq Computer
    Corporation, Compaq Financial Services Corporation, Compaq
    Financial Services Company, Compaq Financial Services Canada
    Corporation 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 October 31,
    2001.

44



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##### Table of Contents



|            |    |                        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|----------- | -- | ---------------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |    | Description of Exhibit
|            |    |                       
|            | 10 | .20                    |  | 12% Convertible, Senior, Secured Note due
    December 31, 2007, issued by the Registrant to Compaq
    Financial Services Corporation, dated November 8, 2001, is
    incorporated herein by reference to Exhibits to the
    Registrants Quarterly Report on Form 10-Q for the
    fiscal quarter ended October 31, 2001.                                                                                                                       
|            | 10 | .21                    |  | 12% Convertible, Senior, Secured Note due
    December 31, 2007, issued by the Registrant to CMGI, Inc.,
    dated November 8, 2001, is incorporated herein by reference
    to Exhibits to the Registrants Quarterly Report on
    Form 10-Q for the fiscal quarter ended October 31,
    2001.                                                                                                                                                  
|            | 10 | .22                    |  | Guarantee and Security Agreement, dated as of
    November 8, 2001, by and among Compaq Financial Services
    Corporation 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 October 31,
    2001.                                                                                                                                         
|            | 10 | .23                    |  | Amendment to and Restatement of the Investor
    Rights Agreement, dated as of November 8, 2001, by and
    among Compaq Financial Services Corporation, CMGI, Inc., 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 October 31, 2001.                                                                                               
|            | 10 | .24(*)                 |  | Form of Executive Retention Agreement by and
    between the Registrant and Robert Poon, dated March 5,
    2002, is incorporated herein by reference to Exhibits to the
    Registrants Quarterly Report on Form 10-Q for the
    fiscal quarter ended January 31, 2002.                                                                                                                                                                         
|            | 10 | .25                    |  | Letter Agreement, dated October 10, 2002,
    between ClearBlue Technologies, Inc. and the Registrant, is
    incorporated herein by reference to Exhibits to the
    Registrants Annual Report on Form 10-K for the fiscal
    year ended July 31, 2002.                                                                                                                                                                                         
|            | 10 | .26(*)                 |  | 2000 Stock Option Plan is incorporated herein by
    reference to Exhibits to the Registrants Annual Report of
    Form 10-K/ A for the fiscal year ended July 31, 2002.                                                                                                                                                                                                                                                                          
|            | 10 | .27                    |  | Assignment Agreement dated October 11, 2002
    by and between the Registrant and Fir Tree Recovery Master Fund,
    LP and Fir Tree Value Partners, LDC is incorporated herein by
    reference to Exhibit 4 to the Schedule 13D filed by
    NaviSite on November 12, 2002 (File No. 005-56549).                                                                                                                                                 
|            | 10 | .28                    |  | Renunciation Letter dated October 11, 2002
    from the Registrant to Interliant, Inc. is incorporated by
    reference to Exhibit 4 to the Schedule 13D filed by
    NaviSite on November 12, 2002 (File No. 005-56549).                                                                                                                                                                                                                          
|            | 10 | .29                    |  | Sublease, dated as of December 20, 2002, by
    and between NaviPath, Inc. and the Registrant, is incorporated
    herein by reference to Exhibits to the Registrants
    Quarterly Report of Form 10-Q for the fiscal quarter ended
    January 31, 2003.                                                                                                                                                                                        
|            | 10 | .30                    |  | Outsourcing Services Agreement, dated as of
    January 1, 2003, by and between ClearBlue Technologies,
    Inc. and the Registrant, is incorporated herein by reference to
    Exhibits to the Registrants Quarterly Report of
    Form 10-Q for the fiscal quarter ended January 31,
    2003.                                                                                                                                                  
|            | 10 | .31                    |  | Statement of Work, dated as of January 1,
    2003, describing the services to be provided to ClearBlue
    Technologies, Inc. by the Registrant under the Outsourcing
    Agreement, dated as of January 1, 2003, by and between
    ClearBlue Technologies, Inc. and the Registrant, is incorporated
    herein by reference to Exhibits to the Registrants
    Quarterly Report of Form 10-Q for the fiscal quarter ended
    January 31, 2003.
|            | 10 | .32                    |  | Loan and Security Agreement, dated as of
    January 3, 2003, by and between ClearBlue Technologies,
    Inc. as Lender and the Registrant as Borrower, is incorporated
    herein by reference to Exhibits to the Registrants
    Quarterly Report of Form 10-Q for the fiscal quarter ended
    January 31, 2003.                                                                                                                               
|            | 10 | .33                    |  | Loan and Security Agreement, dated as of
    January 3, 2003, by and between ClearBlue Technologies,
    Inc. as Borrower and the Registrant as Lender, is incorporated
    herein by reference to Exhibits to the Registrants
    Quarterly Report of Form 10-Q for the fiscal quarter ended
    January 31, 2003.                                                                                                                               
|            | 10 | .34                    |  | Loan and Security Agreement, dated as of
    January 3, 2003, by and between Atlantic Investors, LLC as
    Lender and the Registrant as Borrower, is incorporated herein by
    reference to Exhibits to the Registrants Quarterly Report
    of Form 10-Q for the fiscal quarter ended January 31,
    2003.                                                                                                                                    

45



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##### Table of Contents



|            |    |                        |  |                                                                                                                                                                                                                                                                                                                                                                                                    
|----------- | -- | ---------------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |    | Description of Exhibit
|            |    |                       
|            | 10 | .35(*)                 |  | Severance Agreement and General Release, dated as
    of February 21, 2003, to Patricia Gilligan from the
    Registrant, is incorporated herein by reference to Exhibits to
    the Registrants Quarterly Report of Form 10-Q for the
    fiscal quarter ended January 31, 2003.                                                                                                                 
|            | 10 | .36(*)                 |  | 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 of Form 10-Q for the
    fiscal quarter ended January 31, 2003.                                                                                                                             
|            | 10 | .37(*)                 |  | Offer of Employment Letter to Jim Pluntze dated
    March 25, 2003, is incorporated herein by reference to
    Exhibits to the Registrants Quarterly Report on
    Form 10-Q for the fiscal quarter ended April 30, 2003.                                                                                                                                                                         
|            | 10 | .38(*)                 |  | Agreement, dated as of April 4, 2003, by and
    between the Registrant and James Pluntze, is incorporated herein
    by reference to Exhibits to the Registrants Quarterly
    Report on Form 10-Q for the fiscal quarter ended
    April 30, 2003.                                                                                                                                              
|            | 10 | .39(*)                 |  | Severance Agreement And General Release by and
    between the Registrant and Kevin Lo dated April 30, 2003,
    is incorporated herein by reference to Exhibits to the
    Registrants Quarterly Report on Form 10-Q for the
    fiscal quarter ended April 30, 2003.                                                                                                                            
|            | 10 | .40                    |  | Accounts Receivable Financing Agreement dated
    May 27, 2003 by and between Silicon Valley Bank and the
    Registrant, ClearBlue Technologies Management, Inc., Avasta,
    Inc., Conxion Corporation and Intrepid Acquisition Corp., is
    incorporated herein by reference to Exhibits to the
    Registrants Quarterly Report on Form 10-Q for the
    fiscal quarter ended April 30, 2003.
|            | 10 | .41                    |  | Registration Rights Agreement dated May 27,
    2003 by and between the Registrant and Silicon Valley Bank, is
    incorporated herein by reference to Exhibits to the
    Registrants Quarterly Report on Form 10-Q for the
    fiscal quarter ended April 30, 2003.                                                                                                                             
|            | 10 | .42                    |  | Intellectual Property Security Agreement dated
    May 27, 2003 by and between the Registrant and Silicon
    Valley Bank, is incorporated herein by reference to Exhibits to
    the Registrants Quarterly Report on Form 10-Q for the
    fiscal quarter ended April 30, 2003.                                                                                                                  
|            | 10 | .43                    |  | Warrant to Purchase Stock, dated May 27,
    2003, issued by the Registrant to Silicon Valley Bank, is hereby
    incorporated herein by reference to Exhibits to the
    Registrants Quarterly Report on Form 10-Q for the
    fiscal quarter ended April 30, 2003.                                                                                                                              
|            | 10 | .44                    |  | First Amendment to Loan and Security Agreement,
    dated June 2, 2003, by and between ClearBlue Technologies,
    Inc. and the Registrant, is incorporated herein by reference to
    the Registrants Quarterly Report on Form 10-Q for the
    fiscal quarter ended April 30, 2003.                                                                                                             
|            | 10 | .45                    |  | Transition Services Agreement, dated
    November 25, 2002, by and between CMGI, Inc. and the
    Registrant, is incorporated by reference to the
    Registrants Quarterly Report on Form 10-Q for the
    fiscal quarter ended October 31, 2002.                                                                                                                                                
|            | 10 | .46                    |  | Letter Agreement, dated December 11, 2002,
    between ClearBlue Technologies, Inc. and the Registrant, is
    incorporated by reference to the Registrants Quarterly
    Report on Form 10-Q for the fiscal quarter ended
    October 31, 2002.                                                                                                                                                  
|            | 10 | .47(*)                 |  | Offer of Employment Letter to Kenneth Drake dated
    July 15, 2003.                                                                                                                                                                                                                                                                                                                               
|            | 10 | .48(*)                 |  | 2003 Stock Incentive Plan.                                                                                                                                                                                                                                                                                                                                                                         
|            | 10 | .49(*)                 |  | Form of Indemnification Agreement, as executed by
    Messrs. Andrew Ruhan, Arthur P. Becker, Gabriel Ruhan,
    James H. Dennedy, Larry W. Schwartz, Thomas R. Evans, James W.
    Pluntze and Kenneth Drake.                                                                                                                                                                                     
|            | 10 | .50                    |  | Professional Services Agreement between the New
    York State Department of Labor and AppliedTheory Corporation
    dated November 2, 2000, is incorporated herein by reference
    to Exhibit 10.56 of AppliedTheorys Annual Report on
    Form 10-K for the fiscal year ended December 31, 2000
    (File No. 000-25759).                                                                      
|            | 14 |                        |  | Code of Business Conduct and Ethics of the
    Registrant.                                                                                                                                                                                                                                                                                                                                         
|            | 21 |                        |  | Subsidiaries of the Registrant.                                                                                                                                                                                                                                                                                                                                                                    
|            | 23 |                        |  | Accountants Consent.                                                                                                                                                                                                                                                                                                                                                                              
|            | 31 | .1                     |  | Certification of the Chief Executive Officer
    pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                        

46



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##### Table of Contents



|            |    |                        |  |                                                                                                                                                               
|----------- | -- | ---------------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |    | Description of Exhibit
|            |    |                       
|            | 31 | .2                     |  | Certification of the Chief Financial Officer
    pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                   
|            | 32 | .1                     |  | Certification of the Chief Executive Officer
    pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to
    Section 906 of the Sarbanes-Oxley Act of 2002.
|            | 32 | .2                     |  | Certification of the Chief Financial Officer
    pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to
    Section 906 of the Sarbanes-Oxley Act of 2002.



---



|    |                                                                                                                                       
|--- | --------------------------------------------------------------------------------------------------------------------------------------
|(*) | Management contract or compensatory plan or
    arrangement required to be filed as an Exhibit to this Annual
    Report on Form 10-K.

47



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##### Table of Contents






Item 8.     Financial
Statements and Supplementary Data

NAVISITE, INC. AND SUBSIDIARIES

INDEX TO CONSOLIDATED FINANCIAL
STATEMENTS

|                                                                                                                              |  |      |      | 
|----------------------------------------------------------------------------------------------------------------------------- |  | ---- | ---- | 
|                                                                                                                              |  | Page
|                                                                                                                              |  |     
|Independent Auditors Report                                                                                                  |  |      | F-2  | 
|Consolidated Balance Sheets as of July 31,
    2003 and 2002                                                                  |  |      | F-3  | 
|Consolidated Statements of Operations for the
    years ended July 31, 2003, 2002 and 2001                                    |  |      | F-4  | 
|Consolidated Statements of Changes in
    Stockholders Equity (Deficit) for the years ended
    July 31, 2003, 2002 and 2001 |  |      | F-5  | 
|Consolidated Statements of Cash Flows for the
    years ended July 31, 2003, 2002, and 2001                                   |  |      | F-6  | 
|Notes to Consolidated Financial Statements                                                                                    |  |      | F-8  | 
|Independent Auditors Report on Financial
    Statement Schedule                                                              |  |      | F-36 | 
|Financial Statement
    Schedule IIValuation and Qualifying Accounts                                                         |  |      | S-1  | 

F-1



---



##### Table of Contents



INDEPENDENT AUDITORS REPORT

The Board of Directors and Stockholders

NaviSite, Inc. and Subsidiaries:


We have audited the accompanying consolidated
balance sheets of NaviSite, Inc. and Subsidiaries as of
July 31, 2003 and 2002, and the related consolidated
statements of operations, changes in stockholders equity
(deficit), and cash flows for each of the years in the
three-year period ended July 31, 2003. These financial
statements are the responsibility of the Companys
management. Our responsibility is to express an opinion on these
financial statements on our audits.

We conducted our audits in accordance with
auditing standards generally accepted in the United States of
America. 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 financial statements referred
to above present fairly, in all material respects, the financial
position of NaviSite, Inc. and Subsidiaries as of July 31,
2003 and 2002, and the results of their operations and their
cash flows for each of the years in the three-year period ended
July 31, 2003, in conformity with accounting principles
generally accepted in the United States of America.

The accompanying financial statements have been
prepared assuming that the Company will continue as a going
concern. As discussed in Note 3 to the financial
statements, the Company has incurred recurring losses from
operations since inception and has an accumulated deficit. These
factors, among others as discussed in Note 3 to the
financial statements, raise substantial doubt about the
Companys ability to continue as a going concern.
Managements plans in regard to these matters are also
described in Note 3. The financial statements do not
include any adjustments that might result from the outcome of
this uncertainty.



| |             
| | ------------
| | /s/ KPMG LLP

Boston, Massachusetts

October 21, 2003


F-2



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##### Table of Contents



NAVISITE AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

|                                                                                                                                    |  |                   |          |      |  |   |          |  
|----------------------------------------------------------------------------------------------------------------------------------- |  | ----------------- | -------- | ---- |  | - | -------- | -
|                                                                                                                                    |  |                  
|                                                                                                                                    |  | July 31,         
|                                                                                                                                    |  |                  
|                                                                                                                                    |  | 2003              |          | 2002
|                                                                                                                                    |  |                   |          |     
|                                                                                                                                    |  |                  
|                                                                                                                                    |  | (In thousands,   
|                                                                                                                                    |  | except par value)
|ASSETS                                                                                                                             
|Current Assets:                                                                                                                     |  |                   |          |      |  |   |          |  
|Cash and cash equivalents                                                                                                           |  | $                 | 3,862    |      |  | $ | 21,842   |  
|Accounts receivable, less allowance for doubtful
    accounts of $1,045 and $617 at July 31, 2003 and 2002,
    respectively        |  |                   | 12,306   |      |  |   | 3,553    |  
|Due from related parties                                                                                                            |  |                   | 270      |      |  |   | 3,724    |  
|Prepaid expenses and other current assets                                                                                           |  |                   | 3,755    |      |  |   | 3,292    |  
|Assets held for sale                                                                                                                |  |                   |         |      |  |   | 1,022    |  
|                                                                                                                                    |  |                   |          |      |  |   |          |  
|Total current assets                                                                                                                |  |                   | 20,193   |      |  |   | 33,433   |  
|Property and equipment, net                                                                                                         |  |                   | 16,291   |      |  |   | 12,412   |  
|Customer Lists, net of $2,384 accumulated
    amortization                                                                          |  |                   | 9,702    |      |  |   |         |  
|Goodwill                                                                                                                            |  |                   | 3,206    |      |  |   |         |  
|Other assets                                                                                                                        |  |                   | 5,430    |      |  |   | 3,839    |  
|Restricted cash                                                                                                                     |  |                   | 557      |      |  |   | 3,850    |  
|                                                                                                                                    |  |                   |          |      |  |   |          |  
|Total assets                                                                                                                        |  | $                 | 55,379   |      |  | $ | 53,534   |  
|                                                                                                                                    |  |                   |          |      |  |   |          |  
|LIABILITIES AND STOCKHOLDERS
    EQUITY                                                                                           
|Current Liabilities:                                                                                                                |  |                   |          |      |  |   |          |  
|Accounts receivable financing line                                                                                                  |  | $                 | 6,663    |      |  | $ |         |  
|Current notes payable                                                                                                               |  |                   | 1,211    |      |  |   |         |  
|Capital lease obligations, current portion                                                                                          |  |                   | 2,924    |      |  |   | 2,123    |  
|Current note payable to related party                                                                                               |  |                   | 3,000    |      |  |   |         |  
|Due to CMGI                                                                                                                         |  |                   |         |      |  |   | 3,241    |  
|Accounts payable                                                                                                                    |  |                   | 3,851    |      |  |   | 1,803    |  
|Accrued expenses                                                                                                                    |  |                   | 16,075   |      |  |   | 7,932    |  
|Deferred revenue                                                                                                                    |  |                   | 1,557    |      |  |   | 1,619    |  
|Customer deposits                                                                                                                   |  |                   | 134      |      |  |   | 199      |  
|                                                                                                                                    |  |                   |          |      |  |   |          |  
|Total current liabilities                                                                                                           |  |                   | 35,415   |      |  |   | 16,917   |  
|Capital lease obligations, less current portion                                                                                     |  |                   | 1,907    |      |  |   | 378      |  
|Accrued impairment, less current portion                                                                                            |  |                   | 3,476    |      |  |   |         |  
|Note to AppliedTheory Estate                                                                                                        |  |                   | 6,000    |      |  |   |          |  
|Convertible notes payable to HPFS, net                                                                                              |  |                   |         |      |  |   | 23,440   |  
|Convertible note payable to CMGI, net                                                                                               |  |                   |         |      |  |   | 4,255    |  
|                                                                                                                                    |  |                   |          |      |  |   |          |  
|Total liabilities                                                                                                                   |  |                   | 46,798   |      |  |   | 44,990   |  
|Commitments and contingencies (note 10)                                                                                             |  |                   |          |      |  |   |          |  
|Stockholders equity (deficit):                                                                                                     |  |                   |          |      |  |   |          |  
|Preferred Stock, $0.01 par value. Authorized
    5,000 shares; no shares issued or outstanding at July 31,
    2003 and 2002        |  |                   |         |      |  |   |         |  
|Common Stock, $0.01 par value. Authorized 395,000
    shares; issued and outstanding 23,412 and 6,248 at July 31,
    2003 and 2002 |  |                   | 235      |      |  |   | 62       |  
|Accumulated other comprehensive income                                                                                              |  |                   | (16      | )    |  |   |         |  
|Additional paid-in capital                                                                                                          |  |                   | 415,735  |      |  |   | 345,820  |  
|Accumulated deficit                                                                                                                 |  |                   | (407,373 | )    |  |   | (337,338 | )
|                                                                                                                                    |  |                   |          |      |  |   |          |  
|Total stockholders equity                                                                                                          |  |                   | 8,581    |      |  |   | 8,544    |  
|                                                                                                                                    |  |                   |          |      |  |   |          |  
|Total liabilities and stockholders equity                                                                                          |  | $                 | 55,379   |      |  | $ | 53,534   |  
|                                                                                                                                    |  |                   |          |      |  |   |          |  

See accompanying notes to consolidated financial
statements.

