Steel Connect, Inc. - Quarter Report: 2006 October (Form 10-Q)

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended October 31, 2006

OR

For the transition period from                      to                     

Commission File Number 000-23262

CMGI, INC.

(Exact name of registrant as specified in its charter)

(781) 663-5001

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer  x             Accelerated filer    ¨              Non-accelerated filer  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

As of December 4, 2006, there were 487,002,819 shares outstanding of the registrant’s Common Stock, $.01 par value per share.

Table of Contents

CMGI, INC.

FORM 10-Q

INDEX

2

Table of Contents

CMGI, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share amounts)

(Unaudited)

See accompanying notes to interim unaudited condensed consolidated financial statements

3

Table of Contents

CMGI, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)

(Unaudited)

See accompanying notes to interim unaudited condensed consolidated financial statements

4

Table of Contents

CMGI, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)

See accompanying notes to interim unaudited condensed consolidated financial statements

5

Table of Contents

CMGI, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

CMGI, Inc. (together with its consolidated subsidiaries, “CMGI” or the “Company”), through its subsidiary, ModusLink Corporation (“ModusLink”), provides industry-leading global supply chain management services that help businesses market, sell and distribute their products and services. In addition, CMGI’s venture capital business, @Ventures, invests in a variety of technology ventures. The Company previously operated under the name CMG Information Services, Inc. and was incorporated in Delaware in 1986. CMGI’s address is 1100 Winter Street, Suite 4600, Waltham, Massachusetts 02451.

CMGI’s business strategy in recent years has led to the development, acquisition and operation of majority-owned subsidiaries focused on supply chain management services, as well as the strategic investment in emerging, innovative and promising technology companies. ModusLink is a supply chain management market leader with fiscal 2006 revenue of $1.1 billion and 41 locations in 13 countries (including four locations in Japan operated by an entity in which the Company has a 40% interest), including a significant presence in Asia and Europe. ModusLink has a widely diversified client base that includes leaders in the hardware, software, consumer electronics, telecommunications and storage markets.

The accompanying Condensed Consolidated Financial Statements have been prepared by CMGI in accordance with accounting principles generally accepted in the United States of America (“US GAAP”). In the opinion of management, the accompanying Condensed Consolidated Financial Statements contain all adjustments, consisting only of those of a normal recurring nature, necessary for a fair presentation of the Company’s financial position, results of operations and cash flows at the dates and for the periods indicated. While the Company believes that the disclosures presented are adequate to make the information not misleading, these Condensed Consolidated Financial Statements should be read in conjunction with the audited financial statements and related notes for the year ended July 31, 2006 which are contained in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission (the “SEC”) on October 16, 2006. The results for the three-month period ended October 31, 2006 are not necessarily indicative of the results to be expected for the full fiscal year. Certain prior year amounts in the Condensed Consolidated Financial Statements have been reclassified in accordance with US GAAP to conform to the current year presentation. Discontinued operations reporting has been applied for certain of the Company’s divestitures.

The Company reports three operating segments, Americas, Asia, and Europe. In addition to its three current operating segments, the Company reports an Other category. The Other category represents corporate expenses consisting primarily of directors and officers insurance costs, costs associated with maintaining certain of the Company’s information technology systems and certain corporate administrative functions such as legal and finance, as well as certain administrative costs related to the Company’s venture capital business. The Other category also consists of any residual results from operations that exist through the cessation of operations of Equilibrium, CMGI Solutions, MyWay, iCast, NaviPath, ExchangePath, and Activate, each of which have been divested or substantially wound down, as these entities do not meet the aggregation criteria under Statement of Financial Standards (“SFAS”) No. 131 with respect to the Company’s current reporting segments and were not reported as discontinued operations as they did not meet the criteria in SFAS No. 144. The historical results of these companies were previously reported in the Enterprise Software and Services (Equilibrium and CMGI Solutions), Portals (MyWay and iCast) and Managed Application Services (NaviPath, ExchangePath, and Activate) segments, respectively. The Other category’s balance sheet information includes certain cash

6

Table of Contents

equivalents, available-for-sale securities, investments and other assets, which are not identifiable to the operations of the Company’s operating business segments.

In accordance with accounting principles generally accepted in the United States of America, all significant intercompany transactions and balances have been eliminated in consolidation. Accordingly, segment results reported by the Company exclude the effect of transactions between the Company and its subsidiaries and between the Company’s subsidiaries.

In September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 157, “Fair Value Measurements,” which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS No. 157 is effective for the Company beginning in fiscal 2009. The Company is currently evaluating the impact, if any, that SFAS No. 157 may have on its results of operations or financial position.

