• Software as a Service ("SaaS") - Enablement of SaaS to the ISV community. Services include SaaS starter kits and services specific to the needs of ISVs who offer their software in an on-demand or subscription model.

• Co-location - Physical space offered in a data center. In addition to providing the physical space, NaviSite offers environmental support, specified power with back-up power generation and network connectivity options.

Application Services
• ERP Application and Messaging Management Services - Customer defined services for specific packaged applications.

• Applications include:

• Oracle e-Business Suite

• PeopleSoft Enterprise

• Siebel

• JD Edwards

• Hyperion

• Lawson

• Kronos

• Microsoft Dynamics

• Microsoft Exchange

• Lotus Notes

Services include implementation, upgrade support, monitoring, diagnostics, problem resolution and functional end-user support.
• ERP Professional Services - Planning, implementation, optimization, enhancement and upgrade support for third party ERP applications we support.

• Custom Development Services - Planning, implementation, optimization and enhancement for custom applications that we or our customers have developed.

We provide these services to a range of vertical industries, including financial services, healthcare and pharmaceutical, manufacturing and distribution, publishing, media and communications, business services and public sector and software, through both our own sales force and sales channel relationships.
Our managed application and hosting services are facilitated by our proprietary NaviViewtm collaborative infrastructure and application management platform. Our NaviViewtm platform enables us to provide highly efficient, effective and customized management of enterprise applications and hosted infrastructure. Comprised of a suite of third-party and proprietary products, NaviViewtm provides tools designed specifically to meet the needs of customers who outsource their IT needs.
Supporting both our managed hosting services and applications services is a range of hardware and software technologies designed for the specific needs of our customers. NaviSite is a leader in using virtualized processing, storage and networking as a platform to optimize services for performance, cost and operational efficiency. Utilizing both hardware and software based virtualization strategies, NaviSite continues to innovate as technology develops.
We believe that the combination of NaviViewtm, our dedicated and virtual platform, with our physical infrastructure and technical staff gives us a unique ability to provide complex enterprise hosting and application services for mid-market customers. NaviViewtm is application and operating system neutral. Designed to enable enterprise hosting and software applications to be monitored and managed, the NaviViewtm technology allows us to offer new solutions to our software vendors and new products to our current customers.
We provide our services from a global platform of 14 data centers in the United States, two in the United Kingdom and a Network Operations Center ("NOC") in India. We believe that our data centers and infrastructure have the capacity necessary to expand our business for the foreseeable future. Further, trends in hardware virtualization and the density of computing resources, which reduce footprint in the data center, are favorable to NaviSite's services-oriented offerings as compared with traditional co-location or managed hosting providers. Our services combine our developed infrastructure with established processes and procedures for delivering hosting and application management services. Our high availability infrastructure, high performance monitoring systems, and proactive and collaborative problem resolution and change management processes are designed to identify and address potentially crippling problems before they disrupt our customers' operations.
We currently service over 1,400 customers. Our hosted customers typically enter into service agreements for a term of one to five years, which provide for monthly payment installments, providing us with a base of recurring revenue. Our revenue growth comes from adding new customers or delivering additional services to existing customers. Our recurring revenue base is affected by new customers, renewals and terminations of agreements with existing customers.
During fiscal 2008 and in past years, we have grown through business acquisitions and have restructured our operations. Specifically, in December 2002, we completed a common control merger with ClearBlue Technologies

Management, Inc.; in February 2003, we acquired Avasta, Inc.; in April 2003, we acquired Conxion Corporation; in May 2003, we acquired assets of Interliant, Inc. in August 2003 and April 2004, we completed a common control merger with certain subsidiaries of ClearBlue Technologies, Inc.; and in June 2004, we acquired substantially all of the assets and liabilities of Surebridge (now known as Waythere, Inc.). In January 2005, we formed NaviSite India Private Limited ("NaviSite India"), a New Delhi-based operation which is intended to expand our international capability. NaviSite India provides a range of software services, including design and development of custom and E-commerce solutions, application management, problem resolution management and the deployment and management of IT networks, customer specific infrastructure and data center infrastructure. We expect to make additional acquisitions to take advantage of our available capacity, which will have significant effects on our financial results in the future.
In August 2007, we acquired the assets of Alabanza, LLC and Hosting Ventures, LLC (collectively "Alabanza") and all of the issued and outstanding stock of Jupiter Hosting, Inc. ("Jupiter"). These acquisitions provided additional managed hosting customers, proprietary software for provisioning and additional data center space in the Bay Area market. In September 2007, we acquired netASPx, Inc. ("netASPx"), an application management service provider, and in October 2007, we acquired the assets of iCommerce, Inc., a re-seller of dedicated hosting services.
Results of Operations for the Three Months Ended October 31, 2008 and 2007 The following table sets forth the percentage relationships of certain items from our Condensed Consolidated Statements of Operations as a percentage of total revenue for the periods indicated.