F-3



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##### Table of Contents



NAVISITE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF OPERATIONS

|                                                                           |  |                                           |         |      |  |      |          |   |  |   |          |  
|-------------------------------------------------------------------------- |  | ----------------------------------------- | ------- | ---- |  | ---- | -------- | - |  | - | -------- | -
|                                                                           |  |                                          
|                                                                           |  | Years Ended July 31,                     
|                                                                           |  |                                          
|                                                                           |  | 2003                                      |         | 2002 |  | 2001
|                                                                           |  |                                           |         |      |  |     
|                                                                           |  |                                          
|                                                                           |  | (In thousands, except per share and share
|                                                                           |  | data)                                    
|Revenue:                                                                   |  |                                           |         |      |  |      |          |   |  |   |          |  
|Revenue                                                                    |  | $                                         | 61,445  |      |  | $    | 40,968   |   |  | $ | 66,358   |  
|Revenue, related parties                                                   |  |                                           | 1,310   |      |  |      | 18,453   |   |  |   | 36,368   |  
|                                                                           |  |                                           |         |      |  |      |          |   |  |   |          |  
|Total revenue                                                              |  |                                           | 62,755  |      |  |      | 59,421   |   |  |   | 102,726  |  
|Cost of revenue                                                            |  |                                           | 56,585  |      |  |      | 67,000   |   |  |   | 127,155  |  
|Impairment of long-lived assets                                            |  |                                           |        |      |  |      | 68,317   |   |  |   | 1,930    |  
|                                                                           |  |                                           |         |      |  |      |          |   |  |   |          |  
|Total cost of revenue                                                      |  |                                           | 56,585  |      |  |      | 135,317  |   |  |   | 129,085  |  
|                                                                           |  |                                           |         |      |  |      |          |   |  |   |          |  
|Gross profit (deficit)                                                     |  |                                           | 6,170   |      |  |      | (75,896  | ) |  |   | (26,359  | )
|                                                                          
|Operating expenses:                                                        |  |                                           |         |      |  |      |          |   |  |   |          |  
|Product development                                                        |  |                                           | 950     |      |  |      | 5,281    |   |  |   | 14,072   |  
|Selling and marketing                                                      |  |                                           | 5,829   |      |  |      | 9,703    |   |  |   | 32,251   |  
|General and administrative                                                 |  |                                           | 18,785  |      |  |      | 19,272   |   |  |   | 33,011   |  
|Impairment and restructuring                                               |  |                                           | 6,903   |      |  |      | (2,633   | ) |  |   | 8,011    |  
|                                                                           |  |                                           |         |      |  |      |          |   |  |   |          |  
|Total operating expenses                                                   |  |                                           | 32,467  |      |  |      | 31,623   |   |  |   | 87,345   |  
|                                                                           |  |                                           |         |      |  |      |          |   |  |   |          |  
|Loss from operations                                                       |  |                                           | (26,297 | )    |  |      | (107,519 | ) |  |   | (113,704 | )
|Other income (expense):                                                    |  |                                           |         |      |  |      |          |   |  |   |          |  
|Interest income                                                            |  |                                           | 785     |      |  |      | 1,060    |   |  |   | 2,753    |  
|Interest expense                                                           |  |                                           | (43,289 | )    |  |      | (14,718  | ) |  |   | (8,042   | )
|Other income (expense), net                                                |  |                                           | (719    | )    |  |      | (516     | ) |  |   | 292      |  
|                                                                           |  |                                           |         |      |  |      |          |   |  |   |          |  
|Loss before cumulative effect of change in
    accounting principle        |  |                                           | (69,520 | )    |  |      | (121,693 | ) |  |   | (118,701 | )
|Cumulative effect of change in accounting
    principle                    |  |                                           |        |      |  |      |         |   |  |   | (4,295   | )
|                                                                           |  |                                           |         |      |  |      |          |   |  |   |          |  
|Net loss                                                                   |  | $                                         | (69,520 | )    |  | $    | (121,693 | ) |  | $ | (122,996 | )
|Basic and diluted net loss per common share:                               |  |                                           |         |      |  |      |          |   |  |   |          |  
|Before cumulative effect of change in accounting
    principle             |  | $                                         | (5.97   | )    |  | $    | (22.30   | ) |  | $ | (30.18   | )
|Cumulative effect of change in accounting
    principle                    |  |                                           |        |      |  |      |         |   |  |   | (1.09    | )
|                                                                           |  |                                           |         |      |  |      |          |   |  |   |          |  
|Basic and diluted net loss per common share                                |  | $                                         | (5.97   | )    |  | $    | (22.30   | ) |  | $ | (31.27   | )
|                                                                           |  |                                           |         |      |  |      |          |   |  |   |          |  
|Basic and diluted weighted average number of
    common shares outstanding |  |                                           | 11,654  |      |  |      | 5,457    |   |  |   | 3,933    |  
|                                                                           |  |                                           |         |      |  |      |          |   |  |   |          |  

See accompanying notes to consolidated financial
statements.

F-4



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##### Table of Contents



NAVISITE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN
STOCKHOLDERS EQUITY

|                                                                                                           |  |              |        |          |  |              |     |            |  |                 |       |               |  |                  |     |   |  |   |         |  |  |  |          |   |  |   |          |  
|---------------------------------------------------------------------------------------------------------- |  | ------------ | ------ | -------- |  | ------------ | --- | ---------- |  | --------------- | ----- | ------------- |  | ---------------- | --- | - |  | - | ------- |  |  |  | -------- | - |  | - | -------- | -
|                                                                                                           |  |              |        |          |  |              |     |            |  |                 |       |              
|                                                                                                           |  | Common Stock |        |          |  | Cumulative   |     |            |  |                 |       |              
|                                                                                                           |  |              |        | Deferred |  | Translation  |     | Additional |  | Accumulated     |       | Stockholders
|                                                                                                           |  | Shares       |        | Amount   |  | Compensation |     | Adjustment |  | Paid-in Capital |       | Deficit       |  | Equity (Deficit)
|                                                                                                           |  |              |        |          |  |              |     |            |  |                 |       |               |  |                 
|Balance at July 31, 2000                                                                                   |  |              | 3,891  |          |  | $            | 39  |            |  | $               | (762  | )             |  |                  |     |   |  | $ | 190,846 |  |  |  | (92,649  | ) |  | $ | 97,474   |  
|Issuance of common stock in connection with
    employee stock purchase plan and exercise of stock options |  |              | 48     |          |  |              | 0   |            |  |                 |      |               |  |                  |     |   |  |   | 982     |  |  |  |         |   |  |   | 982      |  
|Issuance of stock warrants in connection with
    convertible debt                                         |  |              |       |          |  |              |    |            |  |                 |      |               |  |                  |     |   |  |   | 12,918  |  |  |  |         |   |  |   | 12,918   |  
|Issuance of common stock in connection with the
    interest on convertible debt                           |  |              | 186    |          |  |              | 2   |            |  |                 |      |               |  |                  |     |   |  |   | 3,607   |  |  |  |         |   |  |   | 3,609    |  
|Deferred stock compensation related to acquisition                                                         |  |              |       |          |  |              |    |            |  |                 | (289  | )             |  |                  |     |   |  |   | 289     |  |  |  |         |   |  |   |         |  
|Amortization of deferred stock compensation                                                                |  |              |       |          |  |              |    |            |  |                 | 1,051 |               |  |                  |     |   |  |   |        |  |  |  |         |   |  |   | 1,051    |  
|Net loss                                                                                                   |  |              |       |          |  |              |    |            |  |                 |      |               |  |                  |     |   |  |   |        |  |  |  | (122,996 | ) |  |   | (122,996 | )
|                                                                                                           |  |              |        |          |  |              |     |            |  |                 |       |               |  |                  |     |   |  |   |         |  |  |  |          |   |  |   |          |  
|Balance at July 31, 2001                                                                                   |  |              | 4,125  |          |  |              | 41  |            |  |                 |      |               |  |                  |    |   |  |   | 208,642 |  |  |  | (215,645 | ) |  |   | (6,962   | )
|Issuance of common stock in connection with
    employee stock purchase plan and exercise of stock options |  |              | 35     |          |  |              | 0   |            |  |                 |      |               |  |                  |     |   |  |   | 36      |  |  |  |         |   |  |   | 36       |  
|Conversion of CMGI convertible debt and other
    amounts due to CMGI                                      |  |              | 1,624  |          |  |              | 16  |            |  |                 |      |               |  |                  |     |   |  |   | 87,137  |  |  |  |         |   |  |   | 87,153   |  
|Issuance of common stock in connection with the
    interest on convertible debt                           |  |              | 464    |          |  |              | 5   |            |  |                 |      |               |  |                  |     |   |  |   | 2,980   |  |  |  |         |   |  |   | 2,985    |  
|Beneficial conversion feature of debt issued to
    CMGI and HPFS                                          |  |              |       |          |  |              |    |            |  |                 |      |               |  |                  |     |   |  |   | 42,561  |  |  |  |         |   |  |   | 42,561   |  
|Net settlement of debt to CMGI                                                                             |  |              |       |          |  |              |    |            |  |                 |      |               |  |                  |     |   |  |   | 4,464   |  |  |  |         |   |  |   | 4,464    |  
|Net loss                                                                                                   |  |              |       |          |  |              |    |            |  |                 |      |               |  |                  |     |   |  |   |        |  |  |  | (121,693 | ) |  |   | (121,693 | )
|                                                                                                           |  |              |        |          |  |              |     |            |  |                 |       |               |  |                  |     |   |  |   |         |  |  |  |          |   |  |   |          |  
|Balance at July 31, 2002                                                                                   |  |              | 6,248  |          |  |              | 62  |            |  |                 |      |               |  |                  |    |   |  |   | 345,820 |  |  |  | (337,338 | ) |  |   | 8,544    |  
|Issuance of common stock in connection with
    employee stock purchase plan and exercise of stock options |  |              | 2      |          |  |              |    |            |  |                 |      |               |  |                  |     |   |  |   | 2       |  |  |  |          |   |  |   | 2        |  
|Common control merger with CBTM                                                                            |  |              | 568    |          |  |              | 6   |            |  |                 |      |               |  |                  |     |   |  |   | 3,360   |  |  |  | (515     | ) |  |   | 2,851    |  
|Conversion of CBT convertible debt and other
    amounts due to CBT                                        |  |              | 16,363 |          |  |              | 165 |            |  |                 |      |               |  |                  |     |   |  |   | 65,816  |  |  |  |          |   |  |   | 65,981   |  
|Issuance of common stock in connection with the
    acquisition of Avasta                                  |  |              | 231    |          |  |              | 2   |            |  |                 |      |               |  |                  |     |   |  |   | 367     |  |  |  |          |   |  |   | 369      |  
|Issuance of stock warrants to Silicon Valley Bank                                                          |  |              |       |          |  |              |    |            |  |                 |      |               |  |                  |     |   |  |   | 370     |  |  |  |          |   |  |   | 370      |  
|Net Loss                                                                                                   |  |              |       |          |  |              |    |            |  |                 |      |               |  |                  |     |   |  |   |        |  |  |  | (69,520  | ) |  |   | (69,520  | )
|Change in foreign currency translation adjustment                                                          |  |              |        |          |  |              |     |            |  |                 |       |               |  |                  | (16 | ) |  |   |         |  |  |  |         |   |  |   | (16      | )
|                                                                                                           |  |              |        |          |  |              |     |            |  |                 |       |               |  |                  |     |   |  |   |         |  |  |  |          |   |  |   |          |  
|Comprehensive loss                                                                                         |  |              |        |          |  |              |     |            |  |                 |       |               |  |                  |     |   |  |   |         |  |  |  |          |   |  |   | (69,536  | )
|                                                                                                           |  |              |        |          |  |              |     |            |  |                 |       |               |  |                  |     |   |  |   |         |  |  |  |          |   |  |   |          |  
|Balance at July 31, 2003                                                                                   |  |              | 23,412 |          |  |              | 235 |            |  |                 |      |               |  |                  | (16 | ) |  |   | 415,735 |  |  |  | (407,373 | ) |  |   | 8,581    |  

See accompanying notes to consolidated financial
statements.

F-5



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##### Table of Contents



NAVISITE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH
FLOWS

|                                                                                 |  |                      |         |      |  |      |          |   |  |   |          |  
|-------------------------------------------------------------------------------- |  | -------------------- | ------- | ---- |  | ---- | -------- | - |  | - | -------- | -
|                                                                                 |  |                     
|                                                                                 |  | Years Ended July 31,
|                                                                                 |  |                     
|                                                                                 |  | 2003                 |         | 2002 |  | 2001
|                                                                                 |  |                      |         |      |  |     
|                                                                                 |  |                     
|                                                                                 |  | (In thousands)      
|Cash flows from operating activities:                                            |  |                      |         |      |  |      |          |   |  |   |          |  
|Net loss                                                                         |  | $                    | (69,520 | )    |  | $    | (121,693 | ) |  | $ | (122,996 | )
|Adjustments to reconcile net loss to net cash
    used for operating activities: |  |                      |         |      |  |      |          |   |  |   |          |  
|Depreciation and amortization                                                    |  |                      | 11,171  |      |  |      | 20,649   |   |  |   | 15,154   |  
|Amortization of beneficial conversion feature to
    interest expense            |  |                      | 37,398  |      |  |      | 5,163    |   |  |   |         |  
|Interest on debt paid in stock                                                   |  |                      | 2,098   |      |  |      | 3,695    |   |  |   |         |  
|Impairment of long-lived assets                                                  |  |                      | 1,042   |      |  |      | 68,317   |   |  |   |         |  
|Impairment of goodwill                                                           |  |                      |        |      |  |      | 186      |   |  |   |         |  
|Writedown of assets held for sale                                                |  |                      |        |      |  |      | 524      |   |  |   |         |  
|(Gain) loss on disposal of assets                                                |  |                      | 250     |      |  |      | 1,363    |   |  |   | (133     | )
|Gain on sale of Streaming Media Assets                                           |  |                      |        |      |  |      | (524     | ) |  |   |         |  
|Costs associated w/abandoned leases                                              |  |                      | 6,127   |      |  |      |         |   |  |   |         |  
|Amortization of Warrants                                                         |  |                      | 66      |      |  |      |         |   |  |   |         |  
|Provision for bad debts                                                          |  |                      | 951     |      |  |      | 3,490    |   |  |   | 11,948   |  
|Amortization of deferred compensation                                            |  |                      |        |      |  |      |         |   |  |   | 1,051    |  
|Interest on convertible notes payable to CMGI                                    |  |                      |        |      |  |      |         |   |  |   | 3,609    |  
|Accretion of debt discount                                                       |  |                      |        |      |  |      | 1,172    |   |  |   | 2,691    |  
|Changes in operating assets and liabilities, net
    of impact of acquisitions:  |  |                      |         |      |  |      |          |   |  |   |          |  
|Accounts receivable                                                              |  |                      | 529     |      |  |      | 3,600    |   |  |   | (6,373   | )
|Due from CMGI and affiliates                                                     |  |                      | (292    | )    |  |      | (266     | ) |  |   | 1,623    |  
|Prepaid expenses and other current assets, net                                   |  |                      | 913     |      |  |      | 178      |   |  |   | 1,016    |  
|Due to CMGI                                                                      |  |                      | (3,241  | )    |  |      | 7,218    |   |  |   | 9,511    |  
|Deposits                                                                         |  |                      |        |      |  |      | (379     | ) |  |   | (58      | )
|Accounts payable                                                                 |  |                      | (2,388  | )    |  |      | (8,537   | ) |  |   | (3,116   | )
|Customer deposits                                                                |  |                      | (65     | )    |  |      | (19      | ) |  |   | 218      |  
|Accrued expenses and deferred revenue                                            |  |                      | (1,286  | )    |  |      | (11,172  | ) |  |   | (2,945   | )
|                                                                                 |  |                      |         |      |  |      |          |   |  |   |          |  
|Net cash used for operating activities                                           |  |                      | (16,247 | )    |  |      | (27,035  | ) |  |   | (88,800  | )
|                                                                                
|Cash flows from investing activities:                                            |  |                      |         |      |  |      |          |   |  |   |          |  
|Net cash acquired in acquisitions                                                |  |                      | 3,981   |      |  |      |         |   |  |   |         |  
|Purchase of property and equipment                                               |  |                      | (586    | )    |  |      | (4,182   | ) |  |   | (25,515  | )
|Purchase of debt securities                                                      |  |                      | (1,963  | )    |  |      |         |   |  |   |         |  
|Cash used to acquire Interliant                                                  |  |                      | (5,830  | )    |  |      |         |   |  |   |         |  
|Loan to related party                                                            |  |                      | (1,596  | )    |  |      |         |   |  |   |         |  
|Proceeds from repayment of loan to related party                                 |  |                      | 200     |      |  |      |         |   |  |   |         |  
|Proceeds from the sale of Streaming Media assets                                 |  |                      |        |      |  |      | 1,600    |   |  |   |         |  
|Proceeds from the sale of equipment                                              |  |                      | 475     |      |  |      | 1,440    |   |  |   | 13,884   |  
|Restricted cash                                                                  |  |                      | 3,945   |      |  |      | 1,201    |   |  |   | (5,051   | )
|Other assets                                                                     |  |                      |        |      |  |      | 577      |   |  |   | (747     | )
|                                                                                 |  |                      |         |      |  |      |          |   |  |   |          |  
|Net cash provided by (used for) investing
    activities                         |  |                      | (1,374  | )    |  |      | 636      |   |  |   | (17,429  | )

F-6



---



##### Table of Contents



|                                                                             |  |                      |         |      |  |      |        |   |  |   |         |  
|---------------------------------------------------------------------------- |  | -------------------- | ------- | ---- |  | ---- | ------ | - |  | - | ------- | -
|                                                                             |  |                     
|                                                                             |  | Years Ended July 31,
|                                                                             |  |                     
|                                                                             |  | 2003                 |         | 2002 |  | 2001
|                                                                             |  |                      |         |      |  |     
|                                                                             |  |                     
|                                                                             |  | (In thousands)      
|Cash flows from financing activities:                                        |  |                      |         |      |  |      |        |   |  |   |         |  
|Issuance of convertible notes payable to CMGI                                |  |                      |        |      |  |      |       |   |  |   | 80,000  |  
|Issuance of convertible notes payable to CMGI and
    HPFS                   |  |                      |        |      |  |      | 30,000 |   |  |   |        |  
|Proceeds from increase in debt to CMGI, net                                  |  |                      |        |      |  |      |       |   |  |   |        |  
|Proceeds from exercise of stock options and
    employee stock purchase plan |  |                      |        |      |  |      | 35     |   |  |   | 982     |  
|Proceeds from issuance of common stock, net of
    offering costs of $8,169  |  |                      |        |      |  |      |       |   |  |   |        |  
|Proceeds from sale-leaseback                                                 |  |                      |        |      |  |      |       |   |  |   |        |  
|Repayment of note payable                                                    |  |                      |        |      |  |      | (1,874 | ) |  |   |        |  
|Debt repayment to Applied Theory Estate                                      |  |                      | (6,100  | )    |  |      |       |   |  |   |        |  
|Borrowing under note to affiliate                                            |  |                      | 5,850   |      |  |      |       |   |  |   |        |  
|Net borrowings under accounts receivable line                                |  |                      | 6,663   |      |  |      |       |   |  |   |        |  
|Payments under note to affiliates                                            |  |                      | (2,600  | )    |  |      |       |   |  |   |        |  
|Payment of capital lease obligations                                         |  |                      | (4,172  | )    |  |      | (1,218 | ) |  |   | (29,646 | )
|Payments of software vendor obligations                                      |  |                      |        |      |  |      | (916   | ) |  |   | (840    | )
|                                                                             |  |                      |         |      |  |      |        |   |  |   |         |  
|Net cash provided (used) by financing
    activities                         |  |                      | (359    | )    |  |      | 26,027 |   |  |   | 50,496  |  
|Net decrease in cash                                                         |  |                      | (17,980 | )    |  |      | (372   | ) |  |   | (55,733 | )
|Cash and cash equivalents, beginning of period                               |  |                      | 21,842  |      |  |      | 22,214 |   |  |   | 77,947  |  
|                                                                             |  |                      |         |      |  |      |        |   |  |   |         |  
|Cash and cash equivalents, end of period                                     |  | $                    | 3,862   |      |  | $    | 21,842 |   |  | $ | 22,214  |  
|                                                                             |  |                      |         |      |  |      |        |   |  |   |         |  
|Supplemental disclosure of cash flow information:                            |  |                      |         |      |  |      |        |   |  |   |         |  
|Cash paid during the period for:                                             |  |                      |         |      |  |      |        |   |  |   |         |  
|Interest                                                                     |  | $                    | 594     |      |  | $    | 3,553  |   |  | $ | 1,364   |  
|                                                                             |  |                      |         |      |  |      |        |   |  |   |         |  

See accompanying notes to consolidated financial
statements.