In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans” an amendment of FASB Statements No. 87, 88, 106, and 132 (R) (“SFAS No. 158”). SFAS No. 158 requires an employer to recognize the over-funded or under-funded status of a defined benefit postretirement plan (other than a multiemployer plan) as an asset or liability in its statement of financial position and to recognize changes in that funded status in the year in which the changes occur through comprehensive income. SFAS No. 158 also requires the measurement of defined benefit plan assets and obligations as of the date of the employer’s fiscal year-end statement of financial position (with limited exceptions). Under SFAS No. 158, the Company will be required to recognize the funded status of its defined benefit postretirement plan and to provide the required disclosures commencing as of July 31, 2007. The Company is currently evaluating the impact, if any, that SFAS No. 158 may have on its results of operations or financial position.

In September 2006, the United States Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin (“SAB”) No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements.” This SAB provides guidance on the consideration of the effects of prior year misstatements in quantifying current year misstatements for the purpose of a materiality assessment. SAB 108 establishes an approach that requires quantification of financial statement errors based on the effects of each of the company’s balance sheet and statement of operations financial statements and the related financial statement disclosures. The SAB permits existing public companies to record the cumulative effect of initially applying this approach in the first fiscal year ending after November 15, 2006 by recording the necessary correcting adjustments to the carrying values of assets and liabilities as of the beginning of that year with the offsetting adjustment recorded to the opening balance of retained earnings. Additionally, the use of the cumulative effect transition method requires detailed disclosure of the nature and amount of each individual error being corrected through the cumulative adjustment and how and when it arose. The Company is currently evaluating the impact that SAB 108 may have on the Company’s results of operations or financial position.

In July 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes-an Interpretation of FASB Statement No. 109.” This Interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This Interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. SFAS No. 48 is effective for the Company beginning in fiscal 2008. The Company is currently evaluating the impact, if any, that FASB No. 48 may have on the Company’s results of operations or financial position.

In March 2006, the FASB issued EITF 06-03, “How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That is, Gross versus Net

7

Table of Contents

Presentation)” that clarifies how a company discloses its recording of taxes collected that are imposed on revenue producing activities. EITF 06-03 is effective for the first interim reporting period beginning after December 15, 2006. The Company is evaluating the impact, if any, that EITF 06-03 may have on the Company’s results of operations or financial position.

The Company considers all highly liquid investments with original maturities of three months or less to be cash equivalents. Investments, which generally have maturities between three and twelve months at the time of acquisition, are considered short-term and classified as available-for-sale.

As of October 31, 2006, the Company had short-term investments in Auction Rate Securities (“ARS”) of approximately $90.2 million. ARS generally have long-term stated maturities of 20 to 30 years. However, these securities have certain economic characteristics of short-term investments due to a rate-setting mechanism and the ability to liquidate them through a Dutch auction process that occurs on pre-determined intervals of less than 90 days. These ARS are classified as short-term investments on the accompanying condensed consolidated balance sheets due to management’s intent regarding these securities and are accounted for as available-for-sale, in accordance with SFAS No. 115 “Accounting for Certain Investments in Debt and Equity Securities.” As of October 31, 2006, there were no unrealized gains or losses associated with these investments.

The purchase price of the assets acquired and the liabilities assumed in a business combination are subject to an allocation period in accordance with SFAS 141, “Business Combinations.” In connection with the Modus acquisition, the allocation period for all adjustments other than those related to tax carryforwards and contingencies expired during the quarter ended October 31, 2005, while the allocation period for certain tax adjustments and contingencies will remain open in accordance with SFAS 109 “Accounting for Income Taxes.” The total of the purchase accounting adjustments recorded during the quarter was $0.1 million. A $0.6 million adjustment was recorded related to an audit from the local tax authorities in Asia for a period prior to the acquisition of Modus, which was offset by adjustments related to the utilization of pre-acquisition net operating losses in the Americas, Europe and Asia regions of approximately ($0.1) million, ($0.3) million and ($0.1) million, respectively.

The changes in the carrying amount of goodwill for the quarter ended October 31, 2006 are as follows:

The amortization of intangible assets for the quarter ended October 31, 2006 would have been primarily allocated to selling expenses had the Company recorded the expenses within the functional operating expense categories.

Stock Option Valuation and Expense Information under SFAS No. 123(R)

On August 1, 2005, the Company adopted SFAS No. 123(R), which requires the measurement and recognition of compensation expense for all share-based payment awards made to the Company’s employees and directors, including employee stock options and employee stock purchases, based on estimated fair values. The

8

Table of Contents

following table summarizes stock-based compensation expense related to employee stock options, employee stock purchases and nonvested shares under SFAS No. 123(R) for the three months ended October 31, 2006 and 2005 which was allocated as follows:

The Company utilizes a binomial-lattice model to estimate grant date fair value, which requires the use of extensive actual employee exercise behavior data and the use of a number of complex assumptions including expected volatility, risk-free interest rate and expected term. The weighted-average fair value of employee stock options granted during the three months ended October 31, 2006 and 2005 was $0.49 and $1.04, per share, respectively using the binomial-lattice model with the following weighted-average assumptions:

The volatility assumption is based on the weighted average of the most recent volatility measures of the Company’s stock as of the grant date.