                                                                       Three Months Ended
                                                                          October 31,
                                                                     2008             2007

Revenue, net                                                          99.8 %           99.8 %
Revenue, related parties                                               0.2 %            0.2 %

Total revenue                                                        100.0 %          100.0 %

Cost of revenue, excluding restructuring charge,
depreciation and amortization                                         54.5 %           57.8 %
Depreciation and amortization                                         14.3 %           11.6 %
Restructuring charge                                                   0.5 %              -

Total cost of revenue                                                 69.3 %           69.4 %

Gross profit                                                          30.7 %           30.6 %

Operating expenses:
Selling and marketing                                                 13.7 %           14.3 %
General and administrative                                            15.0 %           15.6 %
Restructuring Charge                                                   0.6 %              -

Total operating expenses                                              29.3 %           29.9 %

Income from operations                                                 1.4 %            0.7 %

Other income (expense):
Interest income                                                          -              0.3 %
Interest expense                                                      (7.7 )%          (7.3 )%
Loss on debt extinguishment                                              -             (4.6 )%
Other income (expense), net                                            1.2 %            0.8 %

Loss from continuing operations before income taxes and
discontinued operations                                               (5.1 )%         (10.1 )%
Income taxes                                                          (1.2 )%          (1.1 )%

                                                                         Three Months Ended
                                                                            October 31,
                                                                       2008             2007

Loss from continuing operations before discontinued operations          (6.3 )%         (11.2 )%
Discontinued operations, net of income taxes                              (- )%          (0.9 )%

Net loss                                                                (6.3 )%         (12.1 )%
Accretion of preferred stock dividends                                  (2.0 )%          (1.1 )%

Net loss attributable to common stockholders                            (8.3 )%         (13.2 )%

Comparison of the Three Months Ended October 31, 2008 and 2007 Revenue
We derive our revenue from managed IT services, including hosting, co-location and application services comprised of a variety of service offerings and professional services, to mid-market companies and organizations, including mid-sized companies, divisions of large multi-national companies and government agencies.
Total revenue for the three months ended October 31, 2008 increased 10.4% to approximately $39.9 million from approximately $36.1 million for the three months ended October 31, 2007. The overall growth of approximately $3.8 million in revenue was mainly due to increased sales to new and existing NaviSite customers and the inclusion of a full quarter of revenue from acquisitions made during the same period in the prior year. The Company's enterprise hosting and application services revenues increased $5.3 million due to increased sales to new and existing customers. Professional services revenues declined $2.3 million in the current year as compared to the prior year due to lower sales of these types of services. Revenue from related parties during the three months ended October 31, 2008 and 2007 totaled $83,000 and $75,000, respectively. Cost of Revenue and Gross Profit
Cost of revenue consists primarily of salaries and benefits for operations personnel, bandwidth fees and related Internet connectivity charges, equipment costs and related depreciation and costs to run our data centers, such as rent and utilities.
Total cost of revenue for the three months ended October 31, 2008 increased approximately 10.4% to $27.6 million during the three months ended October 31, 2008 from approximately $25.0 million during the three months ended October 31, 2007. As a percentage of revenue, total cost of revenue increased to 69.3% during the three months ended October 31, 2008 from 69.4% during the three months ended October 31, 2007. The overall increase of approximately of $2.6 million was primarily due to increased depreciation expense of approximately $1.5 million, increased facilities related expense including rent and utilities of approximately $1.1 million, increased third party pass through related expenses of approximately $0.6 million, increased outside consultant expenses of $0.4 million and increased software and hardware maintenance and licensing costs of approximately $0.3 million. These incremental expenses of approximately $3.9 million were partially offset by lower salary related expenses of approximately $1.1 million during the period and $0.2 million of acquisition costs incurred in the prior year.
During the three months ended October 31, 2008, the Company initiated the restructuring of its professional services organization in an effort to realign resources. As a result of this initiative, the Company terminated several employees resulting in a restructuring charge for severance and related costs of $0.5 million, of which approximately $0.2 million was included in Cost of Revenue.
Gross profit of approximately $12.2 million for the three months ended October 31, 2008 increased approximately $1.1 million, or 10.4%, from a gross profit of approximately $11.1 million for the three months ended October 31, 2007. Gross profit for the three months ended October 31, 2008 represented 30.7% of total revenue, compared to 30.6% of total revenue for the three months ended October 31, 2007. Gross profit was positively impacted during the three months ended October 31, 2008 as compared to the three months ended October 31, 2007, mainly due to the increased revenues noted above.