F-7



---



##### Table of Contents



NAVISITE, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS



|    |                        
|--- | -----------------------
|(1) | Description of Business

NaviSite, Inc. provides outsourced hosting and
managed application services for mid-sized enterprises,
divisions of large multi-national companies, government agencies
and other businesses conducting mission critical business on the
Internet. Substantially all revenues are generated from
customers in the United States.



|    |                                               
|--- | ----------------------------------------------
|(2) | Summary of Significant Accounting
    Policies



|    |                      
|--- | ---------------------
|(a) | Basis of Presentation



| |                                    
| | -----------------------------------
| | One-for-fifteen Reverse Stock Split

On December 12, 2002, our board of
directors, pursuant to authority previously granted by our
stockholders at the annual meeting on December 19, 2001,
approved a reverse stock split of our common stock at a ratio of
one-for-fifteen (1:15) effective January 7, 2003. All
per-share amounts and number of shares outstanding have been
restated to give effect to the reverse stock split.



| |                                
| | -------------------------------
| | Change in Controlling Ownership

Through September 10, 2002, we were a
majority owned subsidiary of CMGI, Inc. (CMGI). On
September 11, 2002, each of CMGI and Hewlett-Packard
Financial Services Company (HPFS) sold and transferred to
ClearBlue Technologies, Inc. (ClearBlue), a privately-held
managed service provider based in San Francisco, California, the
following equity and debt interests in NaviSite:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Pursuant to a Note and Stock Purchase Agreement
    by and between ClearBlue and CMGI (the CMGI Agreement), CMGI
    sold and transferred to ClearBlue 4,735,293 shares of our common
    stock, $0.01 par value per share, representing approximately 76%
    of the outstanding capital stock of NaviSite, warrants to
    purchase 346,883 shares of our common stock and a convertible
    note of NaviSite with an aggregate principal amount outstanding
    of $10 million. The $10 million convertible note was
    convertible into 2,564,103 shares of our common stock, under
    certain circumstances as defined therein.
|
| |  | Pursuant to a Note and Stock Purchase Agreement
    by and between ClearBlue and HPFS (the HPFS Agreement), HPFS
    sold and transferred to ClearBlue 213,804 shares of our common
    stock, representing approximately 3.4% of our outstanding
    capital stock, and convertible notes of NaviSite with an
    aggregate principal amount outstanding of approximately
    $55 million, convertible into 14,126,496 shares of our
    common stock, under certain circumstances as defined therein.                                                                                                                               

On December 12, 2002, ClearBlue Finance,
Inc., a wholly-owned subsidiary of ClearBlue (ClearBlue
Finance), (i) converted in full the $10 million note
formerly held by CMGI and (ii) converted $10 million
of the $55 million notes formerly held by HPFS. We issued
5,128,205 shares of our common stock to ClearBlue Finance upon
the conversion and partial conversion, respectively, of the
$10 million note formerly held by CMGI and $10 million
of the $55 million notes formerly held by HPFS and issued
458,943 shares of our common stock for payments of interest due
under the convertible notes. A new note (New Note) was issued to
ClearBlue Finance with respect to the portion of the outstanding
principal and interest due under the note formerly held by HPFS
that was not converted ($45,093,333).

On December 13, 2002, ClearBlue transferred
beneficial ownership of all of its shares of our common stock
(except for a fractional share which it retained) to its
shareholders, ClearBlue Atlantic, LLC (ClearBlue Atlantic),
HPFS, CMGI and an employee of ClearBlue Technologies Management,
Inc. (CBTM) on a pro rata basis according to its
shareholders ownership of ClearBlue.

Also, as a result of the change in ownership, the
agreement between NaviSite and CMGI, whereby CMGI provided
certain facilities and administrative support services for us,
automatically terminated. CMGI continued to provide certain
services to us pursuant to a Transition Services Agreement we
entered into with

F-8



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##### Table of Contents



NAVISITE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

CMGI on November 25, 2002 as we transitioned
to a service agreement with ClearBlue or to other third-party
suppliers. This transition agreement concluded during the second
quarter of fiscal year 2003, and we have completely severed our
administrative ties with CMGI; however, CMGI remains a
third-party customer. During the second quarter of fiscal year
2003, we contracted with ClearBlue and other third-party
suppliers for these services.

On December 31, 2002, NaviSite, a majority
owned subsidiary of ClearBlue and its affiliates, completed the
acquisition of CBTM, a wholly-owned subsidiary of ClearBlue
which, in June 2002, acquired certain assets from the bankrupt
estate of AppliedTheory, Inc., in exchange for 567,978 shares of
our common stock, representing 4.5% of our total then
outstanding common stock, inclusive of the common stock issued
as part of the acquisition. The market price of our stock at the
time of the transaction was $2.25 per share. As ClearBlue had a
controlling interest in both companies at the time of the
combination, the transaction was accounted for as a combination
of entities under common control (i.e., as if
pooling) whereby the assets and liabilities of CBTM and
NaviSite were combined at their historical amounts. Accordingly,
our historical consolidated financial statements have been
restated to include the financial results of CBTM back to the
initial date on which ClearBlue acquired a controlling interest
in both NaviSite and CBTM (September 11, 2002). CBTMs
balance sheet has been included in our Consolidated Balance
Sheet at July 31, 2003, and CBTMs results of
operations and cash flows for the eleven-months ended
July 31, 2003 have been included in our Consolidated
Statements of Operations and Consolidated Statements of Cash
Flows for the twelve-month periods ended July 31, 2003.
CBTM is operated as a wholly-owned subsidiary of NaviSite.

On June 16, 2003, we repaid approximately
$3.9 million of the $45.0 million of outstanding New
Note to ClearBlue Finance, Inc. by offsetting amounts due to us
by ClearBlue. On June 17, 2003, we received written notice
from ClearBlue Finance, Inc. stating its election to convert the
remaining approximately $41.2 million of the New Note into
10,559,248 shares of common stock effective June 19, 2003. As of
July 31, 2003 ClearBlue Technologies Equity, Inc.,
ClearBlue Finance, ClearBlue and ClearBlue Atlantic beneficially
owned 19,284,994 shares of our common stock, representing
approximately 78.6% of the outstanding shares of common stock on
a fully converted basis. As a result of these changes in
ownership since September 11, 2002 involving ClearBlue and
its affiliates, the utilization of our federal and state tax net
operating loss carryforwards will be severely limited pursuant
to Internal Revenue Code Section 382.



| |                       
| | ----------------------
| | Impact of Acquisitions

In addition to the acquisition of CBTM, as
discussed above, during fiscal year 2003, we completed the
acquisitions of Avasta, Inc., a California corporation (Avasta),
Conxion Corporation, a California corporation (Conxion), and
substantially all of the assets of Interliant, Inc. (Interliant
Assets) through our wholly-owned subsidiary, Intrepid
Acquisition Corp. (Intrepid). Each of these acquisitions was
accounted for using the purchase method of accounting. The
results of operations and cash flows from Avasta, Conxion, and
Intrepid are included in our Consolidated Statements of
Operations and Consolidated Statements of Cash Flows for the
twelve-month period ended July 31, 2003 from their
respective dates of acquisition, February 5, 2003,
April 2, 2003, and May 16, 2003. See Note 6 for
further discussion of our fiscal year 2003 acquisitions.



|    |                            
|--- | ---------------------------
|(b) | Principles of Consolidation

The accompanying consolidated financial
statements include the accounts of NaviSite and our wholly-owned
subsidiaries, ClickHear, Inc., NaviSite Acquisition Corp., CBTM,
Avasta, Conxion, and Intrepid after elimination of all
significant intercompany balances and transactions.



|    |                 
|--- | ----------------
|(c) | Use of Estimates

The preparation of financial statements in
conformity with accounting principles generally accepted in the
United States of America requires management to make estimates
and assumptions that affect certain

F-9



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##### Table of Contents



NAVISITE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

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 revenues
and expenses during the reporting periods. Actual results could
differ from those estimates. Significant estimates made by
management include the useful lives of fixed assets and
intangible assets, recoverability of long-lived assets and the
collectibility of receivables.



|    |                          
|--- | -------------------------
|(d) | Cash and cash equivalents

Cash equivalents consist of a money market fund,
which invests in high quality short-term debt obligations,
including commercial paper, asset-backed commercial paper,
corporate bonds, U.S. government agency obligations,
taxable municipal securities, and repurchase agreements.

During fiscal year 2003, non-cash financing
activities included the repayment of approximately
$3.9 million of the New Note to ClearBlue Finance, Inc.
with amounts due us by ClearBlue. In addition, fiscal year 2003
non-cash financing activities included the conversion of the
then outstanding $41.2 million New Note into 10,559,248
shares of our common stock. This conversion also resulted in
non-cash charges of (a) $195,000 related to deferred
financing costs; (b)$2.7 million in deferred interest
expense; and (c) $21.6 million related to the amortization
of the remaining balance of the beneficial conversion feature.

During fiscal year 2002, non-cash financing
activities included a $35 million obligation to Compaq
Financial Services Corporation, a wholly-owned subsidiary of
Compaq Computer Corporation subsequently acquired by HPFS,
incurred for the purchase of equipment previously held under
operating lease agreements with a fair value, based on a
third-party appraisal, of $9.6 million.

During fiscal year 2002, non-cash financing
activities included the conversion of the $70.9 million,
net, carrying amount ($80.0 million face value) of
convertible notes payable to CMGI including interest of
$1.5 million, and $16.2 million of amounts due to CMGI
into an aggregate of 1,641,993 shares of our common stock.

During fiscal 2002 and 2001, non-cash financing
activities include the issuance of 464,800 and 186,000 shares of
common stock, respectively, in satisfaction of interest
associated with convertible notes outstanding during fiscal 2002
and 2001.

In August 2002, the Company settled its
intercompany liability to and receivables from CMGI, as of
May 31, 2002, for $3.2 million in cash. The
$3.2 million was remitted to CMGI in August 2002. As a
result of the transaction, the Company realized a
$4.5 million gain on the settlement, which was recorded as
a contribution to additional paid-in capital as of July 31,
2002 as the transaction was considered to be a settlement of
debt between entities under common control.



|    |                                              
|--- | ---------------------------------------------
|(e) | Revenue Recognition and Accounting
    Change

Revenue consists of monthly fees for Web site and
Internet application management, application rentals, hosting,
and professional services. Revenue (other than installation
fees) is generally billed and recognized over the term of the
contract, generally one to three years, based on actual usage.
Payments received in advance of providing services are deferred
until the period such services are provided. Revenue from
professional services is recognized on a time-and-material basis
as the services are performed or under the percentage of
completion method for revenue relating to fixed-price contracts.
We generally sell our professional services under contracts with
terms ranging from one to five years. Revenue and profits on
long-term Internet solutions contracts, which represent
approximately 3.0% of total revenues for the twelve-month period
ended July 31, 2003, performed over extended periods are
recognized under the percentage-of-completion method of
accounting, principally, with adjustments recorded in the period
in which the revisions are made. Any anticipated losses on
contracts are charged to operations as soon as they are
determinable.

F-10



---



##### Table of Contents



NAVISITE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|    |                             
|--- | ----------------------------
|(f) | Concentration of Credit Risk

Our financial instruments include cash, accounts
receivable, obligations under capital leases, software
agreements, accounts payable, and accrued expenses. As of
July 31, 2003, the carrying cost of these instruments
approximated their fair value. The financial instruments that
potentially subject us to concentration of credit risk consist
primarily of accounts receivable. Concentration of credit risk
with respect to trade receivables is limited due to the large
number of customers across many industries that comprise our
customer base. One third-party customer accounted for 26% of our
total revenues for the twelve-months ended July 31, 2003.
Accounts receivable at July 31, 2003 include approximately
$2.3 million due from this third-party customer. ClearBlue,
a related party, owed NaviSite approximately $265,000 as of
July 31, 2003, as described in Note 15.



|    |                            
|--- | ---------------------------
|(g) | Comprehensive Income (Loss)

Comprehensive income is defined as the change in
equity from foreign currency translation adjustments.



|    |                       
|--- | ----------------------
|(h) | 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. Leasehold improvements and
assets acquired under capital leases are amortized using the
straight-line method over the shorter of the lease term or
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.



|    |                                   
|--- | ----------------------------------
|(i) | Goodwill and Intangible
    Assets

Prior to July 31, 2002, goodwill related to
our purchase of Servercast in July 1998 and the purchase of our
wholly-owned subsidiary ClickHear in February 2000. Such costs
were amortized on a straight-line basis over five years, the
period expected to be benefited. In fiscal year 2002, the
goodwill related to ClickHear of $3,400 was written-off as part
of the sale of the majority of the operating assets of the
Streaming Media assets. As part of our impairment analysis
performed at July 31, 2002, it was determined that the
unamortized goodwill at July 31, 2002 of $186,000 was fully
impaired and was included in the accompanying consolidated
statements of operations as a component of general and
administration expense.

At July 31, 2003, our intangible assets
consisted of customer lists and proprietary software resulting
from our acquisitions of CBTM and the Interliant Assets. At
July 31, 2003, our intangible assets were recorded at a
gross carrying value of $12.1 million, less accumulated
amortization of $2.4 million. Amortization expense related
to our customer lists and proprietary software of
$2.2 million for fiscal year 2003 was recorded as a
component of our cost of revenue. Goodwill, resulting from our
acquisition of CBTM, is recorded at its gross carrying value of
$3.2 million.



|    |                                                   
|--- | --------------------------------------------------
|(j) | Accounting for Impairment of Long-Lived
    Assets

We assess the need to record impairment losses on
long-lived assets used in operations when indicators of
impairment are present. On an ongoing basis, management reviews
the value and period of amortization or depreciation of
long-lived assets, including goodwill. During this review, the
significant assumptions used in determining the original cost of
long-lived assets are reevaluated. Although the assumptions may
vary from transaction to transaction, they generally include
revenue growth, operating results, cash flows, and other
indicators of value. Management then determines whether there
has been a permanent impairment of the value of long-lived
assets by comparing future undiscounted cash flows to the
assets carrying value. If the estimated future
undiscounted cash flows are less than the carrying value of the
asset, a loss is recorded based on the excess of the
assets carrying value over fair value.

F-11



---



##### Table of Contents



NAVISITE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|    |             
|--- | ------------
|(k) | Income Taxes

We account for income taxes under the asset and
liability method. Deferred tax assets and liabilities are
recognized for the future tax consequences attributable to
differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases
and operating loss and tax credit carryforwards. Deferred tax
assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those
temporary differences are expected to be recovered or settled.
The effect on deferred tax assets and liabilities of a change in
tax rates is recognized in income in the period that includes
the enactment date.