The risk-free interest rate assumption is based upon the interpolation of various U.S. Treasury rates, as of the month of the grants.

The expected term of employee stock options represents the weighted-average period the stock options are expected to remain outstanding and is a derived output of the binomial-lattice model. The determination of the expected term of employee stock options assumes that employees’ exercise behavior is a function of the option’s remaining vested life and the extent to which the option is in-the-money. The binomial-lattice model estimates the probability of exercise as a function of these two variables based on the entire history of exercises and cancellations on all past option grants made by the Company. The expected term generated by these probabilities reflects actual and anticipated exercise behavior of options granted historically.

As stock-based compensation expense recognized in the Condensed Consolidated Statement of Operations for the three months ended October 31, 2006 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. SFAS No. 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Forfeitures were estimated based primarily on historical experience.

9

Table of Contents

Stock Options

The status of the plans during the quarter ended October 31, 2006 is as follows:

As of October 31, 2006, unrecognized stock-based compensation related to stock options was approximately $7.7 million. This cost is expected to be expensed over a weighted average period of 2.0 years. The aggregate intrinsic value and weighted average remaining contractual life of stock options outstanding as of October 31, 2006 is approximately $2.9 million and 4.9 years, respectively. The aggregate intrinsic value and weighted average remaining contractual life of stock options exercisable as of October 31, 2006 is approximately $2.0 million and 4.0 years, respectively. The aggregate intrinsic value of options exercised during the three months ended October 31, 2006 is approximately $8,000.

The following table summarizes information about the Company’s stock options outstanding at October 31, 2006:

Nonvested Stock

Nonvested stock are shares of common stock that are subject to restrictions on transfer and risk of forfeiture until the fulfillment of specified conditions. Nonvested stock is expensed ratably over the term of the restriction period, ranging from one to five years. Nonvested stock compensation expense for the three months ended October 31, 2006 and 2005 is approximately $0.3 million and $0.5 million, respectively.

10

Table of Contents

A summary of the status of our nonvested stock for the quarter ended October 31, 2006, is as follows:

The fair value of nonvested shares is determined based on market price of the Company’s common stock on the grant date. The total fair value of nonvested stock that vested during the three months ended October 31, 2006 was approximately $0.6 million. As of October 31, 2006, there was approximately $4.6 million of total unrecognized compensation cost related to nonvested stock to be recognized over a weighted-average period of 2.6 years.

The following table reflects the components of “Other gains (losses), net”:

During the three months ended October 31, 2006, the Company recorded a gain of approximately $1.2 million to adjust a previously recorded gain on the sale of Molecular Inc. and a gain of approximately $0.3 million to adjust a previously recorded gain on the sale of Alibris Inc., both due to the release of funds held in escrow. Molecular Inc. and Alibris Inc. were @Ventures portfolio companies that were acquired by third parties in previous reporting periods. Also, during the three months ended October 31, 2006, the Company recorded foreign exchange losses of approximately $0.5 million. These foreign exchange losses related primarily to unhedged foreign currency exposures in Asia of approximately $0.3 million and $0.3 million in Europe as a result of fair value changes on outstanding forward currency exchange contracts. The Company has operations in various countries throughout the world and its operating results and financial position can be affected by significant fluctuations in foreign currency exchange rates. The Company has historically used derivative financial instruments to manage the exposure that results from such fluctuations, and the Company expects to continue such practice.

During the three months ended October 31, 2005, the Company recorded impairment charges related to its available-for-sale securities. The impairment charge consisted of approximately $0.1 million related to the Company’s holdings of shares of Navisite. The Company also recorded foreign exchange gains of approximately $0.5 million and a gain of approximately $2.7 million on the sale of a building in Ireland.

11

Table of Contents

The following table summarizes the activity in the restructuring accrual for the three months ended October 31, 2006:

It is expected that the payments of employee-related expenses will be substantially completed by February 2007. The remaining contractual obligations primarily relate to facility lease obligations for vacant space resulting from the previous restructuring activities of the Company, including excess plant capacity relating to the Company’s Modus acquisition on August 2, 2004. The Company anticipates that contractual obligations will be settled by May 2012.

The net restructuring charges for the three months ended October 31, 2006 and 2005 would have been allocated as follows had the Company recorded the expense and adjustments within the functional department of the restructured activities:

During the three months ended October 31, 2006, the Company recorded a net restructuring adjustment of approximately $0.2 million. The adjustments consisted of ($0.4) million in reductions to estimates for previously recorded facilities lease obligations primarily based on changes to the underlying assumptions regarding the estimated length of time required to sublease vacant space and the expected rent recovery rates. These adjustments were partially offset by restructuring charges of approximately $0.2 million as a result of workforce reductions of 7 employees primarily related to the reorganization of the global sales team in Europe and the elimination of redundant positions related to the Company’s Hub & Spoke initiative.