Operating Expenses
Selling and Marketing. Selling and marketing expense consists primarily of salaries and related benefits, commissions and marketing expenses such as traveling, advertising, product literature, trade show, and marketing and direct mail programs.
Selling and marketing expense increased 5.3% to approximately $5.4 million, or 13.7% of total revenue, during the three months ended October 31, 2008 from approximately $5.2 million, or 14.3% of total revenue, during the three months ended October 31, 2007. The increase of approximately $0.2 million resulted primarily from the increased salary and related headcount expenses of $0.1 million, and increased lead referral fees of approximately $0.1 million.
General and Administrative. General and administrative expense includes the costs of financial, human resources, IT and administrative personnel, professional services, bad debt and corporate overhead.
General and administrative expense increased 6.0% to approximately $6.0 million, or 15.0% of total revenue, during the three months ended October 31, 2008 from approximately $5.6 million, or 15.6% of total revenue, during the three months ended October 31, 2007. The mix of expenses changed such that there was an increase in accounting and legal fees of approximately $0.3 million, an increase in utilities expense of approximately $0.2 million partially offset by lower depreciation expense of approximately $0.1 million. Operating Expenses - Impairment, Restructuring, and Other During the three months ended October 31, 2008, the Company initiated the restructuring of its professional services organization in an effort to realign resources. As a result of this initiative, the Company terminated several employees resulting in a restructuring charge for severance and related costs of $0.5 million, of which approximately $0.3 million was included in Operating Expenses.
No impairment, restructuring, or other charges were recorded during the three months ended October 31, 2007.
Interest Income
During the three months ended October 31, 2008, interest income decreased by approximately $110,000 from $114,000 during the three months ended October 31, 2007. The decrease for the three months ended October 31, 2008 is mainly due to lower levels of average cash balances during the three months ended October 31, 2008 compared to the three months ended October 31, 2007. Interest Expense
During the three months ended October 31, 2008, interest expense increased to approximately $3.0 million from approximately $2.7 million for the three months ended October 31, 2007. The increase of $0.3 million for the three months ended October 31, 2008 is primarily due to an increased rate of interest and high average outstanding term loan balance during the three months ended October 31, 2008 compared to the three months ended October 31, 2007. Loss on debt extinguishment
During the three months ended October 31, 2007, the Company recorded a loss on debt extinguishment of approximately $1.7 million in connection with the refinancing of its Amended Credit Agreement completed in September 2007. The total amount of the loss on debt extinguishment consisted of unamortized transaction fees and expenses related to the prior refinancing of the Company's long-term debt in June 2007.
Other Income (Expense), Net
Other income (expense), net was approximately $461,000 during the three months ended October 31, 2008, compared to Other income (expense), net of approximately $275,000 during the three months ended October 31, 2007. The Other income (expense), net recorded during the three months ended October 31, 2008 is primarily