Prior to the initial public offering on
October 21, 1999, we were greater than 80% owned by CMGI,
and as such, CMGI realized the full benefit of all federal and
part of the state net operating losses that had been incurred by
us for those periods before the fiscal year ended July 31,
2001. Therefore, such net operating losses incurred by NaviSite
were not available to us. The tax sharing agreement between
NaviSite and CMGI required us to reimburse CMGI for the amounts
it contributed to the consolidated tax liability of the CMGI
group; however, under the policy, CMGI was not obligated to
reimburse us for any losses utilized in the consolidated CMGI
group. After our public offering, CMGIs ownership fell
below 80% and we were no longer included in the federal
consolidated group of CMGI. Thus, our federal and state net
operating losses can be carried forward to offset our future
taxable income. As a result of the transaction on
September 11, 2002, NaviSite had a change in ownership as
defined in Section 382 of the Internal Revenue Code. As a
result of the change in ownership, the utilization of its
federal and state tax net operating losses generated prior to
the transaction is severely limited.



|    |                  
|--- | -----------------
|(l) | Advertising Costs

We recognize advertising costs as incurred.
Advertising expense was approximately $0, $4,000, and
$3.1 million for the fiscal years ended July 31, 2003,
2002, and 2001, respectively, and is included in the
accompanying consolidated statements of operations as a
component of selling and marketing expenses.



|    |                                   
|--- | ----------------------------------
|(m) | Stock-Based Compensation
    Plans

We account for our stock option plans under the
recognition and measurement principles of APB Opinion
No. 25, Accounting for Stock Issued to Employees, and
related Interpretations. No stock-based compensation cost is
reflected in net income for these plans, as all options granted
under these plans had an exercise price equal to the market
value of the underlying common stock on the date of grant. The
following table illustrates the effect on net income (loss) and
earnings (loss) per share if we had applied the fair value
recognition

F-12



---



##### Table of Contents



NAVISITE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

provisions of FASB Statement No. 123,
Accounting for Stock-Based Compensation, to stock based
compensation.

|                                                                                                                                                    |                                 |      |         |       |   |      |          |        |   |   |          |        |  
|--------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------- | ---- | ------- | ----- | - | ---- | -------- | ------ | - | - | -------- | ------ | -
|                                                                                                                                                    |                                 | 2003 |         | 2002  |   | 2001
|                                                                                                                                                    |                                 |      |         |       |   |     
|Net Loss, as reported                                                                                                                               |                                 | $    | (69,520 | )     |   | $    | (121,693 | )      |   | $ | (122,996 | )     
|Deduct: Total stock based employee compensation
    expense determined under fair value based method for all awards,
    net of related tax effects |                                 | $    | (8,062  | )     |   | $    | (24,778  | )      |   | $ | (40,072  | )     
|                                                                                                                                                    |                                 |      |         |       |   |      |          |        |   |   |          |       
|Net loss, as adjusted                                                                                                                               |                                 | $    | (77,582 | )     |   | $    | (146,471 | )      |   | $ | (163,068 | )     
|                                                                                                                                                    |                                 |      |         |       |   |      |          |        |   |   |          |       
|Loss per share:                                                                                                                                     |                                 |      |         |       |   |      |          |        |   |   |          |       
|                                                                                                                                                    | Basic and diluted  as reported |      | $       | (5.97 | ) |      | $        | (22.30 | ) |   | $        | (31.27 | )
|                                                                                                                                                    | Basic and diluted  as adjusted |      | $       | (6.66 | ) |      | $        | (26.84 | ) |   | $        | (41.46 | )
|                                                                                                                                                   
|NaviSite:                                                                                                                                           |                                 |      |         |       |   |      |          |        |   |   |          |       
|Risk-free interest rate                                                                                                                             |                                 |      | 1.93    | %     |   |      | 2.23     | %      |   |   | 4.50     | %     
|Expected dividend yield                                                                                                                             |                                 |      | 0.00    | %     |   |      | 0.00     | %      |   |   | 0.00     | %     
|Expected volatility                                                                                                                                 |                                 |      | 160.16  | %     |   |      | 250.00   | %      |   |   | 185.10   | %     
|Expected life (years)                                                                                                                               |                                 |      | 3.07    |       |   |      | 2.12     |        |   |   | 2.08     |       
|Weighted average fair value of options granted
    during the period                                                                                |                                 | $    | 2.56    |       |   | $    | 4.35     |        |   | $ | 219.30   |       
|                                                                                                                                                   
|CMGI:                                                                                                                                               |                                 |      |         |       |   |      |          |        |   |   |          |       
|Risk-free interest rate                                                                                                                             |                                 |      | 2.79    | %     |   |      | 2.79     | %      |   |   | 4.19     | %     
|Expected dividend yield                                                                                                                             |                                 |      | 0.00    | %     |   |      | 0.00     | %      |   |   | 0.00     | %     
|Expected volatility                                                                                                                                 |                                 |      | 97.05   | %     |   |      | 97.05    | %      |   |   | 126.95   | %     
|Expected life (years)                                                                                                                               |                                 |      | 5.85    |       |   |      | 5.85     |        |   |   | 2.91     |       
|Weighted average fair value of options granted
    during the period                                                                                |                                 |      | N/A     |       |   |      | N/A      |        |   |   | N/A      |       



|    |                                                                            
|--- | ---------------------------------------------------------------------------
|(n) | Historical and Unaudited Pro Forma Basic
    and Diluted Net Loss Per Share

Basic earnings (loss) per share is computed using
the weighted average number of common shares outstanding during
the period. Diluted earnings (loss) per share is computed using
the weighted average number of common and diluted common
equivalent shares outstanding during the period, using either
the if-converted method for convertible preferred
stock and notes or the treasury stock method for options, unless
amounts are anti-dilutive.

For fiscal years ended July 31, 2003, 2002,
and 2001, net loss per basic and diluted share is based on
weighted average common shares and excludes any common stock
equivalents, as they would be anti-dilutive due to the reported
losses. There were 2,741, 29,503 and 167,793 of diluted shares
related to employee stock options that were excluded as they
have an anti-dilutive effect due to the loss for fiscal years
2003, 2002, and 2001 respectively.

F-13



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##### Table of Contents



NAVISITE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|    |                  
|--- | -----------------
|(o) | Segment Reporting

We currently operate in one segment, outsourced
hosting and application management services.



| |                                      
| | -------------------------------------
| | (p) New Accounting
    Pronouncements

In May 2003, the Financial Accounting Standards
Board (FASB) finalized Emerging Issues Task Force
(EITF) Issue 01-8, Determining Whether an Arrangement
is a Lease (EITF 01-8). Under EITF 01-8, our relationships
with our customers no longer meet the definition of a lease
arrangement and as such, on a prospective basis after
May 31, 2003, we no longer account for new customer
agreements as direct financing agreements. Customer agreements
that were classified as direct financing agreements before
June 1, 2003 will continue to be treated as direct
financing agreements through the term of the agreements.

In June 2001, the FASB issued SFAS No. 141,
Business Combinations, and SFAS No. 142,
Goodwill and Other Intangible Assets. SFAS
No. 141 applies to all business combinations that we enter
into after June 30, 2001, and eliminates the
pooling-of-interests method of accounting. SFAS No. 142 is
effective for fiscal years beginning after December 15,
2001. Under the new statements, goodwill and intangible assets
deemed to have indefinite lives will no longer be amortized but
will be subject to annual impairment tests in accordance with
the statements. Other intangible assets will continue to be
amortized over their useful lives.

During the first quarter of fiscal 2003
(effective August 1, 2002), the Company adopted Statement
of Financial Accounting Standards No. 142 (SFAS 142),
Goodwill and Intangible Assets, which supersedes APB
Opinion No.17, Intangible Assets. SFAS No. 142
eliminates the current requirement to amortize goodwill and
indefinite-lived intangible assets, addresses the amortization
of intangible assets with a defined life and addresses the
impairment testing and recognition of goodwill and intangible
assets. The following information describes the impact that the
adoption of SFAS No. 142 had on the Company for the fiscal
years ended July 31:



| |                   
| | ------------------
| | Intangible Assets:

Intangible assets as of July 31, 2003 are as
follows:

|               |  |                |        |              |  |   |       | 
|-------------- |  | -------------- | ------ | ------------ |  | - | ----- | 
|               |  | Gross Carrying |        | Accumulated 
|               |  | Amount         |        | Amortization
|               |  |                |        |             
|Customer Lists |  | $              | 12,086 |              |  | $ | 2,384 | 
|               |  |                |        |              |  |   |       | 

Intangible asset amortization expense for the
years ended July 31, 2003, 2002, and 2001 aggregated
$2,384, $0 and $0 respectively. Amortization expense related to
intangible assets for the next five years is as follows:

|                     |  |   |       | 
|-------------------- |  | - | ----- | 
|Year Ending July 31, |  |  
|                     |  |  
|2004                 |  | $ | 2,508 | 
|2005                 |  | $ | 2,216 | 
|2006                 |  | $ | 1,853 | 
|2007                 |  | $ | 1,449 | 
|2008                 |  | $ | 1,047 | 

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##### Table of Contents



NAVISITE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |          
| | ---------
| | Goodwill:

The changes in the carrying amount of goodwill
for the fiscal years ended July 31 are as follows:

|                        |  |        |       |        |  |        |      |   |  |   |      |  
|----------------------- |  | ------ | ----- | ------ |  | ------ | ---- | - |  | - | ---- | -
|                        |  | Fiscal |       | Fiscal |  | Fiscal
|                        |  | 2003   |       | 2002   |  | 2001  
|                        |  |        |       |        |  |       
|Goodwill as of August 1 |  | $      |      |        |  | $      | 394  |   |  | $ | 601  |  
|Goodwill acquired       |  |        | 3,206 |        |  |        |     |   |  |   |     |  
|Goodwill amortization   |  |        |      |        |  |        | (208 | ) |  |   | (207 | )
|Goodwill impairment     |  |        |      |        |  |        | (186 | ) |  |   |     |  
|                        |  |        |       |        |  |        |      |   |  |   |      |  
|Goodwill as of July 31  |  | $      | 3,206 |        |  | $      |     |   |  | $ | 394  |  
|                        |  |        |       |        |  |        |      |   |  |   |      |  

The impact that the adoption of SFAS 142 had
on net income and earnings per share for the fiscal years ended
July 31 are presented as follows:

|                                      |                       |      |         |       |   |      |          |        |   |   |          |        |  
|------------------------------------- | --------------------- | ---- | ------- | ----- | - | ---- | -------- | ------ | - | - | -------- | ------ | -
|                                      |                       | 2003 |         | 2002  |   | 2001
|                                      |                       |      |         |       |   |     
|Net Loss                              |                       | $    | (69,520 | )     |   | $    | (121,693 | )      |   | $ | (122,996 | )     
|Add back Goodwill amortization        |                       |      |        |       |   |      | 208      |        |   |   | 207      |       
|                                      |                       |      |         |       |   |      |          |        |   |   |          |       
|Adjusted net loss                     |                       | $    | (69,520 | )     |   | $    | (121,485 | )      |   | $ | (122,789 | )     
|                                      |                       |      |         |       |   |      |          |        |   |   |          |       
|Basic and diluted earnings per share: |                       |      |         |       |   |      |          |        |   |   |          |       
|                                      | Net income            |      | $       | (5.97 | ) |      | $        | (22.30 | ) |   | $        | (31.27 | )
|                                      | Goodwill amortization |      |         |      |   |      |          | 0.05   |   |   |          | 0.04   |  
|                                      |                       |      |         |       |   |      |          |        |   |   |          |       
|                                      | Adjusted net loss     |      | $       | (5.97 | ) |      | $        | (22.25 | ) |   | $        | (31.23 | )
|                                      |                       |      |         |       |   |      |          |        |   |   |          |       

SFAS No. 143, Accounting for Asset
Retirement Obligations, issued in August 2001, addresses
financial accounting and reporting for obligations associated
with the retirement of tangible long-lived assets and was
adopted beginning in the first quarter of fiscal year 2003. The
adoption of SFAS 143 did not have a material impact on our
financial condition or results of operations.

SFAS 144, Accounting for the
Impairment or Disposal of Long-Lived Assets, issued in
October 2001, addresses financial accounting and reporting for
the impairment or disposal of long-lived assets and is effective
for fiscal years beginning after December 15, 2001.
SFAS 144 establishes a single accounting model for
long-lived assets to be disposed of by sale as well as revising
certain criteria specified in SFAS 121 for the recognition
and measurement of impairment losses related to long-lived
assets. The adoption of SFAS 144 did not have a material
impact on our financial condition or results of operations.

SFAS 146, Accounting for Costs Associated
with Exit or Disposal Activities, issued in July 2002,
addresses financial accounting and reporting for costs
associated with exit or disposal activities and rescinds
Emerging Issues Task Force (EITF) Issue No. 94-3,
Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring). SFAS 146 requires
that a liability for a cost associated with an exit or disposal
activity be recognized when the liability is incurred. Under
EITF Issue No. 94-3, a liability for an exit cost as
defined in EITF Issue No. 94-3 was recognized at the date
of an entitys commitment to an exit plan. SFAS 146
also establishes that fair value is the objective for initial
measurement of the liability. The provisions of SFAS 146
are effective for exit and disposal activities that are
initiated after December 31, 2002. We applied the
provisions of SFAS 146 in January 2003 in connection with
the lease abandonments.

In November 2002, the FASB issued Interpretation
No. 45 (FIN 45), Guarantors Accounting and
Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others, which clarifies
disclosure and recognition/measurement requirements related to
certain guarantees. The disclosure

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NAVISITE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

requirements are effective for financial
statements issued after December 15, 2002 and the
recognition/measurement requirements are effective on a
prospective basis for guarantees issued or modified after
December 31, 2002. The application of the requirements of
FIN 45 did not have a material impact on our financial position
or results of operations.

In December 2002, the FASB issued SFAS
No. 148, Accounting for Stock-Based
Compensation  Transition and Disclosure. SFAS
No. 148 amends SFAS No. 123 to provide alternative
methods of transition for a voluntary change to the fair value
based method of accounting for stock-based employee
compensation. In addition, SFAS No. 148 amends the
disclosure requirements of SFAS No. 123 to require
prominent disclosures in both annual and interim financial
statements about the method of accounting for stock-based
employee compensation and the effect of the method used on
reported results. The transition guidance and annual disclosure
provisions of SFAS No. 148 are effective for fiscal years
ending after December 15, 2002. The interim disclosure
provisions are effective for financial reports containing
financial statements for interim periods beginning after
December 15, 2002. As we did not make a voluntary change to
the fair value based method of accounting for stock-based
employee compensation in fiscal year 2003, the adoption of
SFAS No. 148 did not have a material impact on the our
financial position and results of operations.

In May 2003, the FASB issued SFAS 150,
Accounting For Certain Financial Instruments with
Characteristics of Both Liabilities and Equity which
establishes standards for how an issuer of financial instruments
classifies and measures certain financial instruments with
characteristics of both liabilities and equity. It requires that
an issuer classify a financial instrument that is within its
scope as a liability (or an asset in some circumstances) if, at
inception, the monetary value of the obligation is based solely
or predominantly on a fixed monetary amount known at inception,
variations in something other than the fair value of the
issuers equity shares or variations inversely related to
changes in the fair value of the issuers equity shares.
This Statement is effective for financial instruments entered
into or modified after May 31, 2003, and otherwise is
effective at the beginning of the first interim period beginning
after June 15, 2003. The adoption of SFAS 150 is not
expected to have a material impact on our financial position or
results of operations.



| |                      
| | ---------------------
| | (q) Reclassifications

Certain fiscal year 2002 balances have been
reclassified to conform with the fiscal year 2003 financial
statement presentation.



| |                     
| | --------------------
| | (r) Foreign Currency

The functional currencies of our wholly-owned
subsidiaries are the local currencies. The financial statements
of the subsidiaries are translated into U.S. dollars using
period-end exchange rates for assets and liabilities and average
exchange rates during corresponding period for revenues, cost of
revenues and expenses. Translation gains and losses are deferred
and accumulated as a separate component of stockholders
equity (accumulated other comprehensive income (loss)).

(3) Liquidity

Our cash and cash equivalents decreased to
approximately $3.9 million at July 31, 2003 from
approximately $21.8 million at July 31, 2002. Net cash
used in operating activities was approximately
$16.2 million for the year ended July 31, 2003,
resulting primarily from net losses, decreases in accrued
expenses and accounts payables, and a decrease in amounts due to
CMGI, partially offset by non-cash charges for the write-off and
amortization of the beneficial conversion feature of the
convertible debt, interest paid in stock, costs related to
abandoned leases, impairment of assets, depreciation and
amortization, and provision for bad debt. Net cash used in
investing activities was approximately $1.4 million for the
year ended July 31, 2003, resulting primarily from
purchases of property and equipment, the purchase of certain
assets of

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##### Table of Contents



NAVISITE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Interliant, the purchase of convertible notes of
Interliant, a loan made to a related party, partially offset by
cash acquired in acquisitions and the release of restricted
cash. Net cash used for financing activities was approximately
$359,000 for the fiscal year ended July 31, 2003, resulting
primarily from repayment of debt to the estate of AppliedTheory,
repayment of notes to affiliates, the payment of capital lease
obligations, partially offset by borrowings from affiliates and
borrowings from our accounts receivable financing line.

At July 31, 2003, we had a working capital
deficit of $15.2 million, an accumulated deficit of
$407 million, and have reported losses from operations
since incorporation. We have used cash from continuing
operations of $16.2 million, $27.0 million and
$88.8 million in the years ended July 31, 2003, 2002,
and 2001, respectively. We anticipate incurring additional
losses throughout our next fiscal year. NaviSite has taken
several actions it believes will allow us to continue as a going
concern through July 31, 2004, including the closing and
integration of strategic acquisitions, the change in our Board
of Directors and senior management and bringing costs more in
line with projected revenues. Based upon our cash flow estimates
we believe that we will more than likely need to raise funds to
meet our anticipated needs for working capital and capital
expenditures for at least the next twelve months. Our cash flow
estimates are based upon attaining certain levels of sales,
maintaining budgeted levels of operating expenses, collections
of accounts receivable and maintaining our current borrowing
line with Silicon Valley Bank among other assumptions, including
the improvement in the overall macroeconomic environment. Our
sales estimate includes revenue from new and existing customers
which may not be realized and we may be required to further
reduce expenses if budgeted sales are not attained. We may be
unsuccessful in reducing expenses in proportion to any shortfall
in projected sales and our estimate of collections of accounts
receivable may be hindered by our customers ability to pay.

We believe that we will more than likely need to
raise funds through the issuance of equity or convertible debt
securities, or through credit arrangements with financial
institutions. The accompanying consolidated financial statements
have been prepared assuming NaviSite will continue as a going
concern and, as such, do not include any adjustments that may
result from the outcome of these uncertainties.

(4) Impairment of Assets Held for
Sale

During the third fiscal quarter of 2003, we
evaluated the net realizable value of our assets held for sale
and determined, based upon third party quotes for purchase of
these assets, that the net fair market value of our assets held
for sale less was than the carrying value. As a result, we
recorded a $1.0 million charge related to the reduction in
the net realizable value of our assets held for sale as a
component of other income. These assets were sold to third
parties in the fourth fiscal quarter of 2003.

(5) Property and Equipment

Property and equipment at July 31, 2003 and
2002 are summarized as follows:

|                                               |  |                |         |      |  |   |         |  
|---------------------------------------------- |  | -------------- | ------- | ---- |  | - | ------- | -
|                                               |  |               
|                                               |  | July 31,      
|                                               |  |               
|                                               |  | 2003           |         | 2002
|                                               |  |                |         |     
|                                               |  |               
|                                               |  | (In thousands)
|Office furniture and equipment                 |  | $              | 2,421   |      |  | $ | 1,232   |  
|Computer equipment                             |  |                | 23,468  |      |  |   | 15,237  |  
|Software licenses                              |  |                | 9,308   |      |  |   | 8,982   |  
|Leasehold improvements                         |  |                | 7,302   |      |  |   | 3,717   |  
|                                               |  |                |         |      |  |   |         |  
|                                               |  |                | 42,499  |      |  |   | 29,168  |  
|Less accumulated depreciation and amortization |  |                | (26,208 | )    |  |   | (16,756 | )
|                                               |  |                |         |      |  |   |         |  
|Property and equipment, net                    |  | $              | 16,291  |      |  | $ | 12,412  |  
|                                               |  |                |         |      |  |   |         |  

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##### Table of Contents



NAVISITE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The estimated useful lives of our fixed assets
are as follows: office furniture and equipment, 5 years;
computer equipment, 3 years; software licenses,
3 years or life of the license; and leasehold improvements,
4 years or life of the lease.