During the three months ended October 31, 2005, the Company recorded net restructuring charges of approximately $1.0 million. These charges consisted of approximately $0.5 million relating to a workforce reduction of 34 employees, and $0.5 million relating to unutilized facilities for which the Company expects to realize no future economic benefit. These charges were partially offset by a $0.2 million reduction of a previously recorded employee severance accrual.

In addition, during the three months ended October 31, 2005, the Company accrued a purchase accounting adjustment to goodwill of approximately $4.3 million for restructuring activities related to the acquisition of Modus. These restructuring activities occurred primarily in the Americas and Europe regions in the amounts of ($0.4) million and ($3.9) million, respectively. The restructuring in the Americas region was employee severance

12

Table of Contents

related in connection with the elimination of redundant positions. The restructuring in Europe primarily related to the closure of a plant in Scotland and consists of approximately $3.1 million of severance for 130 employees and $0.8 million relating to unoccupied facilities for which the Company expects to realize no future economic benefit.

The following table summarizes the regional activity in the restructuring accrual for the three months ended October 31, 2006:

The Company enters into forward currency exchange contracts to manage exposures to certain foreign currencies. The fair value of the Company’s foreign currency exchange contracts is estimated based on the foreign exchange rates as of October 31, 2006. The Company’s policy is not to allow the use of derivatives for trading or speculative purposes. At October 31, 2006, the notional value of the Company’s foreign currency exchange contracts was to sell 18.8 million Euro and 14.0 million Czech Koruna and to buy 788.2 million Hungarian Forints and 20.7 million U.S. Dollars.

The Company believes that its forward currency exchange contracts economically function as effective hedges of the underlying exposures; however the foreign currency contracts do not meet the specific criteria for hedge accounting defined in SFAS No. 133, thus requiring the Company to record all changes in the fair value of these contracts in earnings in the period of the change. During the period ended October 31, 2006, the Company recorded a loss of approximately $0.3 million as a result of fair value changes on its outstanding forward currency exchange contracts. This loss has been included in “Other gains (losses), net” in the Company’s consolidated statement of operations.

Based on the information provided to the Company’s Chief Operating Decision-Maker (“CODM”) for purposes of making decisions about allocating resources and assessing performance, the Company reports three operating segments, Americas, Asia and Europe.

In addition to its three current operating segments, the Company reports an Other category. The Other category represents corporate expenses consisting primarily of directors and officers insurance costs, costs associated with maintaining certain of the Company’s information technology systems and certain corporate administrative functions such as legal and finance, as well as certain administrative costs related to the Company’s venture capital affiliates. The Other category also consists of any residual results from operations, that exist through the cessation of operations of Equilibrium, CMGI Solutions, MyWay, iCast, NaviPath, ExchangePath, and Activate, each of which have been divested or substantially wound down, as these entities do not meet the aggregation criteria under SFAS No. 131 with respect to the Company’s current reporting segments and were not reported as discontinued operations as they did not meet the criteria in SFAS No. 144. The historical results of these companies were previously reported in the Enterprise Software and Services

13

Table of Contents

(Equilibrium and CMGI Solutions), Portals (MyWay and iCast) and Managed Application Services (NaviPath, ExchangePath, and Activate) segments, respectively. The Other category’s balance sheet information includes certain cash equivalents, available-for-sale securities, investments and other assets, which are not identifiable to the operations of the Company’s operating business segments.

Management evaluates segment performance based on segment net revenue, operating income (loss) and “Non-GAAP operating income (loss)”, which is defined as the operating income/(loss) excluding net charges related to depreciation, long-lived asset impairment, restructuring, and amortization of intangible assets and stock-based compensation. The Company believes that its Non-GAAP measure of operating income/(loss) provides investors with a useful supplemental measure of the Company’s operating performance by excluding the impact of non-cash charges and restructuring activities. Each of the excluded items (depreciation, long-lived asset impairment, amortization of intangible assets and stock-based compensation and restructuring) were excluded because they may be considered to be of a non-operational or non-cash nature. Historically, the Company has recorded significant impairment and restructuring charges and therefore management uses Non-GAAP operating income/(loss) to assist in evaluating the performance of the Company’s core operations. Non-GAAP operating income/(loss) does not have any standardized definition and therefore is unlikely to be comparable to similar measures presented by other reporting companies. These Non-GAAP results should not be evaluated in isolation of, or as a substitute for the Company’s financial results prepared in accordance with US GAAP.

Two clients, Hewlett-Packard and Advanced Micro Devices, accounted for approximately 31% and 11%, respectively, of CMGI’s consolidated net revenue for the three months ended October 31, 2006. Two clients, Hewlett-Packard and Kodak, accounted for approximately 29% and 15%, respectively, of CMGI’s consolidated net revenue for the three months ended October 31, 2005.