attributable to sublease income and gains and losses from our interest rate cap protection related to our long-term debt and a gain of $0.3 million in foreign currency fluctuation during the three months ended October 31, 2008. Income Tax Expense
The Company recorded $0.5 million and $0.4 million of deferred income tax expense during the three months ended October 31, 2008 and 2007, respectively. No income tax benefit was recorded for the losses incurred due to a valuation allowance recognized against deferred tax assets. The deferred tax expense primarily resulted from tax goodwill amortization related to the acquisitions of Surebridge and Alabanza, the acquisition of AppliedTheory Corporation by ClearBlue Technologies Management, Inc. and the carry-over amortization of goodwill resulting from the acquisition of netASPx. Acquired goodwill for these acquisitions is amortizable for tax purposes over fifteen years. For financial statement purposes, goodwill is not amortized but is tested for impairment when evidence of impairment may exist, but at least annually. Tax amortization of goodwill results in a taxable temporary difference, which will not reverse until the goodwill is impaired, written off or the underlying assets are sold by the Company. The resulting taxable temporary difference may not be offset by deductible temporary differences currently available, such as net operating loss carryforwards which expire within a definite period. Discontinued Operations
The discontinued operations relates to the Company's employment services operation called American's Job Exchange ("AJE"). During fiscal year 2008 the Company made the determination that AJE was not core to our business and is actively looking to dispose of this asset.
During the three months ended October 31, 2008 the Company's loss from discontinued operations was $17,000 as compared to a loss of $0.3 million for the three months ended October 31, 2007. The loss from discontinued operations decrease during the period was due to increased sales attributed to AJE. Liquidity and Capital Resources
As of October 31, 2008, our principal sources of liquidity included cash and cash equivalents of $5.0 million and a revolving credit facility of $10.0 million provided under our Amended Credit Agreement ($7.0 million available at October 31, 2008). Our current assets, including cash and cash equivalents of $5.0 million, were approximately $0.8 million less than current liabilities for the period, giving us a negative working capital position at October 31, 2008.
The total net change in cash and cash equivalents for the three months ended October 31, 2008 was an increase of $1.8 million. The primary uses of cash during the three months ended October 31, 2008 included $3.7 million for purchases of property and equipment, approximately $3.7 million in repayments of notes payable and capital lease obligations, and $1.2 million in debt issuance costs. Our primary sources of cash during the three months ended October 31, 2008 were $9.5 million generated from operations and $0.9 million in borrowings on notes payable.
During fiscal year 2008, the Company entered into a deposit agreement to secure additional data center space in the United Kingdom, totaling $5.0 million. This deposit was returned during the three months ended October 31, 2008.
Our revolving credit facility with our lending group allows for maximum borrowing of $10.0 million and expires in June 2012. Outstanding amounts bear interest at either the LIBOR Rate plus 8% or the Base Rate, as defined in the credit agreement, plus 7%, at the Company's option. Interest rates include 2% paid-in-kind ("PIK") interest until the Consolidated Leverage Ratio, as defined, has been lowered to 3:1. Minimum LIBOR was fixed at 3.15% and LIBOR interest becomes due and is payable quarterly in arrears. At October 31, 2008, the Company had $3.0 million outstanding on the revolving credit facility.
The Company believes that it has sufficient liquidity to support its operations over the remainder of the fiscal year and for the foreseeable future with its cash resources and committed lines of credit as of October 31, 2008. Recent Accounting Pronouncements
In November 2008, the SEC issued for comment a proposed roadmap regarding the potential use by U.S. issuers of financial statements prepared in accordance with International Financial Reporting Standards ("IFRS"). IFRS is a comprehensive series of accounting standards published by the International Accounting Standards Board ("IASB"). Under the proposed roadmap, we could be required in fiscal 2015 to prepare financial statements in accordance with IFRS, and the SEC will make a determination in 2011 regarding the mandatory adoption of IFRS. We are currently assessing the impact that this potential change would have on our consolidated financial statements, and we will continue to monitor the development of the potential implementation of IFRS.

In May 2008, the FASB issued Statement of Financial Accounting Standards No. 162, "The Hierarchy of Generally Accepted Accounting Principles" ("SFAS 162"), which identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with U.S. GAAP. SFAS 162 is effective for the Company 60 days following the SEC's approval of the Public Company Accounting Oversight Board ("PCAOB") amendments to AU Section 411, "The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles." The adoption of this Standard is not expected to have a material impact on our results of operations or financial position.
In April 2008, the FASB issued FSP FAS 142-3, "Determination of the Useful Life of Intangible Assets" ("FSP FAS 142-3"). FSP FAS 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under FASB Statement No. 142, Goodwill and Other Intangible Asset. FSP FAS 142-3 is effective for the Company beginning in fiscal 2010. The Company is currently evaluating FSP FAS 142-3 and the impact, if any, that it may have on its results of operations or financial position.
In March 2008, the FASB issued Statement of Financial Accounting Standards No. 161 ("SFAS 161"), "Disclosures about Derivative Instruments and Hedging Activities - an amendment of FASB Statement No. 133". SFAS 161 requires enhanced disclosures about an entity's derivative and hedging activities and thereby improves the transparency of financial reporting. SFAS 161 is effective for fiscal years beginning on or after November 15, 2008. The Company is currently evaluating the impact that the adoption of SFAS 161 will have on its financial position, results of operations and cash flows.
In December 2007, the FASB issued SFAS No. 160, "Non-controlling Interests in Consolidated Financial Statements, an amendment of ARB NO. 151," ("SFAS 160"), which requires non-controlling interests (previously referred to as minority interest) to be treated as a separate component of equity, not as a liability as is current practice. SFAS 160 applies to non-controlling interests and transactions with non-controlling interest holders in consolidated financial statements. SFAS 160 is effective for periods beginning on or after December 15, . . .