As a result of our abandoning our administrative
space located on the second floor of our leased facility at 400
Minuteman Road in Andover, MA on January 31, 2003, certain
long-lived assets consisting mostly of leasehold and furniture
and fixtures were abandoned. We took a charge against our
earnings in the second quarter of fiscal 2003 of approximately
$62,000 in accordance with SFAS 144, Accounting for the
Impairment or Disposal of Long-Lived Assets.

The cost and related accumulated amortization of
property and equipment held under capital leases (classified as
computer equipment above) are as follows:

|                                          |  |                |        |      |  |   |      |  
|----------------------------------------- |  | -------------- | ------ | ---- |  | - | ---- | -
|                                          |  |               
|                                          |  | July 31,      
|                                          |  |               
|                                          |  | 2003           |        | 2002
|                                          |  |                |        |     
|                                          |  |               
|                                          |  | (In thousands)
|Cost                                      |  | $              | 5,386  |      |  | $ | 457  |  
|Accumulated depreciation and amortization |  |                | (1,646 | )    |  |   | (189 | )
|                                          |  |                |        |      |  |   |      |  
|                                          |  | $              | 3,740  |      |  | $ | 268  |  
|                                          |  |                |        |      |  |   |      |  

(6) Acquisitions

CBTM.We acquired
CBTM in December 2002 in a transaction accounted for as a
combination of entities under common control (i.e., as if
pooling) (see Note 1). In June 2002, prior to our
acquisition of CBTM, CBTM acquired substantially all of the
assets used or useful in the web hosting and Internet solutions
business and assumed certain associated liabilities from the
bankruptcy estate of AppliedTheory Corporation (AppliedTheory),
which had filed for bankruptcy on April 17, 2002. On
June 13, 2002, the acquisition of AppliedTheory by CBTM was
consummated, effective June 6, 2002. The results of
operations of AppliedTheory have been included in the financial
statements of CBTM since June 6, 2002.

The aggregate purchase price paid by CBTM for the
AppliedTheory assets, excluding assumed liabilities, was
$16.0 million of which $3.9 million was paid in cash
and $12.1 million was paid with the issuance of four notes
payable to the AppliedTheory Estate: two unsecured promissory
notes totaling $6.0 million, bearing interest at 8% per
annum and due June 10, 2006, a secured promissory note
totaling $700,000, bearing interest at 8% per annum and due
December 10, 2002 and a $5.4 million secured
promissory note, non-interest bearing, due December 10,
2002. The two notes due December 10, 2002 were paid in
December 2002.

Of the $6.2 million in identifiable
intangible assets, $5.8 million was assigned to customer
lists which are being amortized over eight years, except for the
New York State Department of Labor customer contract, which is
being amortized over five years, and represents the remaining
life on the contract. The remaining $440,000 of acquired
intangible assets was allocated to proprietary software, which
is being amortized over five years.

Avasta, Inc.On
February 5, 2003, we acquired Avasta, a provider of remote
hosting and managed service operations in an all-stock
transaction valued at approximately $370,000. The acquisition
was made to enhance our ability to be a full service provider of
applications management services and technology to our
customers. The purchase price consisted of 231,039 shares
of common stock at a per share value of $1.60 (representing a
five-day average of the market value of our common stock at the
time of the acquisition). The purchase price of $442,000
consists of the issuance of common stock for approximately
$370,000 and approximately $72,000 in acquisition costs. The
Agreement and Plan of Merger provided that up to an additional
1,004,518 shares of common stock could be issued in the
event certain revenue targets are achieved through June 2003. As
a result of the earnout calculation, in September 2003 we issued
179,353 shares of our

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##### Table of Contents



NAVISITE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

common stock at a per share value of $4.14
(representing the market value of our common stock the day
preceding the issuance of the additional shares for the
attainment of certain revenue targets). The negative goodwill of
approximately $342,000 reduced the recorded basis of property
and equipment. This acquisition was accounted for using the
purchase method of accounting.

The following table summarizes the fair value of
the assets acquired and liabilities assumed at the date of
acquisition:

|                          |  |                |       | 
|------------------------- |  | -------------- | ----- | 
|                          |  | Avasta        
|                          |  |               
|                          |  | (In thousands)
|Current assets            |  | $              | 488   | 
|Property and equipment    |  |                | 3,239 | 
|                          |  |                |       | 
|Total assets acquired     |  |                | 3,728 | 
|Current liabilities       |  |                | 3,285 | 
|Long-term debt            |  |                |      | 
|                          |  |                |       | 
|Total liabilities assumed |  |                | 3,285 | 
|                          |  |                |       | 
|Net assets acquired       |  | $              | 442   | 
|                          |  |                |       | 

Conxion Corporation.On April 2, 2003, we completed the acquisition of Conxion,
a provider of software distribution services and network/server
security expertise for its customers, pursuant to an Agreement
and Plan of Merger, dated as of March 26, 2003 (Conxion
Agreement), by and between us, Union Acquisition Corp., a
Delaware corporation and our wholly-owned subsidiary and
Conxion. Pursuant to the Conxion Agreement, the shareholders of
Conxion received an aggregate of $1,925,000 in cash. The
acquisition was made to enhance our ability to be a full service
provider of applications management services and technology to
our customers. The source of funds used for the acquisition of
Conxion was our cash on hand. The acquisition price was based on
the parties determination of the fair value of Conxion and
the terms of the Conxion Agreement were derived from arms-length
negotiation among the parties. The purchase price of $2,031,000
consisted of the $1,925,000 paid to the Conxion shareholders and
approximately $106,000 in acquisition costs. The negative
goodwill of approximately $2.5 million reduced the recorded
basis of property and equipment. This acquisition was accounted
for using the purchase method of accounting.

The following table summarizes the fair value of
the assets acquired and liabilities assumed at the date of
acquisition:

|                          |  |                |       | 
|------------------------- |  | -------------- | ----- | 
|                          |  | Conxion       
|                          |  |               
|                          |  | (In thousands)
|Current assets            |  | $              | 7,819 | 
|Property and equipment    |  |                | 187   | 
|                          |  |                |       | 
|Total assets acquired     |  |                | 8,007 | 
|Current liabilities       |  |                | 5,976 | 
|Long-term debt            |  |                |      | 
|                          |  |                |       | 
|Total liabilities assumed |  |                | 5,976 | 
|                          |  |                |       | 
|Net assets acquired       |  | $              | 2,031 | 
|                          |  |                |       | 

Interliant.On
May 16, 2003, we completed the acquisition of substantially
all of the assets relating to the managed infrastructure
solutions business, encompassing messaging and collaboration,
managed hosting, bundled-in managed security, and integrated and
related professional services in the United States and in Europe
of Interliant, Inc., a Delaware corporation, and several of its
subsidiaries (Debtors) in the bankruptcy

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##### Table of Contents



NAVISITE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

proceedings of the Debtors under Chapter 11
of Title 11 of the United States Bankruptcy Code pending in
the Southern District of New York (White Plains), pursuant to an
Asset Purchase Agreement, dated as of May 15, 2003 (the
Agreement), by and between our subsidiary, Intrepid Acquisition
Corp. and the Debtors, approved by order of the Bankruptcy Court
on May 15, 2003. Pursuant to the Agreement, the aggregate
purchase price for the Interliant assets was approximately
$7,204,000 after adjustments, based upon the Debtors
adjusted net worth, comprised of approximately $5,830,000 in
cash, $624,000 in the form of a credit of future distributions
to be paid on the Interliant Notes, $550,000 in principal amount
of a non-interest bearing, 180-day promissory note, secured by
the Interliant Debt and approximately $200,000 in
acquisition-related costs. On May 16, 2003, our subsidiary
closed on the purchase of all of the Interliant Assets, other
than the Debtors accounts receivable. On June 6, 2003
our subsidiary closed on the purchase of the accounts
receivable. The source of funds used for the initial closing was
our cash on hand combined with the funds provided from and
through financing of our accounts receivable with Silicon Valley
Bank (SVB), as discussed below, cash acquired with the
Interliant assets, and cash receipts from the purchased accounts
receivable. The acquisition price was determined through
arms-length negotiations and competitive bidding for the
Interliant Assets at an auction conducted under the auspices of
the Bankruptcy Court. Initial purchase accounting is pending
further resolution of the net worth calculation.

The following table summarizes the fair value of
the assets acquired and liabilities assumed at the date of
acquisition:

|                          |  |                |        | 
|------------------------- |  | -------------- | ------ | 
|                          |  | Interliant    
|                          |  |               
|                          |  | (In thousands)
|Current assets            |  | $              | 3,966  | 
|Long-term assets          |  |                | 5,940  | 
|Property and equipment    |  |                | 2,178  | 
|                          |  |                |        | 
|Total assets acquired     |  |                | 12,084 | 
|Current liabilities       |  |                | 4,880  | 
|Long-term debt            |  |                |       | 
|                          |  |                |        | 
|Total liabilities assumed |  |                | 4,880  | 
|                          |  |                |        | 
|Net assets acquired       |  | $              | 7,204  | 
|                          |  |                |        | 

The following unaudited pro forma results of
operations for the twelve-months ended July 31, 2003 and
2002 give effect to CBTMs acquisition of AppliedTheory
assets and our fiscal year 2003 acquisitions as if the
transactions had occurred at the beginning of fiscal year 2002.
The pro forma information does not necessarily reflect the
results of operations that would have occurred had the
acquisitions taken place at the beginning of the fiscal 2001
period and is not necessarily indicative of results that may be
obtained in the future (in thousands, except for per share
amounts).

|                                    |  |                          |         |      |  |      |          |   |  |   |          |  
|----------------------------------- |  | ------------------------ | ------- | ---- |  | ---- | -------- | - |  | - | -------- | -
|                                    |  |                         
|                                    |  | Year Ended July 31, 2003
|                                    |  |                         
|                                    |  | 2003                     |         | 2002 |  | 2001
|                                    |  |                          |         |      |  |     
|                                    |  |                         
|                                    |  | (In thousands)          
|Revenue                             |  | $                        | 100,914 |      |  | $    | 183,227  |   |  | $ | 267,766  |  
|Net Loss before extraordinary items |  |                          | (84,599 | )    |  |      | (320,525 | ) |  | $ | (400,442 | )
|Net loss                            |  |                          | (84,599 | )    |  |      | (285,568 | ) |  | $ | (352,011 | )
|Pro forma net loss per share        |  | $                        | (7.26   | )    |  | $    | (52.33   | ) |  | $ | (89.50   | )

On August 8, 2003, we completed the
acquisition of certain assets and the assumption of certain
liabilities of ClearBlue Technologies, Inc., a Delaware
corporation (ClearBlue), pursuant to a Stock and Asset

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NAVISITE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Acquisition Agreement, dated as of August 8,
2003 (the Agreement). At the time of the Agreement,
we were a majority owned subsidiary of ClearBlue and its
affiliates. See Note 17 for further discussion.

(7) Investment in Debt
Securities

In a privately negotiated transaction with Fir
Tree Recovery Master Fund, LP and Fir Tree Value Partners, LDC
pursuant to an Assignment Agreement dated October 11, 2002
and in a series of open market transactions from certain other
third-party holders, we acquired an aggregate principal amount
of approximately $36.3 million face value, 10% convertible
senior notes (Interliant Notes) due in 2006 of Interliant, Inc.
(Interliant) for a total consideration of approximately
$2 million. Interliant is a provider of managed services,
which filed a petition under Chapter 11 of Title 11 of the
United States Bankruptcy Code in the Southern District of New
York on August 5, 2002, and we made this investment with
the intention of participating in the reorganization/sale of
Interliant.

On May 16, 2003, the Southern District of
New York (White Plains) confirmed us as the successful bidder
for the purchase of the Interliant Assets (see Note 6). We
used $624,000 of the value of our Interliant Notes as partial
payment for the assets acquired. As such, we have reduced the
carrying value of the Interliant Notes by this amount. The final
value we will receive for the Interliant Notes has not been
determined, however, we estimate the value to approximate the
$1.4 million carrying value included in other assets on our
Consolidated Balance Sheet. The Interliant Estate has filed a
plan of liquidation with the bankruptcy court which is subject
to creditor approval and resolution of further contested claims.

(8) Accrued Expenses

Accrued expenses consist of the following:

|                                          |  |                |        |      |  |   |       | 
|----------------------------------------- |  | -------------- | ------ | ---- |  | - | ----- | 
|                                          |  |               
|                                          |  | July 31,      
|                                          |  |               
|                                          |  | 2003           |        | 2002
|                                          |  |                |        |     
|                                          |  |               
|                                          |  | (In thousands)
|Accrued payroll, benefits and commissions |  | $              | 2,959  |      |  | $ | 2,037 | 
|Accrued accounts payable                  |  |                | 3,455  |      |  |   | 1,328 | 
|Due to AppliedTheory estate               |  |                | 1,461  |      |  |   |      | 
|Accrued lease exit costs                  |  |                | 2,536  |      |  |   | 189   | 
|Accrued interest                          |  |                | 351    |      |  |   | 1,565 | 
|Accrued contract termination fees         |  |                | 2,096  |      |  |   |      | 
|Accrued other                             |  |                | 3,217  |      |  |   | 2,813 | 
|                                          |  |                |        |      |  |   |       | 
|                                          |  | $              | 16,075 |      |  | $ | 7,932 | 
|                                          |  |                |        |      |  |   |       | 

(9) Debt

(a) Convertible
Notes Payable

On September 11, 2002, CMGI and HPFS sold
their equity and convertible interests in NaviSite to ClearBlue
Technologies, Inc. (ClearBlue). Subsequent to July 31,
2002, we had not paid the interest payable on the Notes and due
on September 30, 2002. We were also no longer listed on the
Nasdaq National Market and were instead listed on the Nasdaq
SmallCap Market. Pursuant to the Notes, this new listing on the
Nasdaq SmallCap Market requires us to seek ClearBlues
prior written consent before paying interest and principal in
the form of common stock. On October 10, 2002, we received
a waiver from ClearBlue permitting the payment of interest to be
made in the form of stock consistent with our listing on the
Nasdaq SmallCap Market and the waiver for any noncompliance of
timely payments of interest or principal and we paid the
interest due to ClearBlue.

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NAVISITE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

On December 12, 2002, ClearBlue gave us the
right, at our option, to prepay 100% of the interest accrued at
December 12, 2002 (due December 31, 2002) on the New
Note in shares of our common stock. On December 12, 2002,
we paid approximately $1.1 million of interest owing on the
balance of the New Note with 317,932 shares of our common stock.
In addition, ClearBlue waived all interest for the period
December 12, 2002 through December 31, 2003 resulting
from the unconverted notes. We recognized an imputed interest
charge for this interest free period.

In connection with ClearBlue Finances
conversion of $20.0 million of convertible notes to common
stock (see Note 2), $10.7 million of the unamortized
beneficial conversion related to the converted notes was charged
to interest expense during the second fiscal quarter of 2003. As
part of the conversion of the converted notes, $469,000 in
accrued interest related to the Converted Notes was converted
into approximately 141,011 shares of our common stock.

On June 16, 2003, we repaid approximately
$3.9 million of the $45.0 million of outstanding New
Note payable to ClearBlue Finance with amounts due to us by
ClearBlue. The $3.9 million consisted of $1.9 million
of intercompany amounts due to us by ClearBlue and a
$2.0 million ClearBlue note payable to us. On June 17,
2003, we received written notice from ClearBlue Finance stating
its election to convert the remaining $41.2 million of the
New Note into 10,559,248 shares of our common stock
effective June 19, 2003. Concurrent with the conversion, in
the fourth fiscal quarter of 2003 we realized a
$21.6 million interest charge for the unamortized
beneficial conversion feature related to the converted and
repaid convertible notes payable. ClearBlue had previously
waived all interest for the period December 12, 2002
through December 31, 2003 on the $45.0 million of
convertible notes payable and, accordingly, we had been accruing
an imputed interest expense for this period. Subsequent to the
conversion, in the fourth fiscal quarter of 2003, we recorded a
$2.6 million contribution to additional paid in capital for
the imputed accrued interest on the converted and repaid
convertible notes payable, as ClearBlue is a related party.

In fiscal year 2002, the Company issued 446,724
shares of common stock in satisfaction of accrued interest
associated with the $65 million notes payable to CMGI and
HPFS.

(b) Accounts
Receivable Financing Agreements

On May 26, 2003, we entered into an Accounts
Receivable Financing Agreement (Financing Agreement) with SVB
whereby we can finance up to a maximum of $12.5 million of
our eligible accounts receivables with an 80% advance rate.
Under the Financing Agreement, we are required to repay advances
upon the earlier of our receipt of payment on the financed
accounts receivables from our customers, or the financed
accounts receivable being aged greater than ninety days from
date of service. The Financing Agreement has a one-year term and
bears an annual interest rate of prime rate plus 4.0%, with a
minimum $10,000 monthly finance charge. The Financing Agreement
also contains certain affirmative and negative covenants and is
secured by substantially all of our assets, tangible and
intangible. As part of the Financing Agreement, on May 27,
2003 we issued to Silicon Valley Bank (SVB) warrants to purchase
up to 165,000 shares of NaviSite common stock with an
exercise price of $2.50, the closing price of our stock on the
last business day before the issuance of the warrant. We fair
valued the warrants at $370,000 using the Black-Scholes
option-pricing model. The value of the warrants is being
amortized into interest expense over the term of the Financing
Agreement. At July 31, 2003, we had $6.7 million
outstanding under the Financing Agreement, which represented the
maximum borrowings under the Financing Agreement at that time.

(c) Note
Payable to Atlantic Investors, LLC (Atlantic)

On January 29, 2003, we entered into a
$10 million Loan and Security Agreement (Atlantic Loan)
with Atlantic, a related party. The Atlantic Loan has a
termination date of February 1, 2004 and bears an interest
rate of 8% per annum. Interest is payable upon demand or, at
Atlantics option, interest may be added to the outstanding
balance due to Atlantic by NaviSite. Atlantic may make demand
for payment of amounts in

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NAVISITE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

excess of the minimum Atlantic Loan amount of
$2.0 million (Minimum Loan Amount), with 60 days
notice, but not such that the payment would be required before
February 1, 2004. Atlantic can demand payment of the
Minimum Loan Amount with 90 days notice, but not such that
payment would be required before August 1, 2003. Under the
Atlantic Loan agreement, we can require Atlantic to loan us
(1) up to $2.0 million to repay an amount due from
CBTM to Unicorn, a related party to NaviSite and Atlantic;
(2) $1.0 million for costs associated with our
acquisition of Avasta; and (3) up to $500,000 for the
post-acquisition working capital needs of Avasta, Atlantic, at
its sole and absolute discretion, may advance other amounts to
us such that the aggregate amount borrowed by NaviSite does not
exceed the maximum loan amount, defined as the lesser of
$10.0 million or 65% of our consolidated accounts
receivables. On May 30, 2003 we repaid $2.0 million of
the approximate $3.0 million outstanding under the Atlantic
Loan and on June 11, 2003, we borrowed $2.0 million
under the Atlantic Loan. At July 31, 2003, we had
$3.0 million outstanding under the Atlantic Loan. This
amount is shown as Current Note Payable to Related Party on our
Consolidated Balance Sheet. The Atlantic Loan is secured by all
of our receivables.