Summarized financial information of the Company’s continuing operations by business segment is as follows:

14

Table of Contents

The following table reconciles non-GAAP operating income to GAAP operating income and net income (loss):

The Company calculates earnings per share in accordance with SFAS No. 128, “Earnings per Share.” Basic earnings per share are computed based on the weighted average number of common shares outstanding during the period. The dilutive effect of common stock equivalents is included in the calculation of diluted earnings per share only when the effect of the inclusion would be dilutive.

Approximately 1.3 million weighted average common stock equivalents were included in the denominator in the calculation of dilutive earnings per share for the three months ended October 31, 2006. Approximately 15.3 million common stock equivalent shares and approximately 3.1 million nonvested shares were excluded from the denominator in the diluted earnings per share calculation as their inclusion would have been antidilutive. For the three months ended October 31, 2005, approximately 5.3 million weighted average common stock equivalents were included in the denominator in the calculation of dilutive earnings per share. Approximately 3.9 million common stock equivalent shares and approximately 0.4 million nonvested shares were excluded from the denominator in the diluted earnings per share calculation as their inclusion would have been antidilutive.

15

Table of Contents

The components of comprehensive income (loss), net of income taxes, are as follows:

The components of accumulated other comprehensive income are as follows:

Significant non-cash activities during the three months ended October 31, 2006 included the issuance of approximately 0.4 million shares of nonvested CMGI common stock (valued at approximately $0.5 million) to certain executives and employees of the Company.

Significant non-cash activities during the three months ended October 31, 2005 included the issuance of approximately 1.0 million shares of nonvested CMGI common stock (valued at approximately $1.4 million) to certain executives and employees of the Company.

Inventories are stated at the lower of cost or market. Cost is primarily determined by the first-in, first-out (“FIFO”) method. Inventories at October 31, 2006 and July 31, 2006 consisted of the following:

16

Table of Contents

The Company’s subsidiary, ModusLink, has a revolving credit agreement (“ the Loan Agreement”) with a bank syndicate. The Loan Agreement is a three-year $60.0 million revolving credit facility, with a scheduled maturity of October 31, 2008. Advances under the Loan Agreement may be in the form of loans or letters of credit. Outstanding borrowings under the former Loan Agreement have been assumed by the new loan facility such that at October 31, 2006, approximately $24.8 million of borrowings were outstanding under the facility, and approximately $0.2 million had been reserved in support of outstanding letters of credit. Interest on the revolving credit facility is based on Prime or LIBOR plus an applicable margin (ranging from 1.25 – 1.75%). The effective interest rate was 6.63% and 5.59% at October 31, 2006 and 2005, respectively. The Loan Agreement is secured by all assets of ModusLink and includes certain restrictive financial covenants, all of which ModusLink was in compliance with at October 31, 2006. These covenants include balance sheet leverage, liquidity and profitability measures and restrictions that limit the ability of ModusLink, among other things, to merge, acquire or sell assets without prior approval from the lenders.

During fiscal year 2006, CMGI’s Board of Directors authorized the divestiture of SalesLink’s marketing distribution services business. On June 28, 2006, SalesLink was sold to Automatic Data Processing, Inc. (“ADP”). The operations of SalesLink have been classified in the Company’s financial statements as discontinued operations. This business unit had previously been included within the Company’s Americas reporting segment.

For the three months ended October 31, 2006, the Company recorded income from discontinued operations of approximately $0.6 million primarily related to changes to previously recorded estimates for facility lease obligations based on changes to the underlying assumptions regarding the estimated length of time required to sublease the vacant space and the expected rent recovery rate for the SalesLink divestiture.

For the three months ended October 31, 2005, the Company recorded a loss from discontinued operations of approximately $2.7 million. The loss from discontinued operations is composed of a $2.6 million impairment charge for an other than temporary decline in the carrying value of a note receivable and warrant as well as the discontinued operating results of SalesLink.

From time to time, the Company may become involved in litigation relating to claims arising out of operations in the normal course of business, which it considers routine and incidental to its business. The Company currently is not a party to any legal proceedings, the adverse outcome of which, in management’s opinion, would have a material adverse effect on the Company’s business, results of operation or financial condition.

On November 15, 2006, EMC Corporation (“EMC”) completed its acquisition of one of CMGI’s @Ventures portfolio companies, Avamar Technologies, Inc. (“Avamar”). Under the terms of the merger agreement, EMC acquired Avamar in a cash transaction valued at approximately $165 million. The Company’s allocation of the cash proceeds paid at closing was approximately $28.7 million, and the Company expects to record a pre-tax gain on this transaction of approximately $28.7 million in its second fiscal quarter ended January 31, 2007. The Company may also receive up to an additional $3.3 million of consideration currently held in escrow, subject to the satisfaction of certain indemnification provisions of the transaction. These potential proceeds from escrow have not been included in the estimated gain of $28.7 million.