(d) Note
Payable to AppliedTheory Estate

As part of CBTMs acquisition of certain
AppliedTheory assets, CBTM entered into a long-term liability of
$6.0 million (Estate Liability) due to the AppliedTheory
Estate in June 10, 2006. The Estate Liability bears
interest at 8% per annum, which is due and payable at the
termination date of the Estate Liability. At July 31, 2003,
we had approximately $80,000 in accrued interest related to this
note.

(e) Notes
Payable to the Interliant Estate

As part of our acquisition of certain Interliant
Assets, we entered into a promissory note with the Interliant
Estate (Interliant Promissory Note) in the amount of $550,000,
payable without interest on the earlier of (i) the 180th
day following the Second Closing Date or (ii) the date
Interliant estates make distributions to their general unsecured
creditors. The Interliant Promissory Note is secured by the
Interliant Notes (see Note 6).

(10) Commitments and
Contingencies

(a) Leases

Abandoned Leased
Facilities.On January 31, 2003,
we abandoned our administrative space on the second floor of our
400 Minuteman Road, Andover, MA leased location. We continue to
maintain and operate our Data Center on the first floor of the
building, which also serves as our corporate headquarters. While
we remain obligated under the terms of the lease for the rent
and other costs associated with the second floor of the
building, we ceased to use the space on January 31, 2003
and have no foreseeable plans to occupy the second floor in the
future. Therefore, in accordance with SFAS 146,
Accounting for Costs Associated with Exit or Disposal
Activities, issued in July 2002, we recorded a charge to
our current earnings in fiscal year 2003 of approximately
$5.4 million to recognize the costs of exiting the space.
The amount is included in the caption Impairment and
restructuring in the accompanying Consolidated Statements
of Operations. The liability is equal to the total amount of
rent and other direct costs for the period of time the second
floor of the building was expected to remain unoccupied plus the
present value of the amount by which the rent paid by us to the
landlord exceeds any rent paid to us by a tenant under a
sublease over the remainder of the lease term, which is May 2011.

Near the end of our fiscal year 2002, we
abandoned our sales office space in La Jolla, CA. At that time
we were able to sublet the space to a third party. During the
second quarter of this fiscal year, the sublease tenant stopped
making payments under the sublease and has abandoned the space.
The facility is currently empty and we remain obligated under
the terms of the lease for the rent and other costs associated
with the building. We have no foreseeable plans to occupy the
space, therefore, under SFAS 146, we recorded a charge to
our

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NAVISITE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

earnings of approximately $1.4 million to
recognize the costs of exiting the building. The amount is
included in the caption Impairment and restructuring
in the accompanying Consolidated Statements of Operations. We
are actively pursuing options for subleasing or otherwise
terminating the lease, but have not reached any agreement at
this time. We believe it is more likely than not that we will be
able to sublet the building to a tenant at, at a rate below our
current rent rate or will have otherwise ended the lease via a
lease termination agreement, by January 2004. As such, we have
recorded a liability equal to the present value of our estimated
future payments.

Details of activity in the lease exit accrual for
the year ended July 31, 2003 were as follows (in thousands):

|                                      |  |            |   |                |  |             |        |            |  |   |       |  |  |   |       | 
|------------------------------------- |  | ---------- | - | -------------- |  | ----------- | ------ | ---------- |  | - | ----- |  |  | - | ----- | 
|                                      |  | Balance at |   |                |  |             |        | Balance at
|                                      |  | July 31,   |   |                |  |             |        | July 31,  
|                                      |  | 2002       |   | Payments       |  | Adjustments |        | 2003      
|                                      |  |            |   |                |  |             |        |           
|                                      |  |            |   |                |  |            
|                                      |  |            |   | (In thousands) |  |            
|400 Minuteman Lease abandonment costs |  | $          |  |                |  | $           | (2,069 | )          |  | $ | 5,409 |  |  | $ | 3,340 | 
|La Jolla Lease abandonment costs      |  |            |  |                |  |             | (322   | )          |  |   | 1,431 |  |  |   | 1,109 | 
|                                      |  |            |   |                |  |             |        |            |  |   |       |  |  |   |       | 
|                                      |  | $          |  |                |  | $           | (2,391 | )          |  | $ | 6,840 |  |  | $ | 4,449 | 
|                                      |  |            |   |                |  |             |        |            |  |   |       |  |  |   |       | 

We are obligated under various capital and
operating leases for facilities and equipment. CMGI had entered
into non-cancelable operating and capital leases on our behalf
covering certain of our office facilities and equipment, which
expire through 2012. In addition, until we moved our
headquarters in January 2000, we paid CMGI for office facilities
used as our headquarters for which we were charged based upon an
allocation of the total costs for the facilities at market
rates. Prior to our IPO, substantially all leases for real
property were guaranteed by CMGI. CMGI charged us the actual
lease fees under these arrangements. Our total rent expense
amounted to $10,217,000, $19,567,000, and $58,465,000 for the
fiscal years ended July 31, 2003, 2002, and 2001,
respectively. In June 2000, we sold certain equipment and
leasehold improvements in our data centers in a sale-leaseback
transaction to a bank for approximately $30.0 million. We
entered into a capital lease for the leaseback of those assets.
In January 2001, we paid-off these capital lease obligations for
approximately $27.0 million. During the second quarter of
fiscal year 2001, we sold certain equipment in sale-leaseback
transactions for a total of approximately $13.9 million.
Simultaneously with the sales, we entered into operating leases
for the equipment.

During fiscal 2002, we renegotiated or bought out
the majority of its operating lease obligations for equipment.

Minimum annual rental commitments under operating
leases and other commitments are as follows as of July 31,
2003:

|                                  |  |       |        |           |  |           |        |           |  |         |        |  |  |   |       |  |  |   |       | 
|--------------------------------- |  | ----- | ------ | --------- |  | --------- | ------ | --------- |  | ------- | ------ |  |  | - | ----- |  |  | - | ----- | 
|                                  |  |       |        | Less Than |  |           |        |           |  | After 5
|Description                       |  | Total |        | 1 year    |  | 1-3 Years |        | 4-5 Years |  | Years  
|                                  |  |       |        |           |  |           |        |           |  |        
|Short/ Long-term debt             |  | $     | 9,550  |           |  | $         | 3,550  |           |  | $       | 6,000  |  |  | $ |      |  |  | $ |      | 
|Interest on debt                  |  |       | 1,610  |           |  |           | 650    |           |  |         | 960    |  |  |   |      |  |  |   |      | 
|Capital leases                    |  |       | 5,492  |           |  |           | 3,590  |           |  |         | 1,902  |  |  |   |      |  |  |   |      | 
|Operating leases                  |  |       | 1,337  |           |  |           | 1,008  |           |  |         | 328    |  |  |   |      |  |  |   |      | 
|Bandwidth commitments             |  |       | 6,716  |           |  |           | 3,542  |           |  |         | 2,384  |  |  |   | 791   |  |  |   |      | 
|Maintenance for hardware/software |  |       | 1,405  |           |  |           | 1,405  |           |  |         |       |  |  |   |      |  |  |   |      | 
|Property leases                   |  |       | 38,937 |           |  |           | 8,271  |           |  |         | 14,383 |  |  |   | 7,666 |  |  |   | 8,616 | 
|                                  |  |       |        |           |  |           |        |           |  |         |        |  |  |   |       |  |  |   |       | 
|                                  |  | $     | 65,047 |           |  | $         | 22,016 |           |  | $       | 25,957 |  |  | $ | 8,457 |  |  | $ | 8,616 | 
|                                  |  |       |        |           |  |           |        |           |  |         |        |  |  |   |       |  |  |   |       | 

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NAVISITE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |                  
| | -----------------
| | (b) Legal Matters

On or about June 13, 2001, Stuart Werman and
Lynn McFarlane filed a lawsuit against us, BancBoston Robertson
Stephens, an underwriter of our initial public offering in
October 1999, Joel B. Rosen, our then chief executive
officer, and Kenneth W. Hale, our then chief financial officer.
The suit was filed in the United States District Court for the
Southern District of New York. The suit generally alleges that
the defendants violated federal securities laws by not
disclosing certain actions allegedly taken by Robertson Stephens
in connection with our initial public offering. The suit alleges
specifically that Robertson Stephens, in exchange for the
allocation to its customers of shares of our common stock sold
in our initial public offering, solicited and received from its
customers agreements to purchase additional shares of our
common stock in the aftermarket at pre-determined prices. The
suit seeks unspecified monetary damages and certification of a
plaintiff class consisting of all persons who acquired shares of
our common stock between October 22, 1999 and
December 6, 2000.Three other substantially similar
lawsuits were filed between June 15, 2001 and July 10,
2001 by Moses Mayer (filed June 15, 2001), Barry Feldman
(filed June 19, 2001), and Binh Nguyen (filed July 10,
2001). Robert E. Eisenberg, our president at the time of
the initial public offering in 1999, also was named as a
defendant in the Nguyen lawsuit.

On or about June 21, 2001, David Federico
filed in the United States District Court for the Southern
District of New York a lawsuit against us, Mr. Rosen,
Mr. Hale, Robertson Stephens and other underwriter
defendants including J.P. Morgan Chase, First Albany
Companies, Inc., Bank of America Securities, LLC, Bear
Stearns & Co., Inc., B.T. Alex. Brown, Inc., Chase
Securities, Inc., CIBC World Markets, Credit Suisse First Boston
Corp., Dain Rauscher, Inc., Deutsche Bank Securities, Inc., The
Goldman Sachs Group, Inc., J.P. Morgan & Co., J.P.
Morgan Securities, Lehman Brothers, Inc., Merrill Lynch, Pierce,
Fenner & Smith, Inc., Morgan Stanley Dean
Witter & Co., Robert Fleming, Inc. and Salomon Smith
Barney, Inc. The suit generally alleges that the defendants
violated the anti-trust laws and the federal securities laws by
conspiring and agreeing to raise and increase the compensation
received by the underwriter defendants by requiring those who
received allocation of initial public offering stock to agree to
purchase shares of manipulated securities in the after-market of
the initial public offering at escalating price levels designed
to inflate the price of the manipulated stock, thus artificially
creating an appearance of demand and high prices for that stock,
and initial public offering stock in general, leading to further
stock offerings. The suit also alleges that the defendants
arranged for the underwriter defendants to receive undisclosed
and excessive brokerage commissions and that, as a consequence,
the underwriter defendants successfully increased investor
interest in the manipulated initial public offering of
securities and increased the underwriter defendants
individual and collective underwritings, compensation, and
revenues. The suit further alleges that the defendants violated
the federal securities laws by issuing and selling securities
pursuant to the initial public offering without disclosing to
investors that the underwriter defendants in the offering,
including the lead underwriters, had solicited and received
excessive and undisclosed commissions from certain investors.
The suit seeks unspecified monetary damages and certification of
a plaintiff class consisting of all persons who acquired shares
of our common stock between October 22, 1999 and
June 12, 2001.

Those five cases, along with lawsuits naming more
than 300 other issuers and over 50 investment banks
which have been sued in substantially similar lawsuits, have
been assigned to the Honorable Shira A. Scheindlin (the
Court) for all pretrial purposes (the IPO
Securities Litigation). On September 6, 2001, the
Court entered an order consolidating the five individual cases
involving us and designating Werman v. NaviSite, Inc.,
et al., Civil Action No. 01-CV-5374 as the lead case.
A consolidated, amended complaint was filed thereafter on
April 19, 2002 (the Class Action
Litigation) on behalf of plaintiffs Arvid Brandstrom and
Tony Tse against 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 and against us and Messrs. Rosen, Hale and
Eisenberg (collectively, the NaviSite Defendants).
Plaintiffs uniformly allege that all defendants, including the
NaviSite Defendants, violated the federal securities laws (i.e.,
Sections 11 and 15 of the Securities Act,
Sections 10(b) and 20(a) of the Exchange Act

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NAVISITE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

and Rule 10b-5) by issuing and selling our
common stock pursuant to the October 22, 1999, initial
public offering, without disclosing to investors that some of
the underwriters of the offering, including the lead
underwriters, had solicited and received extensive and
undisclosed agreements from certain investors to purchase
aftermarket shares at pre-arranged, escalating prices and also
to receive additional commissions and/or other compensation from
those investors. At this time, plaintiffs have not specified the
amount of damages they are seeking in the Class Action
Litigation.

Between July and September 2002, the parties to
the IPO Securities Litigation briefed motions to dismiss filed
by the underwriter defendants and the issuer defendants,
including NaviSite. On November 1, 2002, the Court held
oral argument on the motions to dismiss. The plaintiffs have
since agreed to dismiss the claims against Messrs. Rosen,
Hale and Eisenberg without prejudice, in return for their
agreement to toll any statute of limitations applicable to those
claims. By stipulation entered by the Court on November 18,
2002, Messrs. Rosen, Hale and Eisenberg were dismissed
without prejudice from the Class Action Litigation. On
February 19, 2003, an opinion and order was issued on
defendants motion to dismiss the IPO Securities
Litigation, essentially denying the motions to dismiss of all
55 underwriter defendants and of 185 of the 301 issuer
defendants.

We believe that the allegations against us are
without merit and we intend to vigorously defend against the
plaintiffs claims. We are not able to predict the possible
outcome of the suits and their ultimate effect, if any, on our
financial condition.

In March 2001, we engaged Goldman
Sachs & Co. to serve as our financial advisor in
connection with the possible sale of all or a portion of
NaviSite. On September 17, 2002, Goldman made a written
demand for payment of a $3 million success fee in
connection with the September 2002 acquisition by ClearBlue of
the stock and convertible debt of NaviSite from CMGI and
Hewlett-Packard Financial Services Company. We have rejected
Goldmans demands, as we believe they are without merit. No
legal actions have been filed concerning the Goldman claim. As
this matter is in the initial stage, we are not able to predict
the possible outcome of this matter and the effect, if any, on
our financial condition.

On or about September 27, 2002, we received
a demand for a wage payment of $850,000 from our former
Procurement Director, Joseph Cloonan. We rejected the demand,
alleging that Mr. Cloonans claim is based, among
other things, on a potentially fraudulent contract.
Mr. Cloonan also claimed $40,300 for allegedly unpaid
accrued vacation and bonuses and that he may be statutorily
entitled to treble damages and legal fees. On October 11,
2002, NaviSite filed a civil complaint with the Massachusetts
Superior Court, Essex County, seeking a declaratory judgment and
asserting claims against Mr. Cloonan for civil fraud,
misrepresentation, unjust enrichment and breach of duty of
loyalty. We believe the allegations are without merit and intend
to vigorously defend against Mr. Cloonans claims. As
the litigation is in the initial discovery stage, we are not
able to predict the possible outcome of this matter and the
effect, if any, on our financial condition.

On October 28, 2002, ClearBlue Technologies
Management, Inc., one of our subsidiaries, filed a complaint in
United States District Court for the Southern District of New
York against Lighthouse International, alleging six causes of
action for copyright infringement, breach of contract, account
stated, unjust enrichment, unfair competition, and
misappropriation and/or conversion. The total claimed damages
are in the amount of $1,866,450. On or about January 16,
2003, Lighthouse filed and served its answer and counterclaimed
against ClearBlue Technologies Management, Inc. claiming
$3,130,000 in damages and $5,000,000 in punitive relief.

On June 17, 2003, the U.S. Bankruptcy
Court for the Southern District of New York heard oral argument
on Lighthouses Motion for an Order Compelling the Debtor
(AppliedTheory) to Assume or Reject an Agreement, filed in
response to ClearBlue Technologies Management, Inc.s.
complaint, and the objections to Lighthouses motion filed
by ClearBlue Technologies Management and AppliedTheory.
Lighthouse made this motion on the basis that it never received
notice of ClearBlue Technologies Management assuming the

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NAVISITE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

AppliedTheory contract for the LighthouseLink Web
site. The Bankruptcy Court declined to grant Lighthouses
motion, and instead ordered that an evidentiary hearing be
conducted to determine whether Lighthouse received appropriate
notice of the proposed assignment of the contract by
AppliedTheory to ClearBlue Technologies Management. The
Bankruptcy Court ordered that the parties first conduct
discovery, and upon completion of discovery, which is expected
to be completed on or about the end of November 2003, the
Bankruptcy Court would schedule an evidentiary hearing on the
issue of notice.

As to the U.S. District Court matter, the
exchange of written discovery is near completion, with a number
of discovery disputes to be resolved by the Court in October
2003 at a discovery status conference. All depositions of
witnesses have been stayed pending completion of the Bankruptcy
Court evidentiary hearing. Because of the continuing discovery,
and the uncertain outcome of the evidentiary hearing before the
Bankruptcy Court, we are not able to predict the possible
outcome of this matter, if any, on our financial condition.

On December 12, 2002, our Board of
Directors, pursuant to authority previously granted by our
stockholders at the annual meeting of stockholders held on
December 19, 2001, approved a reverse stock split of our
common stock at a ratio of one-for-fifteen (1:15) (the
Reverse Split). The Reverse Split was effective on
January 7, 2003. On May 28, 2003 we received a letter
from Mr. Edward W. Roberts, as trustee of The Roberts
Family Trust, stating that in June 2002 the trust had purchased
13,000 shares of our common stock and due to the Reverse Split,
the trust now owns 866 shares of common stock (i.e. 13,000
shares divided by 15). As a result of the Reverse Split,
Mr. Roberts states an intention to institute a derivative
action requesting $7.5 million in damages. On
October 20, 2003, we received a letter dated
October 13, 2003, from Mr. Robertson, as trustee on
behalf of The Roberts Family Trust, stating his intention to
prove conspiracy and collusion relating to the
September 11, 2002 transactions between ClearBlue
Technologies, Inc. and Hewlett-Packard Financial Services
Company and relating to the later Reverse Split. No legal
actions have been filed concerning this matter. This matter is
in its initial stages and we are not able to predict the
possible outcome of this matter, and the effect, if any, on our
financial condition. We believe the claim is without merit and
intend to vigorously defend any action that may be brought
against us.

On October 14, 2003, we received a letter
purportedly on behalf of the former stockholders of Avasta
relating to the issuance of additional shares of common stock
pursuant to the earnout calculations pursuant to the Agreement
and Plan of Merger and Reorganization dated as of
January 29, 2003 among Avasta Corp., Avasta, Inc. and
NaviSite. No legal actions have been filed concerning this
matter. As this matter is in the initial stage, we are not able
to predict the possible outcome of this matter and the effect,
if any, on our financial condition.

We are also subject to other legal proceedings
and claims which arise in the ordinary course of our business.
In the opinion of management, the amount of ultimate liability
with respect to these actions will not materially affect our
consolidated financial position or results from our operations.