17

Table of Contents

The matters discussed in this report contain forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and Section 27A of the Securities Act of 1933, as amended, that involve risks and uncertainties. All statements other than statements of historical information provided herein may be deemed to be forward-looking statements. Without limiting the foregoing, the words “believes”, “anticipates”, “plans”, “expects” and similar expressions are intended to identify forward-looking statements. Factors that could cause actual results to differ materially from those reflected in the forward-looking statements include, but are not limited to, those discussed in Part II—Item 1A below and elsewhere in this report and the risks discussed in the Company’s Annual Report on Form 10-K filed with the SEC. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s analysis, judgment, belief or expectation only as of the date hereof. The Company undertakes no obligation to publicly revise these forward-looking statements to reflect events or circumstances that arise after the date hereof.

Overview

CMGI, through its subsidiary, ModusLink, provides industry-leading global supply chain management services. ModusLink provides extended supply chain management services and solutions to the technology industry on a global basis. These services and solutions include consulting and demand planning, sourcing and supply base management, manufacturing and product configuration, logistics management, marketing distribution and print-on demand, e-commerce, sales support and the complete range of after market services, from testing and repair to asset disposition.

We also invest in emerging, innovative and promising technologies and industries through our venture capital business, @Ventures. During the three months ended October 31, 2006, an aggregate of $3.1 million was invested by @Ventures and $1.5 million of proceeds were received from liquidity events from portfolio companies.

Management evaluates operating performance based on net revenue, operating income (loss), and net income (loss), and, across its segments, on the basis of “non-GAAP operating income (loss),” which is defined as the operating income (loss) excluding net charges related to depreciation, long-lived asset impairment, restructuring, amortization of intangible assets and stock-based compensation. See Note J of Notes to Condensed Consolidated Financial Statements for segment information, including a reconciliation of non-GAAP operating income (loss) to net income (loss).

During the latter part of fiscal 2005, we developed a set of strategic initiatives and an operating plan focused on increasing both revenue and profitability. We view the continued development of our global operational infrastructure and footprint as a primary source of differentiation in the marketplace. We believe that by leveraging our global footprint we will be able to optimize our client’s supply chains using multi-facility, multi-geographic solutions. In line with this focus, during fiscal 2005, we made our initial investment in the implementation of a new global systems infrastructure, the foundation of which will be run on SAP’s Enterprise Resource Planning (“ERP”) system.

During fiscal 2007, our focus is on executing against our strategic plan, including the continued implementation of the following initiatives to achieve our goals:

Drive sales growth through a combination of existing client penetration, and targeting new vertical markets; A significant portion of our revenues are currently generated from clients in the computing and software verticals. These verticals are mature and, as a result, gross margins in these verticals are low. To address this, we have expanded our sales focus to include three new markets, in addition to the computing and software verticals, that we believe can benefit from our supply chain expertise. We believe these verticals, communications, including broadband, storage devices, and consumer electronics, are experiencing faster growth than our

18

Table of Contents

historical markets, and represent opportunities to realize higher gross margins on our services. Companies in these markets often are early in their product life cycles and have significant need for a supply chain partner who will be an extension to their business models.

Increase the value delivered to clients through service expansion; We will continue to focus on and invest in expanding our e-commerce and logistics management services offerings, which we believe will increase the overall value of the supply chain solutions we deliver to our existing clients and to new clients. We expect these solutions will enhance our gross margins and drive greater profitability. Further, we believe that the addition of new services to existing clients will strengthen our relationship with these clients, and further integrate us with their business.

Drive operational efficiencies throughout our organization; As a result of the acquisition of Modus Media, Inc. in August 2004, the Company has been running multiple information technology systems at a significant cost. Our strategy is to offer an integrated supply chain system infrastructure that extends from front-end order management through distribution and returns management. This end-to-end solution will enable clients to link supply and demand in real time, improve visibility and performance throughout the supply chain, and provide real-time access to information for greater collaboration and making informed business decisions. We believe our clients will benefit greatly from a global integrated business solution while we too reduce our operating costs. We currently expect to invest a total of approximately $31.5 million in this initiative, approximately half of which has been incurred to date. Our cost estimate has increased from our earlier estimates, primarily as a result of changes to our implementation schedule and infrastructure requirements. Another program that we expect will drive further operational efficiencies in the future is the implementation of a global shared services model utilizing centralized “hub” locations to service multiple “spoke” locations across the Americas, Asia and Europe regions. We believe this initiative will yield improved process standardization and operating efficiency gains, as well as lower our operating costs.

We believe that successful execution of these initiatives will enable the Company to increase its gross margin percentage to approximately 12% to 14%, compared to the fiscal 2006 gross margins of approximately 10.6%. We also believe that these initiatives will allow us to reduce our overall selling, general and administrative, restructuring and amortization costs to approximately 7% of revenue. These actions are expected to result in an operating margin between 5% and 7%. We expect to make steady progress toward these goals and to be operating at this level by the end of fiscal year 2008. Among the key factors that will influence our performance against these goals are successful execution and implementation of our strategic initiatives, global economic conditions, especially in the technology sector, demand for our clients’ products, and demand for outsourcing services.

For the three months ended October 31, 2006, CMGI reported net revenue of $283.6 million, an operating profit of $5.1 million, income from continuing operations of $8.3 million and net income of $10.3 million. We currently conduct business in The Netherlands, Hungary, France, Singapore, Taiwan, China, Malaysia, Ireland, the Czech Republic, Mexico and other foreign locations, in addition to the Company’s United States operations. At October 31, 2006, we had cash and cash equivalents, available for sale securities and short-term investments of $222.2 million, and working capital of $282.5 million. Our primary use of cash during the three months ended October 31, 2006 was for working capital requirements in support of new client programs.

As a large portion of our revenue comes from outsourcing services provided to clients such as hardware manufacturers, software publishers, telecommunications carriers, broadband and wireless service providers and consumer electronics companies, our operating performance could be adversely affected by declines in the overall performance of the technology sector. The market for our supply chain management products and services is very competitive. We also face pressure from our clients to continually realize efficiency gains in order to help our clients maintain their gross margins and profitability. Increased competition and client demands for efficiency improvements may result in price reductions, reduced gross margins and in some cases loss of

19

Table of Contents

market share. As a result of these competitive and client pressures, the gross margins in our business are low. Increased competition arising from industry consolidation and/or low demand for our clients’ products and services may hinder our ability to maintain or improve our gross margins, profitability and cash flows. We must continue to focus on margin improvement, through implementation of our strategic initiatives, cost reductions and asset and employee productivity gains in order to improve the profitability of our business and maintain our competitive position. We are reacting to margin and pricing pressures in several ways, including efforts to target new vertical markets, expand our service offerings and to lower our infrastructure costs. Our ERP and hub and spoke initiatives are key enablers to drive efficiencies and lower our operating costs. We also seek to lower our cost to service clients by moving work to lower-cost venues, establishing facilities closer to our clients to gain efficiencies, and other actions designed to improve the productivity of our operations.

Historically, a limited number of key clients have accounted for a significant percentage of our revenue. For the three months ended October 31, 2006, sales to Hewlett-Packard and Advanced Micro Devices, accounted for approximately 31% and 11%, respectively, of the Company’s consolidated net revenues. During the three months ended October 31, 2006, five clients accounted for approximately 62% of the Company’s net revenues. In fiscal 2007, we expect to realize lower annual revenues from Kodak, which accounted for 11% of our consolidated net revenues in fiscal 2006, as a result of changes to certain programs that we currently execute on their behalf. We expect to continue to derive the vast majority of our operating revenue from sales to a small number of key clients. We currently do not have any agreements which obligate any client to buy a minimum amount of products or services from us or designate us as an exclusive service provider. Consequently, our sales are subject to demand variability by our clients. The level and timing of orders placed by our clients vary for a variety of reasons, including seasonal buying by end-users, the introduction of new technologies and general economic conditions.

Basis of Presentation

The Company reports three operating segments, Americas, Asia, and Europe. In addition to its three current operating segments, the Company reports an Other category. The Other category represents corporate expenses consisting primarily of directors and officers insurance costs, costs associated with maintaining certain of the Company’s information technology systems and certain corporate administrative functions such as legal and finance, as well as certain administrative costs related to the Company’s venture capital business. The Other category also consists of any residual results from operations that exist through the cessation of operations of Equilibrium, MyWay, iCast, NaviPath, ExchangePath, and Activate, each of which have been divested or substantially wound down, as these entities do not meet the aggregation criteria under SFAS No. 131 with respect to the Company’s current reporting segments. The Other category’s balance sheet information includes certain cash equivalents, available-for-sale securities, investments and other assets, which are not identifiable to the operations of the Company’s operating business segments.

Certain prior year amounts in the Condensed Consolidated Financial Statements have been reclassified in accordance with US GAAP to conform to the current year presentation.

In accordance with accounting principles generally accepted in the United States of America, all significant intercompany transactions and balances have been eliminated in consolidation. Accordingly, segment results reported by the Company exclude the effect of transactions between the Company and its subsidiaries and between the Company’s subsidiaries.