(11) Income Taxes

No provision for federal and state income taxes
has been recorded as the Company incurred net operating losses
for all periods presented. Prior to the initial public offering
on October 21, 1999, we were greater than 80% owned by
CMGI, and as such, CMGI realized the full benefit of all federal
and part of the state net operating losses that had been
incurred by us for those periods before the fiscal year ended
July 31, 2001. Therefore, such net operating losses
incurred by NaviSite were not available to us. The tax sharing
agreement between NaviSite and CMGI required us to reimburse
CMGI for the amounts it contributed to the consolidated tax
liability of the CMGI group; however, under the policy, CMGI was
not obligated to reimburse us for any losses utilized in the
consolidated CMGI group. After our public offering, CMGIs
ownership fell below 80% and we were no longer included in the
federal consolidated group of CMGI. Thus, our federal and state
net operating losses can be carried forward to offset our future
taxable income and no

F-27



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##### Table of Contents



NAVISITE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

provision for federal or state income taxes has
been recorded. The Company has recorded a full valuation
allowance against its deferred tax assets since management
believes that, after considering all the available objective
evidence, both positive and negative, historical and
prospective, with greater weight given to historical evidence,
it is not more likely than not that these assets will be
realized.

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:

|                                      |                               |          |             |            |  |   |              |             | 
|------------------------------------- | ----------------------------- | -------- | ----------- | ---------- |  | - | ------------ | ----------- | 
|                                      |                               | 07/31/03 |             | 07/31/02  
|                                      |                               |          |             |           
|Deferred tax assets:                  |                               |          |             |            |  |   |              |            
|                                      | Accruals and reserves         |          |             | 3,815,612  |  |   | $            | 2,206,000   | 
|                                      | Loss Carryforwards            |          |             | 20,470,707 |  |   | $            | 103,311,000 | 
|                                      | Depreciation and amortization |          |             | 31,704,341 |  |   | $            | 36,958,000  | 
|                                      |                               |          |             |            |  |   |              |            
|Total deferred tax assets             |                               | $        | 55,990,660  |            |  | $ | 142,475,000  |            
|Less: Valuation allowance             |                               |          | (55,990,660 | )          |  | $ | (142,475,000 | )          
|                                      |                               |          |             |            |  |   |              |            
|Net deferred tax (assets) liabilities |                               | $        |            |            |  | $ |             |            
|                                      |                               |          |             |            |  |   |              |            

Valuation allowance decreased by
$86.5 million and increased by $47.0 million for the
years ended July 31, 2003 and 2002, respectively.

As a result of the transaction on
September 11, 2002, the Company experienced a change in
ownership as defined in Section 382 of the Internal Revenue
Code. As a result of the change in ownership, the utilization of
its federal and state tax net operating losses generated prior
to the transaction is subject to an annual limitation of
approximately $1.2 million. As a result of this limitation,
the Company expects that a substantial portion of its federal
and state net operating loss carryforwards will expire unused.

The Company has net operating loss carryforwards
for federal and state tax purposes of approximately
$49.8 million, after taking into consideration net
operating losses expected to expire unused due to the
Section 382 limitation. The federal net operating loss
carryforwards will expire from fiscal year 2011 to fiscal year
2023.

(12) Reserved.

(13) Stockholders Equity



| |                                 
| | --------------------------------
| | (a) Issuance of Common
    Stock

On December 12, 2002, ClearBlue cancelled
warrants to purchase 346,883 shares of our common stock at
an exercise price ranging from $86.55 to $103.80 per share.

The 567,978 shares issued to ClearBlue on
December 31, 2002 in connection with the acquisition of
CBTM have been accounted for by us as a dividend distribution to
ClearBlue because ClearBlue and its affiliates are considered to
have controlling interest over both CBTM and NaviSite. As a
result, we reported a reduction of retained earnings of
$1,277,950, which represents the number of common shares issued
at the then current market value of $2.25 per share.

On February 5, 2003, we issued 231,039
shares of our common stock at a per share value of $1.60 in
connection with the acquisition of Avasta (see Note 6). In
September 2003 we issued 179,353 shares of our common stock at a
per share value of $4.14 (representing the market value of our
common stock the day preceding the issuance of the addition
shares) for the attainment of certain revenue targets in
conjunction with the Avasta acquisition.

F-28



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##### Table of Contents



NAVISITE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

(14) Stock Option Plans



| |                                          
| | -----------------------------------------
| | (a) 1999 Employee Stock Purchase
    Plan

The 1999 Employee Stock Purchase Plan (the Stock
Purchase Plan) was adopted by NaviSites board of directors
and stockholders in October 1999. The Stock Purchase Plan
provides for the issuance of a maximum of 16,666 shares of our
common stock. The Plan allows participants to purchase shares at
85% of the closing price of common stock on the first business
day of the Plan period or the last business day of the Plan
period, whichever closing price is less. During fiscal year
2002, no additional shares were issued under this plan.

During fiscal year 2003, no additional shares
were issued under this plan. We issued a total of 16,657 shares
since the plans inception.



| |                                   
| | ----------------------------------
| | (b) Deferred Compensation
    Plan

A Deferred Compensation Plan (the Deferred
Compensation Plan) was adopted by NaviSites board of
directors in October 1999. Under the terms of the Deferred
Compensation Plan, our employees who are selected by the board
of directors (as well as certain of our employees who previously
participated in a deferred compensation plan sponsored by CMGI)
will be able to elect to defer a portion of their compensation
for the following calendar year. We also may make discretionary
contributions to a participants account, to which the
participant generally will become entitled after five years of
service with us. Effective December 18, 2001, the plan was
terminated. During 2001 and through the termination date in
2002, we did not make any discretionary contributions to the
plan.



| |                                        
| | ---------------------------------------
| | (c) 1999 Director Stock Option
    Plan

In October 1999, NaviSite ceased issuing options
under the 1998 Director Plan and the board of directors and the
stockholders approved and adopted the 1999 Stock Option Plan for
Non-employee Directors (the 1999 Director Plan). A total of
33,333 shares of Common Stock are reserved for issuance
under the 1999 Director Plan. Directors who are not NaviSite
employees or otherwise affiliates, employees or designees of an
institutional or corporate investor that owns more than 5% of
outstanding Common Stock will be eligible to receive
non-statutory stock options under the 1999 Director Plan. On
March 5, 2002, the 1999 Director Plan was amended to
increase the initial options granted to each eligible director
to 3,333 shares from the original 1,667 shares and to
increase the subsequent annual grants to directors to
667 shares from the original 417 shares.

The board of directors has discretion to increase
to up to 6,667 shares the number of shares of Common Stock
subject to any initial option or additional option covering any
vesting period of up to 48 months that may be granted to an
eligible director after the date of the increase.

During fiscal year 2003 no options were granted
and there were no outstanding options under this plan.



| |                                        
| | ---------------------------------------
| | (d) 1998 Director Stock Option
    Plan

In December 1998, NaviSites board of
directors and stockholders approved the 1998 Director Stock
Option Plan (the 1998 Director Plan). In October 1999, we ceased
issuing options under the 1998 Director Plan. Upon the adoption
of the 1999 Director Plan, each NaviSite director (who is not
also an employee of NaviSite, any subsidiary of NaviSite or of
CMGI) was entitled to receive, upon the date of his or her
election, a non-statutory option to purchase Common Stock as
defined. A maximum number of 16,666 shares of Common Stock were
authorized for issuance under the 1998 Director Plan. Each
automatic grant had an exercise price equal to the current fair
market value of the Common Stock at the time of grant and a
maximum term of ten years, subject to earlier termination
following the optionees cessation of service on the board
of directors.

F-29



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##### Table of Contents



NAVISITE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

During fiscal 2003, no options were granted and
no options were outstanding under the 1998 Director Plan.



| |                                        
| | ---------------------------------------
| | (e) NaviSite 2000 Stock Option
    Plan

In November 2000, NaviSites board of
directors approved the 2000 Stock Option Plan (the Plan). Under
the Plan, nonqualified stock options or incentive stock options
may be granted to NaviSites employees, other than those
who are also officers or directors, and our consultants and
advisors, as defined, up to a maximum number of shares of Common
Stock not to exceed 66,666 shares. The board of directors
administers this plan, selects the individuals who are eligible
to be granted options under the Plan and determines the number
of shares and exercise price of each option. Options granted
under the Plan have a five-year maximum term and typically vest
over a one-year period. The following table reflects activity of
stock options under our Plan for the year ended July 31,
2003:

|                                         |  |        |         |          |  |        |        |          |  |        |         |          |  |   |        |  |  |  |         |   |  |   |        | 
|---------------------------------------- |  | ------ | ------- | -------- |  | ------ | ------ | -------- |  | ------ | ------- | -------- |  | - | ------ |  |  |  | ------- | - |  | - | ------ | 
|                                         |  |        |         |          |  |       
|                                         |  | 2003   |         | 2002     |  | 2001  
|                                         |  |        |         |          |  |       
|                                         |  |        |         | Weighted |  |        |        | Weighted |  |        |         | Weighted
|                                         |  | Number |         | Average  |  | Number |        | Average  |  | Number |         | Average 
|                                         |  | of     |         | Exercise |  | of     |        | Exercise |  | of     |         | Exercise
|                                         |  | Shares |         | Price    |  | Shares |        | Price    |  | Shares |         | Price   
|                                         |  |        |         |          |  |        |        |          |  |        |         |         
|Options outstanding beginning of year    |  |        | 16,266  |          |  | $      | 128.44 |          |  |        | 32,157  |          |  | $ | 128.44 |  |  |  |        |   |  | $ |       | 
|Granted                                  |  |        |        |          |  |        |       |          |  |        |        |          |  |   |       |  |  |  | 53,037  |   |  |   | 128.44 | 
|Exercised                                |  |        |        |          |  |        |       |          |  |        |        |          |  |   |       |  |  |  |        |   |  |   |       | 
|Cancelled                                |  |        | (11,394 | )        |  |        | 128.44 |          |  |        | (15,891 | )        |  |   | 128.44 |  |  |  | (20,880 | ) |  |   | 128.44 | 
|                                         |  |        |         |          |  |        |        |          |  |        |         |          |  |   |        |  |  |  |         |   |  |   |        | 
|Options outstanding, end of year         |  |        | 4,872   |          |  | $      | 128.44 |          |  |        | 16,266  |          |  | $ | 128.44 |  |  |  | 32,157  |   |  | $ | 128.44 | 
|                                         |  |        |         |          |  |        |        |          |  |        |         |          |  |   |        |  |  |  |         |   |  |   |        | 
|Options exercisable, end of year         |  |        | 4,872   |          |  |        |        |          |  |        | 16,266  |          |  |   |        |  |  |  |        |   |  |   |        | 
|                                         |  |        |         |          |  |        |        |          |  |        |         |          |  |   |        |  |  |  |         |   |  |   |        | 
|Options available for grant, end of year |  |        | 61,794  |          |  |        |        |          |  |        | 50,400  |          |  |   |        |  |  |  | 34,509  |   |  |   |        | 
|                                         |  |        |         |          |  |        |        |          |  |        |         |          |  |   |        |  |  |  |         |   |  |   |        | 

(f) NaviSite
1998 Equity Incentive Plan

In December 1998, NaviSites board of
directors and stockholders approved the 1998 Equity Incentive
Plan, as amended (the 1998 Plan). The 1998 Plan replaced
NaviSite Internet Services Corporations 1997 Equity
Incentive Plan (the 1997 Plan). All options outstanding under
the 1997 Plan were cancelled and replaced with an equivalent
amount of options issued in accordance with the 1998 Plan. Under
the original 1998 Plan, nonqualified stock options or incentive
stock options may be granted to NaviSites or its
affiliates employees, directors, and consultants, as
defined, up to a maximum number of shares of Common Stock not to
exceed 333,333 shares. In August 1999, the board of directors
approved an increase in the number of shares authorized under
the 1998 Plan to 741,628. In December 2000, the board of
directors approved an additional increase in the number of
shares authorized under the 1998 Plan to 1,000,000 shares. The
board of directors administers this plan, selects the
individuals who are eligible to be granted options under the
1998 Plan and determines the number of shares and exercise price
of each option. The chief executive officer, upon authority
granted by the board of directors, is authorized to approve the
grant of options to purchase Common Stock under the 1998 Plan to
certain persons. Options are granted at fair market value.
Options granted under the 1998 Plan have a five-year maximum
term and typically vest over a four year period, with 25% of
options granted becoming exercisable one year from the date of
grant and the remaining 75% vesting monthly for the

F-30



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##### Table of Contents



NAVISITE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

next thirty-six (36) months. The following
table reflects activity and historical exercise prices of stock
options under our 1998 Plan for the three years ended
July 31, 2003.

|                                         |  |           |          |          |  |           |        |          |  |           |          |          |  |   |        |  |  |  |          |   |  |   |        | 
|---------------------------------------- |  | --------- | -------- | -------- |  | --------- | ------ | -------- |  | --------- | -------- | -------- |  | - | ------ |  |  |  | -------- | - |  | - | ------ | 
|                                         |  |           |          |          |  |          
|                                         |  | 2003      |          | 2002     |  | 2001     
|                                         |  |           |          |          |  |          
|                                         |  |           |          | Weighted |  |           |        | Weighted |  |           |          | Weighted
|                                         |  |           |          | Average  |  |           |        | Average  |  |           |          | Average 
|                                         |  | Number of |          | Exercise |  | Number of |        | Exercise |  | Number of |          | Exercise
|                                         |  | Shares    |          | Price    |  | Shares    |        | Price    |  | Shares    |          | Price   
|                                         |  |           |          |          |  |           |        |          |  |           |          |         
|Options outstanding beginning of year    |  |           | 452,801  |          |  | $         | 149.40 |          |  |           | 522,560  |          |  | $ | 276.00 |  |  |  | 534,262  |   |  | $ | 416.85 | 
|Granted                                  |  |           | 128,164  |          |  |           | 2.57   |          |  |           | 268,397  |          |  |   | 4.65   |  |  |  | 427,638  |   |  |   | 100.20 | 
|Exercised                                |  |           | (1,905   | )        |  |           | 1.18   |          |  |           | (34,901  | )        |  |   | 1.05   |  |  |  | (35,153  | ) |  |   | 9.00   | 
|Cancelled                                |  |           | (313,091 | )        |  |           | 160.79 |          |  |           | (303,255 | )        |  |   | 256.35 |  |  |  | (404,187 | ) |  |   | 297.60 | 
|                                         |  |           |          |          |  |           |        |          |  |           |          |          |  |   |        |  |  |  |          |   |  |   |        | 
|Options outstanding, end of year         |  |           | 265,969  |          |  | $         | 66.14  |          |  |           | 452,801  |          |  | $ | 149.40 |  |  |  | 522,560  |   |  | $ | 276.00 | 
|                                         |  |           |          |          |  |           |        |          |  |           |          |          |  |   |        |  |  |  |          |   |  |   |        | 
|Options exercisable, end of year         |  |           | 175,555  |          |  |           | 84.18  |          |  |           | 131,156  |          |  | $ | 294.60 |  |  |  | 198,472  |   |  | $ | 266.85 | 
|                                         |  |           |          |          |  |           |        |          |  |           |          |          |  |   |        |  |  |  |          |   |  |   |        | 
|Options available for grant, end of year |  |           | 571,661  |          |  |           |        |          |  |           | 386,606  |          |  |   |        |  |  |  | 351,781  |   |  |   |        | 
|                                         |  |           |          |          |  |           |        |          |  |           |          |          |  |   |        |  |  |  |          |   |  |   |        | 

|                         |  |                     |         |                     |  |          |       |             |  |          |        |  |  |  |         |  |  |   |        | 
|------------------------ |  | ------------------- | ------- | ------------------- |  | -------- | ----- | ----------- |  | -------- | ------ |  |  |  | ------- |  |  | - | ------ | 
|                         |  |                     |         |                    
|                         |  | Options Outstanding |         | Options Exercisable
|                         |  |                     |         |                    
|                         |  |                     |         | Weighted            |  |          |       |            
|                         |  |                     |         | Average             |  | Weighted |       |             |  | Weighted
|                         |  |                     |         | Remaining           |  | Average  |       |             |  | Average 
|                         |  | Number              |         | Contractual         |  | Exercise |       | Number      |  | Exercise
|Range of Exercise Prices |  | Outstanding         |         | Life (Years)        |  | Price    |       | Outstanding |  | Price   
|                         |  |                     |         |                     |  |          |       |             |  |         
|.01 -   2.40             |  |                     | 6,413   |                     |  |          | 1.12  |             |  | $        | 0.90   |  |  |  | 5,214   |  |  | $ | 0.58   | 
|2.41 -   2.55            |  |                     | 120,000 |                     |  |          | 9.94  |             |  |          | 2.55   |  |  |  | 60,000  |  |  |   | 2.55   | 
|2.56 -   3.90            |  |                     | 42,511  |                     |  |          | 3.64  |             |  |          | 3.90   |  |  |  | 22,771  |  |  |   | 3.90   | 
|3.91 -   9.60            |  |                     | 37,157  |                     |  |          | 3.30  |             |  |          | 4.87   |  |  |  | 36,948  |  |  |   | 4.86   | 
|9.61 -  27.75            |  |                     | 29,153  |                     |  |          | 22.39 |             |  |          | 2.68   |  |  |  | 24,610  |  |  |   | 23.32  | 
|27.76 -  73.13           |  |                     | 5,042   |                     |  |          | 2.04  |             |  |          | 51.16  |  |  |  | 3,839   |  |  |   | 51.52  | 
|73.14 - 182.82           |  |                     | 7,160   |                     |  |          | 1.31  |             |  |          | 113.02 |  |  |  | 6,537   |  |  |   | 110.86 | 
|182.83 - 671.25          |  |                     | 7,054   |                     |  |          | 1.82  |             |  |          | 620.52 |  |  |  | 5,504   |  |  |   | 618.92 | 
|671.26 up                |  |                     | 11,479  |                     |  |          | 1.53  |             |  |          | 943.99 |  |  |  | 10,132  |  |  |   | 932.79 | 
|                         |  |                     |         |                     |  |          |       |             |  |          |        |  |  |  |         |  |  |   |        | 
|                         |  |                     | 265,969 |                     |  |          |       |             |  |          |        |  |  |  | 175,555 |  |  |   |        | 
|                         |  |                     |         |                     |  |          |       |             |  |          |        |  |  |  |         |  |  |   |        | 

(g) NaviSite
2003 Stock Option Plan

On July 10, 2003, the 2003 Stock Incentive
Plan (the 2003 Plan) was approved by the Board of
Directors. The 2003 Plan has not yet been approved by
NaviSites Stockholders. The 2003 Plan provides that stock
options or restricted stock awards may be granted to employees,
officers, directors, consultants, and advisors or NaviSite (or
any present or future parent or subsidiary corporations and any
other business venture (including, without limitation, joint
venture or limited liability company) in which NaviSite has a
controlling interest, as determined by the Board of Directors of
NaviSite) The board of directors has authorized 2,600,000 shares
of common stock for issuance under the 2003 Plan.

The 2003 Plan is administered by the Board of
Directors of NaviSite or any committee to which the Board
delegates its powers under the 2003 Plan. Subject to the
provisions of the 2003 Plan, the Board of Directors will
determine the terms of each award, including the number of
shares of common stock subject to the award and the exercise
thereof.

F-31



---



##### Table of Contents



NAVISITE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The Board of Directors may, in its sole
discretion, amend, modify or terminate any award granted or made
under the 2003 Plan, so long as such amendment, modification or
termination would not materially and adversely affect the
participant. The Board of Directors may also provide that any
stock option shall become immediately exercisable, in full or in
part, or that any restricted stock granted under the 2003 Plan
shall be free of some or all restrictions.

As of July 31, 2003, stock options to
purchase 2,272,000 shares of common stock at an average exercise
price of $2.55 per share were outstanding under the 2003 Plan.
During fiscal year 2003, no options were exercised or cancelled.
The options do not become exercisable until the stockholders of
the Company have duly approved the plan. Once approved, the
options will become exercisable as to 25% of the original number
of shares on grant date and thereafter in equal amounts monthly
over the three year period commencing on the grant date.

(h) CMGI
1986 Stock Option Plan

Certain NaviSite employees have been granted
options for the purchase of CMGI Common Stock under the CMGI
1986 Stock Option Plan (the 1986 Plan). Options under the 1986
Plan are granted at fair market value on the date of grant and
are generally exercisable in equal cumulative installments over
a four-to-ten year period beginning one year after the date of
grant. Outstanding options under the 1986 Plan expire through
2007. Under the 1986 Plan, nonqualified stock options or
incentive stock options may be granted to CMGIs or its
subsidiaries employees, as defined. The board of directors
of CMGI administers this plan, selects the individuals to whom
options will be granted and determines the number of shares and
exercise price of each option.

The following table reflects activity and
historical exercise prices of stock options granted to NaviSite
employees under the 1986 Plan for the three years ended
July 31, 2003. Options held by employees who transferred to
NaviSite from CMGI or CMGI subsidiaries kept their CMGI options
and during fiscal year 2003, 2002 and 2001 are shown as
transfers into the 1986 plan. Employees that transferred to CMGI
from an affiliate could not keep their affiliate options.

On September 11, 2002 each of CMGI and
Hewlett-Packard Financial Services Company (HPFS) sold and
transferred to ClearBlue Technologies, Inc. (ClearBlue), a
privately-held managed service provider based in San Francisco,
California equity and debt interests. Due to this transaction,
NaviSite employees had 30 days from September 11, 2002
to exercise vested CMGI options. There were no options exercised
and subsequently all outstanding options were cancelled.

F-32



---



##### Table of Contents



NAVISITE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The following table summarizes information about
stock options granted NaviSite employees under the 1986 Plan
outstanding at July 31, 2003:

|                                      |  |           |          |          |  |           |      |          |  |           |          |          |  |   |       |  |  |  |          |   |  |   |       | 
|------------------------------------- |  | --------- | -------- | -------- |  | --------- | ---- | -------- |  | --------- | -------- | -------- |  | - | ----- |  |  |  | -------- | - |  | - | ----- | 
|                                      |  |           |          |          |  |          
|                                      |  | 2003      |          | 2002     |  | 2001     
|                                      |  |           |          |          |  |          
|                                      |  |           |          | Weighted |  |           |      | Weighted |  |           |          | Weighted
|                                      |  |           |          | Average  |  |           |      | Average  |  |           |          | Average 
|                                      |  | Number of |          | Exercise |  | Number of |      | Exercise |  | Number of |          | Exercise
|                                      |  | Shares    |          | Price    |  | Shares    |      | Price    |  | Shares    |          | Price   
|                                      |  |           |          |          |  |           |      |          |  |           |          |         
|Options outstanding beginning of year |  |           | 106,582  |          |  | $         | 8.76 |          |  |           | 349,562  |          |  | $ | 26.10 |  |  |  | 510,923  |   |  | $ | 27.85 | 
|Granted                               |  |           |          |          |  |           |      |          |  |           |         |          |  |   |      |  |  |  |         |   |  |   |      | 
|Transfers                             |  |           |          |          |  |           |      |          |  |           | (2,834   | )        |  |   | 20.26 |  |  |  | 14,615   |   |  |   | 24.40 | 
|Exercised                             |  |           |          |          |  |           |      |          |  |           |         |          |  |   |      |  |  |  | (48,803  | ) |  |   | 4.72  | 
|Cancelled                             |  |           | (106,582 | )        |  |           | 8.76 |          |  |           | (240,146 | )        |  |   | 32.44 |  |  |  | (127,173 | ) |  |   | 44.60 | 
|                                      |  |           |          |          |  |           |      |          |  |           |          |          |  |   |       |  |  |  |          |   |  |   |       | 
|Options outstanding, end of year      |  |           |         |          |  | $         |     |          |  |           | 106,582  |          |  | $ | 8.76  |  |  |  | 349,562  |   |  | $ | 26.10 | 
|                                      |  |           |          |          |  |           |      |          |  |           |          |          |  |   |       |  |  |  |          |   |  |   |       | 
|Options exercisable, end of year      |  |           |         |          |  |           |      |          |  |           | 97,486   |          |  | $ | 7.86  |  |  |  | 261,090  |   |  | $ | 31.39 | 
|                                      |  |           |          |          |  |           |      |          |  |           |          |          |  |   |       |  |  |  |          |   |  |   |       | 

(i) Other
Stock Option Grants

At July 31, 2003, we had 2,665 outstanding
stock options issued outside of existing plans to certain
directors at an average exercise price of $135.56. These stock
options were fully vested on the grant date and have a
contractual life of 10 years.

(j) Other
Disclosure

SFAS No. 123, Accounting for Stock-Based
Compensation (SFAS 123), sets forth a fair-value based
method of recognizing stock-based compensation expense. As
permitted by SFAS No. 123, we have elected to continue to
apply APB No. 25 to account for the stock-based
compensation plans in which NaviSites employees
participate.

(15) Related Party Transactions

For the period August 1, 2002 through
September 11, 2002, we classified revenue from CMGI and
CMGI affiliates as revenue from related parties. For the period
September 12, 2002 through July 31, 2003, we
classified revenue from CMGI and CMGI affiliates as third-party
revenue.

The consolidated financial statements include
certain allocations from CMGI for certain general and
administrative expenses, such as rent, legal services,
insurance, and employee benefits. Allocations are based
primarily on headcount. Management believes that the method used
to allocate the costs and expenses is reasonable; however, such
allocated amounts may or may not necessarily be indicative of
what actual expenses would have been incurred had we operated
independently of CMGI. As a result of CMGIs sale of its
debt and equity interests in us, the agreement between NaviSite
and CMGI whereby CMGI provided certain services for us
automatically terminated. CMGI continued to provide certain
services to us pursuant to a Transition Services Agreement we
entered into with CMGI on November 25, 2002, as we
transitioned to services agreements with ClearBlue and to other
third-party suppliers. This transition agreement concluded
during the second quarter of fiscal year 2003 and we have
completely severed our administrative ties with CMGI; however,
CMGI remains a third-party customer. During the second quarter
of fiscal year 2003, we contracted with ClearBlue and other
third-party suppliers for these services. We currently rent
administrative facilities from CMGI at 800 Federal Street,
Andover, Massachusetts.

F-33



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##### Table of Contents



NAVISITE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

On December 31, 2002, CBTM was required to
pay a $6.1 million liability owed to the AppliedTheory
Estate as a result of CBTMs acquisition of AppliedTheory.
In order to fund the $6.1 million payment, CBTM entered
into a $6.0 million line of credit with Unicorn Worldwide
Holding Limited (Unicorn), a related party to NaviSite and CBTM.
CBTM drew down $4.6 million and together with cash on hand
at December 31, 2002, paid the $6.1 million liability
due to the AppliedTheory Estate. In January 2003, CBTM paid
$2.6 million of the $4.6 million due to Unicorn,
leaving a liability to Unicorn of $2.0 million at
January 31, 2003. In January 2003, we entered into a Loan
and Security Agreement with Atlantic and in February 2003, drew
down on this facility to pay off the remaining $2.0 million
due Unicorn by CBTM. CBTM has a long-term liability of
$6.0 million (Estate Liability) due to the AppliedTheory
Estate in June 10, 2006. The Estate Liability bears
interest at 8% per annum, which is due and payable at the
termination date of the Estate Liability.

Beginning January 1, 2003, we entered into
an Outsourcing Agreement with ClearBlue whereby we provided
certain management services as well as manage the day-to-day
operations of ClearBlues data centers. We charge ClearBlue
actual costs incurred plus a 5% mark-up on labor costs only. In
fiscal year 2003, we charged ClearBlue approximately $270,000
under this agreement. This amount is included other income in
the Consolidated Statement of Operations. In connection with the
Outsourcing Agreement, we entered into two loan arrangements,
one whereby we will loan amounts to ClearBlue for working
capital needs (NaviSite Loan) and one whereby ClearBlue will
loan amounts to NaviSite for working capital needs (ClearBlue
Loan). The two loans may be drawn down upon, at the sole
discretion of the lender, up to a maximum aggregate amount of
$2.0 million per note. ClearBlue owed us approximately
$1.9 million at April 30, 2003 under the NaviSite
Loan. In addition to the amount due under the NaviSite loan,
ClearBlue owed certain amounts to CBTM at the time of
CBTMs sale to NaviSite. On June 2, 2003, we amended
the NaviSite Loan to increase the borrowing facility, on a
temporary basis, to $2,250,000 and loaned an additional $200,000
to ClearBlue. The additional $200,000 funding to ClearBlue was
repaid to us on June 6, 2003. On June 16, 2003, we
used $3.9 million of the amounts due to us by ClearBlue to
pay down a portion of our $45.0 million outstanding on the
New Note.

On January 29, 2003, we entered into a
$10 million Loan and Security Agreement (Atlantic Loan)
with Atlantic, a related party. The Atlantic Loan has a
termination date of February 1, 2004 and bears an interest
rate of 8% per annum. Interest is payable upon demand or, at
Atlantics option, interest may be added to the outstanding
balance due to Atlantic by NaviSite. Atlantic may make demand
for payment of amounts in excess of the minimum Atlantic Loan
amount of $2.0 million (Minimum Loan Amount), with
60 days notice, but not such that the payment would be
required before February 1, 2003. Atlantic can demand
payment of the Minimum Loan Amount with 90 days notice, but
not such that payment would be required before August 1,
2003. Under the Atlantic Loan agreement, we can require Atlantic
to loan us (1) up to $2.0 million to repay an amount
due from CBTM to Unicorn, a related party to NaviSite and
Atlantic; (2) $1.0 million for costs associated with
our acquisition of Avasta; and (3) up to $500,000 for the
post-acquisition working capital needs of Avasta Atlantic, at
its sole and absolute discretion, may advance other amounts to
us such that the aggregate amount borrowed by NaviSite does not
exceed the maximum loan amount, defined as the lesser of
$10.0 million or 65% of our consolidated accounts
receivables. At July 31,, 2003, we had $3.0 million
outstanding under the Atlantic Loan and had approximately
$500,000 available to us. This amount is shown as Due to
Affiliate on our Consolidated Balance Sheet. The Atlantic Loan
is secured by all of our receivables. On May 30, 2003 we
repaid $2.0 million of the approximate $3.0 million
outstanding under the Atlantic Loan and on June 11, 2003,
we borrowed $2.0 million under the Atlantic Loan.

F-34



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##### Table of Contents



NAVISITE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

(16) Selected Quarterly Financial Data
(Unaudited)

Financial information for interim periods was as
follows:

|                   |  |                                 |        |    |  |    |         |    |  |   |         |   |  |   |         |  
|------------------ |  | ------------------------------- | ------ | -- |  | -- | ------- | -- |  | - | ------- | - |  | - | ------- | -
|                   |  |                                
|                   |  | Fiscal Year Ended July 31, 2003
|                   |  |                                
|                   |  | Q1                              |        | Q2 |  | Q3 |         | Q4
|                   |  |                                 |        |    |  |    |         |   
|Net revenue        |  | $                               | 13,449 |    |  | $  | 14,803  |    |  | $ | 15,877  |   |  | $ | 18,626  |  
|Gross margin       |  |                                 | (157   | )  |  |    | 1,797   |    |  |   | 2,244   |   |  |   | 2,286   |  
|Net loss           |  |                                 | (9,915 | )  |  |    | (19,081 | )  |  |   | (10,992 | ) |  |   | (29,532 | )
|Net loss per share |  | $                               | (1.59  | )  |  | $  | (2.03   | )  |  | $ | (0.86   | ) |  | $ | (1.66   | )

|                   |  |                                 |         |    |  |    |         |    |  |   |        |   |  |   |         |  
|------------------ |  | ------------------------------- | ------- | -- |  | -- | ------- | -- |  | - | ------ | - |  | - | ------- | -
|                   |  |                                
|                   |  | Fiscal Year Ended July 31, 2002
|                   |  |                                
|                   |  | Q1                              |         | Q2 |  | Q3 |         | Q4
|                   |  |                                 |         |    |  |    |         |   
|Net revenue        |  | $                               | 19,279  |    |  | $  | 15,674  |    |  | $ | 14,717 |   |  | $ | 9,752   |  
|Gross margin       |  |                                 | (29,457 | )  |  |    | (11,859 | )  |  |   | 4,552  |   |  |   | (39,132 | )
|Net loss           |  |                                 | (44,340 | )  |  |    | (26,779 | )  |  |   | (2,044 | ) |  |   | (48,531 | )
|Net loss per share |  | $                               | (0.71   | )  |  | $  | (0.31   | )  |  | $ | (0.02  | ) |  | $ | (0.53   | )



---



|    |                                                                                                                                                                                                                                                                                              
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) | Net loss per common share is computed
    independently for each of the quarters based on the weighted
    average number of shares outstanding during the quarter.
    Therefore, the aggregate per share amount for the quarters may
    not equal the amount calculated for the full year.

(17) Subsequent Events

On August 8, 2003, we completed the
acquisition of certain assets and the assumption of certain
liabilities of ClearBlue Technologies, Inc. pursuant to a Stock
and Asset Acquisition Agreement (the CBT Agreement).
Pursuant to the CBT Agreement, we acquired all outstanding
shares of six (6) wholly-owned subsidiaries of ClearBlue
Technologies, Inc. with data centers located in Chicago, Las
Vegas, Los Angeles, Milwaukee, Oakbrook and Vienna.

In addition, we assumed the revenue and expense,
as of the date of the CBT Agreement, of four (4) additional
wholly-owned subsidiaries of ClearBlue Technologies, Inc. with
data centers located in Dallas, New York, San Francisco and
Santa Clara. Ownership of these subsidiaries will automatically
be transferred, under certain conditions, to us for no
additional consideration in February 2004.

In exchange for these subsidiaries and certain
assets and contracts relating to them, we: (i) issued
1.1 million shares of our common stock, to ClearBlue
Technologies, Inc.; (ii) released ClearBlue Technologies,
Inc. from certain inter-company advances in an amount up to
$300,000; (iii) assumed all of ClearBlue Technologies,
Inc.s obligations under certain assets and contracts
relating to the these subsidiaries; and (iv) released
ClearBlue Technologies, Inc. from certain payment obligations
owed to us pursuant to the Outsourcing Agreement in an amount
not to exceed $263,000.

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##### Table of Contents



INDEPENDENT AUDITORS REPORT ON FINANCIAL
STATEMENT SCHEDULE

The Board of Directors and Stockholders

NaviSite, Inc. and Subsidiaries:


Under date of October 21, 2003, we reported
on the consolidated balance sheets of NaviSite, Inc. as of
July 31, 2003 and 2002 and the related consolidated
statements of operations, changes in stockholders equity
(deficit), and cash flows for each of the fiscal years in the
three-year period ended July 31, 2003, which are included
in the Form 10-K for the year ended July 31, 2003. In
connection with our audits of the aforementioned consolidated
financial statements, we also audited the related consolidated
financial statement schedule of Valuation and Qualifying
Accounts in the Form 10-K. This financial statement
schedule is the responsibility of the Companys management.
Our responsibility is to express an opinion on this financial
statement schedule based on our audits. In our opinion, such
financial statement schedule when considered in relation to the
basic consolidated financial statements taken as a whole,
presents fairly in all material respects the information set
forth therein.

The audit report on the consolidated financial
statements of NaviSite, Inc. referred to above contains an
explanatory paragraph that states that the Companys
recurring losses since inception and accumulated deficit, as
well as other factors, raise substantial doubt about the
entitys ability to continue as a going concern. The
financial statement schedule does not include any adjustments
that might result from the outcome of this uncertainty.



| |             
| | ------------
| | /s/ KPMG LLP

Boston, Massachusetts

October 21, 2003


F-36



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##### Table of Contents



NaviSite, Inc. and Subsidiaries

Valuation and Qualifying Accounts

|                                |  |                                           |       |            |  |            |        |          |  |            |        |   |  |  |       |  |  |   |       | 
|------------------------------- |  | ----------------------------------------- | ----- | ---------- |  | ---------- | ------ | -------- |  | ---------- | ------ | - |  |  | ----- |  |  | - | ----- | 
|                                |  |                                          
|                                |  | Years Ended July 31, 2003, 2002, and 2001
|                                |  |                                          
|                                |  | Balance at                                |       | Additions  |  | Deductions |        |          |  | Balance at
|                                |  | beginning                                 |       | charged to |  | from       |        |          |  | end of    
|                                |  | of year                                   |       | expense    |  | reserve    |        | Other(1) |  | year      
|                                |  |                                           |       |            |  |            |        |          |  |           
|                                |  |                                          
|                                |  | (In thousands)                           
|Year ended July 31, 2001:       |  |                                           |       |            |  |            |        |          |  |            |        |   |  |  |       |  |  |   |       | 
|Allowance for doubtful accounts |  | $                                         | 1,219 |            |  |            | 11,948 |          |  |            | (6,308 | ) |  |  |      |  |  | $ | 6,859 | 
|Year ended July 31, 2002:       |  |                                           |       |            |  |            |        |          |  |            |        |   |  |  |       |  |  |   |       | 
|Allowance for doubtful accounts |  | $                                         | 6,859 |            |  |            | 3,490  |          |  |            | (9,732 | ) |  |  |      |  |  | $ | 617   | 
|Year ended July 31, 2003:       |  |                                           |       |            |  |            |        |          |  |            |        |   |  |  |       |  |  |   |       | 
|Allowance for doubtful accounts |  | $                                         | 617   |            |  |            | 1,186  |          |  |            | (3,525 | ) |  |  | 2,767 |  |  | $ | 1,045 | 



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|    |                                                                                       
|--- | --------------------------------------------------------------------------------------
|(1) | Represents allowance for doubtful accounts of
    CBTM (acquired in fiscal year 2003).

S-1