20

Table of Contents

Results of Operations

Three months ended October 31, 2006 compared to the three months ended October 31, 2005

Net Revenue:

Net revenue decreased for the three months ended October 31, 2006, as compared to the same period in the prior year, primarily as a result of lower revenue of approximately $20.2 million from Kodak in connection with the anticipated change in their supply chain model. This decline affected the Americas, Asia and Europe segments by approximately $13.3 million, $1.9 million, and $5.0 million, respectively. In addition to the decline mentioned above, the net revenue in the Americas region was also negatively impacted by a combination of lower revenue of approximately $4.0 million as a result of decreased order volumes for a certain client and lower revenue of approximately $6.7 million due to a change in a client’s program. Within the Asia region, the net revenue growth of $5.7 million resulted primarily from approximately $9.0 million of higher revenues due to increased order volumes for certain clients’ programs partially offset by a decline from the change in Kodak’s supply chain model mentioned above. Within the Europe region, the net revenue decline was the result of the change in a Kodak’s supply chain model, as well as lower order volume for another client of approximately $6.8 million. These declines were partially offset by approximately $7.0 million of revenue for a new client program.

The Company continues to see volatility in the global consumer electronics markets and as such maintains a conservative view on order volumes and revenue. Our current ability to forecast the amount and timing of future order volumes is low, and we expect such condition to continue for the foreseeable future, as the Company is highly dependent upon the business needs of its clients, whose businesses, in turn, depend upon various factors related to the high tech sector generally and demand for products and services in that industry. The Company sells primarily on a purchase order basis, rather than pursuant to contracts with minimum purchase requirements. These purchase orders are generally for quantities necessary to support near-term demand for our clients’ products. A significant portion of our client base operates in the technology sector, which is intensely competitive and very volatile. Our clients’ order volumes vary from quarter to quarter for a variety of reasons, including market acceptance of their new product introductions and overall demand for their products. This business environment, and our mode of transacting business with our clients, does not lend itself to precise measurement of the amount and timing of future order volumes, and as a result, future sales volumes and revenues could vary significantly from period to period.

Cost of Revenue:

21

Table of Contents

Cost of revenue consists primarily of expenses related to the cost of products purchased for sale or distribution as well as salaries and benefit expenses, consulting and contract labor costs, fulfillment and shipping costs, and applicable facilities costs. In total, the decrease in cost of revenue for the three months ended October 31, 2006 was consistent with the change in revenues for the three operating segments as compared to the prior year. Overall net revenue and cost of revenue both decreased 7% compared to the prior year. Gross margins for the first quarter of fiscal 2007 were 10.6% as compared to 10.2% in the prior year quarter.

For the three months ended October 31, 2006, the Company’s gross margin percentages within the Americas, Asia and Europe regions were 11%, 21% and 4%, as compared to 9%, 20% and 7%, respectively, for the same period of the prior year. Within the Americas region, the $0.5 million or two-percentage point increase in gross margin percentage was primarily attributable to an improvement in the sales mix to higher margin business and cost reduction initiatives implemented to improve operational efficiencies. Within the Asia region, the $2.2 million or one-percentage point increase in gross margin percentage was attributable to an increase in volume for certain client programs with higher margins. Within the Europe region, the $3.7 million or three-percentage point decline in gross margin percentage was primarily attributable to an increase in contract labor of approximately $1.9 million of which a portion related to start up costs incurred for two new client programs.

As a result of the lower overall cost of delivering the Company’s products and services in the Asia region, particularly China, and the increasing demand for supply chain management services in that region, we expect gross margin levels in Asia to continue to exceed those earned in the Americas and Europe regions. However, we expect that there will continue to be pressure on gross margin levels in Asia as the market, particularly China, matures. Our gross margins are impacted by a number of factors, including competition, order volumes, pricing, client and product mix and configuration, and overall demand for our clients’ products. A significant portion of the costs required to deliver our products and services is fixed in nature.

As outlined in our strategic initiative discussion in the Overview section above, the Company remains focused on margin improvement through several revenue and operating efficiency initiatives designed to improve the profitability of our business and maintain our competitive position. We are reacting to margin and pricing pressures in several ways including efforts to target new vertical markets, expand our service offerings and lower our infrastructure costs. We believe our ERP and hub and spoke initiatives are key enablers to drive efficiencies and lower our operating costs. We also seek to lower our cost to service clients by moving work to lower-cost venues and establishing facilities closer to our clients to gain efficiencies.

Selling Expenses:

Selling expenses consist primarily of compensation and employee-related expenses, sales commissions, facilities costs, consulting fees, marketing expenses and travel costs. Selling expenses during the three months ended October 31, 2006 decreased by approximately $1.6 million, primarily as a result of lower employee-related and travel and entertainment costs of approximately $1.2 million and $0.2 million, respectively. The decrease in employee related costs throughout the regions is the result of the reorganization of the global sales team. The $0.8 million decrease in selling expenses within the Americas region is largely the result of lower

22

Table of Contents

employee-related costs of approximately $0.7 million. The $0.6 million decrease in selling expenses within the Europe region is primarily the result of lower employee-related costs as a result of lower headcount. For the three months ended October 31, 2006 and 2005, employee related costs represented approximately 62% and 67% of the total selling expense, respectively. The Company expects its selling expenses to continue to approximate 1% of net revenue for the foreseeable future.

General and Administrative Expenses: