We can make this company
thrive(we’re hard at work)
2005 A N NUAL REPORT
COMPANY PROFILE
Internap is a market leader of intelligent route control solutions that bring
reliability, performance and security to the Internet. The Company’s patented
and patent-pending technologies address the inherent weaknesses of the
Internet, enabling enterprises to take full advantage of the benefits of
deploying business-critical applications such as e-commerce, Voice-over-
IP (VoIP), video-conferencing and streaming audio/video across the Internet.
Through a portfolio of high-performance Internet Protocol (IP) solutions,
customers can bypass congestion points, overcome routing inefficiencies
and optimize performance of their applications.
Proactively Monitored and Managed by the Internap NOC
Corporate
Headquarters
®
Internap
®
P-NAP
AT&T
MCI
Sprint
Level 3
Global X
Verio
NSP X
NSP Y
Branch
Remote
User
End User /
Customer
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Our Management Team
Far Right: James P. DeBlasio, President and Chief Executive Officer
Left to Right: Eric Klinker (standing), Eric Suddith (sitting),
Andrew Albrecht, David Abrahamson, David Buckel,
Dorothy An and Bob Smith
TO OUR STOCKHOLDERS:
Today, those who arrive at Internap each morning are working harder and smarter than
ever to realize this goal. An enviable strategic position and considerable competitive
strengths support their efforts and serve as reminders that Internap can succeed.
The original proposition upon which Internap was founded – that the Internet is
inherently a dynamic, unpredictable and chaotic medium – is still as true today as it was
ten years ago. What has changed is the Internet’s growth in relevance to critical business
applications. According to Forrester Research, by the year 2010 more than $315 billion
Look up the word “thrive” and you will read descriptions
in strategic transactions per year are expected to occur via the Internet, and most will
such as growing, healthy and successful. It is time for
involve far more complex applications than a decade ago. This includes business that can
such words to be associated with Internap. However,
only be conducted through an online network such as e-commerce, gaming, online finan-
before an enterprise can really thrive, it must survive
cial transactions, software downloads, VoIP and IPTV. Through our patented technology
and stabilize. We believe that we are well on our way,
and intellectual expertise, Internap is a leading supplier that offers a full-service solution
but there remains much work to be done.
for IP optimization, which we believe ideally positions us to take advantage of opportuni-
When I accepted the position of CEO in the latter
ties within this multi-billion dollar marketplace.
part of 2005, it was not with the intent to manage to
To truly appreciate this position, look no further than our base of more than 2,000
the status quo. Rather, I asked this organization to join
customers. Many of these long-standing customers are industry leaders and household
me in a commitment to achieve sustained profitability
names, as well as emerging Internet-based companies that have impacted the way
and to deliver long overdue value to our stockholders.
technology is used today. The depth and breadth of this base reflects the attractiveness
of our key market differentiators – a service proposi-
During the fourth quarter of 2005, we added $1.3 million in new monthly recurring
tion that offers a 100% guarantee for reliability and
revenue, an increase of 40% versus the third quarter of 2005. This represented 397 new
quality and a focus on end-to-end service, from
orders in the fourth quarter of 2005, up 13% from the previous quarter. Also during
professional consulting and solution implementation
the fourth quarter, we counted 60 net new customers versus 13 in the third quarter.
to ongoing award-winning technical support. Together,
These improvements are the result of redeploying our sales force to concentrate on key
these components bring a level of expertise that we
vertical markets in which we have an existing specialty, namely retail, finance, gaming,
believe is simply unmatched in the marketplace.
media and travel. This shift in sales strategy is a good example of how better focus can
produce markedly improved results.
Financial Improvements Continue in 2005
Our owned and leased data centers, network operation centers and professional
Internap ended 2005 on a positive note, with a
consulting services continue to provide us with a complete package to augment our IP
significant level of momentum in the fourth quarter.
business and offer customers a complete solution. A successful strategy, for example,
Financial performance for the year included:
has been the bundling of our IP services with our data centers. This type of product
• Revenues grew 6.3% over 2004 to $153.7 million.
grouping experienced 40% growth in annual revenue over the past year and demonstrates
• Gross margins1 were 47%, consistent with 2004.
how colocation can be a means to drive growth in our core bandwidth business.
• Operating expenses, excluding the direct cost of
revenues, decreased 9%.
• Net loss was $5.0 million, representing a $13.1 million,
or 73%, improvement over 2004.
• Total customers grew 8.4% to 2,092 customers at
year-end.
A Mandate for Profitability
Clearly, Internap has a strong foundation – strategic relevancy, a world-class portfolio of
technology solutions, a large and loyal customer base, an experienced team of experts
and a set of improving financial and operational metrics. The imperative for our Company
is to maximize these strengths in order to generate renewed stockholder value. This
effort is well underway, characterized by new levels of discipline and focus to eliminate
• Customer network usage jumped 54% year-over-year.
unnecessary costs. Our objective is to achieve a cost structure that generates greater
These results are significant accomplishments
operating leverage so that an increased percentage of every incremental revenue
and demonstrate the positive direction in which the
dollar can drop to the bottom line. At the same time, we also are improving operational
Company is headed. However, we are focused on
efficiencies to create processes that can sustain a more cost-effective environment.
additional progress.
Accountability is key to these efforts, with every action driven down to the level of
1
Defined as revenue less direct cost of network divided by revenues.
individual responsibility.
Our operational plan in 2006 focuses on three vital areas. First, we must stabilize and
fortify the core business by continuing to expand our customer base, drive customer
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Fortify The Core
Business
• Expand Customer Base
• Drive Customer Renewals
• Mitigate Customer Churn
• Broaden Customer Offerings
Execute With Excellence
• Increase & Focus
Marketing Efforts
• Reduce Network Costs
• Increase Cash Flows from
Operations
Create A Winning
Environment
• Attract & Retain Leading Talent
• Ensure Internap Is Employer
We
can
of Choice
• Maintain High Percentage of
Front-Line Positions
Winning
• Instill & Reward a Passion for
(We’re
Selling Best-
in-Class
2006 Operational
Plan and Strategy
Performance)
renewals and mitigate customer churn. At the same
our points of presence through a network of data centers and P-NAPs® and intensifying
time, we will continue to explore the addition of new
marketing efforts. We will also be strategically looking at new technologies and solutions
products and services to broaden our customer
that can leverage our existing business.
offerings. Second, we must execute from a position
In closing, I must extend my personal appreciation to our board of directors and our
of excellence. There can be no exceptions. From
employees, all of whom share my personal commitment to see Internap not only succeed,
reducing network costs to better focusing product and
but thrive. On behalf of everyone at Internap, I also extend thanks to our exceptionally
service marketing, we must raise every aspect of our
loyal customers and to those stockholders who have stood by the Company during the
game. Finally, we must ensure that Internap fosters a
past ten years. We are energized by the challenge and opportunity to execute our plans
winning environment for our employees. Consider that
and realize our goals during 2006. As the results of these efforts unfold, we intend to
approximately 88% of our employees interact directly
provide stockholders with increased visibility and insight into the business. We look
with customers. This is an impressive statistic and
forward to frequent communication to update you on our progress toward making
competitive advantage, which challenges us to ensure
Internap a thriving enterprise that delivers renewed value to all its stockholders.
that we constantly attract and retain top talent.
These initiatives are necessary to bring Internap to
Sincerely,
profitability. Once profitable, however, the real work
begins as we evaluate opportunities – both organic
and strategic ones – that will hasten top-line growth.
These opportunities include selling more solutions and
James P. DeBlasio
bandwidth to our existing customer base, increasing
President and Chief Executive Officer
We can make this company
perform
(we’re selling best-in-class IP services)
Internap Has Over 2,000
Customers In Key
Market Segments
The Internet that exists today can represent a company’s biggest opportunity, as well as its
biggest challenge. As the Web grows more complex, so do the business-critical applications
that depend upon it – applications such as e-commerce, streaming audio/video, VoIP and
virtual private networks (VPNs). The unpredictable, often chaotic nature of the Internet can
make the deployment of these applications challenging. Speed, congestion and availability
can have profound revenue and cost implications and can even threaten the overall viability
of a business.
Ten years ago, when use of the Internet was in its infancy, Internap revolutionized the way
businesses can use the Internet with the introduction of its Performance IP™ service, which
was created to address difficulties such as latency and packet loss that can plague conven-
tional Internet connectivity. Our P-NAP architecture, combined with our intelligent route
control technology, offers unmatched reliability and speed by identifying optimal data paths
for customers to connect with suppliers, customers and other critical stakeholders. A decade
later, amid a much more complex environment, this technology remains unsurpassed, as does
the service level agreement that backs it up – a 100% up-time performance guarantee and
on-demand, 24/7 access to certified network engineers in our Network Operations Centers
(NOCs). These engineers possess the requisite global view and information to quickly resolve
performance issues.
We can make this company
perform
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Market-leading technology and service guarantees,
however, are just the start of the Internap value propo-
sition that now includes an entire suite of high-perfor-
mance IP solutions. With these products and services,
Internap offers customers a single source for IP technol-
ogy, data center services and consultative expertise.
The advanced technologies address application perfor-
mance issues such as control, speed, delivery and reach.
Internap data centers increase application performance
by providing a stable, more dependable infrastructure,
while lowering total ownership costs and minimizing
application risks. And because every business has unique
Network Performance Challenges
A “Send” command is no guarantee of performance on the Internet today. A
recent Internap study shows that nearly 35% of Internet traffic used paths of
insufficient quality and would benefit from the Company’s technology service
requirements, Internap Professional Services is available
solutions. This is no surprise, given that according to Internap's study, tradi-
to assess, design and implement customized solutions
to help maximize return on investment.
These broad and best-in-class offerings enable us to
bundle products and services in order to drive the core
tional Internet technology on average runs 30% below optimum performance
and endures more than 40% packet loss. And according to Gartner, latency is
also responsible for up to 95% of application delays. Traditional solutions,
bandwidth business. In doing so, we ensure peak
such as increasing bandwidth or traditional multi-homing, have proven to be
performance for our customers and for our stockholders.
inadequate. Constantly acquiring or updating technology is costly and requires
expertise. Combined, these factors create a compelling demand scenario for
Internap’s comprehensive technology solutions and service expertise.
We can make this company
focus
(our best assets are not on the balance sheet)
88% of Internap's
Employees Are Front-Line
Customer Service and
Engineering Focused
A multi-billion dollar, Internet-based enterprise experiences a dramatic slowdown in connectivity.
Every second that a network is down costs revenue and possibly customers. How much is
it worth to make one call and speak to an engineer who can quickly diagnose and resolve
the issue? Another business wants to move mission-critical IT functions from a costly
private network to the public Internet. Proper planning and design can mitigate risks associ-
ated with this shift. How much is it worth to have years of Internet optimization experience
lead the effort? The answers to these and similar questions may be hard to quantify, but
the issues are real and require specialized IP expertise. At Internap, this type of intellectual
capital resides with our people, who are a vital and intangible asset to our Company.
The talent, commitment and experience of our people have not only added value by
helping us secure and retain an exceptionally loyal customer base, but also serve as the
foundation of Internap Professional Services, a team of individuals who have extensive expe-
rience in IP and WAN optimization technologies. This team, combined with customer support
engineers in our NOCs, are a formidable competitive advantage for us and contribute to
the premium level of our product and service offerings. As a result, Internap can position
itself in the marketplace not simply as a provider of bandwidth, but rather as a strategic
focus
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partner to resolve critical IP issues. Indeed, our con-
sultative role and outsourced solutions are a major
point of differentiation.
Internap’s client-driven approach takes every
customer’s unique combination of network and
application requirements, technical infrastructure
and internal service support needs into account.
This formula has helped to create a reputation for a
Award-Winning Customer Service
high level of customer service that sets us apart
In 2005, Internap Professional Services received the prestigious Achievement in
from the competition.
Whether it is our core Performance IP services,
data center services or the deployment of advanced
technologies to address specialized performance
Customer Excellence (ACE) Award for its client-driven approach to service. Based
on overall customer relationships and technical support, the award revealed a
superior client approval rating above 90%. The award serves as a testament to
issues, the Internap solution is always focused on the
Internap’s commitment to addressing each customer’s unique needs and hiring
specific needs of our more than 2,000 customers.
the best and brightest minds in the industry.
$200
150
100
50
2,200
1,650
1,100
550
$125
250
375
500
Intensified marketing,
product development
and customer penetration
have generated increased
revenue.
01 02 03 04 05
Revenue (figures in $ millions)
We can make this company
deliver
(discipline is key)
Our growing customer
base continues to
include Fortune 1000
companies who rely
on Internap to optimize
performance.
From winning new business to improving efficiencies in operating our business, every
endeavor is focused on achieving and sustaining profitability. This effort requires attacking
both sides of the income statement in a disciplined fashion. Operational efficiencies and
increased scale help reduce the expense side of the equation. Capital deployment in
return-driven marketing campaigns, strategic product development and deeper customer
penetration should also help grow revenue. Individual accountability and compensation
are tied closely to our goals, and we are focused on improving operating cash flow. Most
important, Internap believes strongly in the value of its technology, people and business
model, and we are determined to put each of these to work for our stockholders.
A new level of operational
efficiency and a strong
focus on top line growth
have resulted in improved
company performance.
01 02 03 04 05
Customer Growth
01 02 03 04 05
Net Loss (figures in $ millions)
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A Message From
Gene Eidenberg
Chairman of the Board
Dear Fellow Stockholders,
2005 was a year of important transition for Internap. In
broadband penetration and other market trends, have helped to create a favorable environ-
November, Internap’s board of directors appointed James
ment for Internap’s bundled Internet and data center services.
DeBlasio as President and Chief Executive Officer of your
Today, we believe that Internap is poised to take advantage of this evolving landscape to
Company. Jim is no stranger to Internap, having been a
achieve and sustain long-term success. In the past six months, the board has seen a new
valued member of Internap’s board since 2003 and hav-
level of energy within the Company and is confident that Internap is on track to achieving
ing served as Chairman of the Audit Committee until his
value for its stockholders. Every member of the board is grateful for your continued support
appointment as the Company’s new President and CEO.
of the Company.
Jim accepted the board’s invitation following a 20-year
career with AT&T and Lucent Technologies.
Sincerely,
We believe that Jim’s leadership has positioned the
Company to take advantage of growing momentum in
our business sector, as many companies are showing
increased interest in the advantages Internap can bring
to their business.
Driven primarily by innovative e-business models that
require higher network capacity and solutions that can
support complex applications, the demand for Internet
connectivity and associated services is showing healthy
growth. These developments, along with increased
Gene Eidenberg
2005 Financial Information
Financial Statements
Selected Financial Data
10
12 Management’s Discussion and Analysis of Financial Condition and Results of Operations
26
30 Notes to Consolidated Financial Statements
46
Report of Independent Registered Public Accounting Firm
47 Management’s Report on Internal Control Over Financial Reporting
48
Stockholder Information
SELECTED FINANCIAL DATA
The consolidated statement of operations data and other financial data presented below were prepared using the consolidated financial statements
of Internap for the five years ended December 31, 2005. You should read this selected consolidated financial data together with the Consolidated
Financial Statements and related Notes contained in this Report and in our 2004 Annual Report on Form 10-K report filed with the SEC, as well as
the section of this Report and of our 2004 Annual Report on Form 10-K entitled, “Management’s Discussion and Analysis of Financial Condition and
Results of Operations.”
(In thousands, except per share data)
Consolidated Statement of Operations Data:
Revenue
Costs and expense:
Direct cost of revenue, exclusive of depreciation and amortization,
shown below
Customer support
Product development
Sales and marketing
General and administrative
Depreciation and amortization
Amortization of goodwill(1) and other intangible assets
Amortization of deferred stock compensation
Pre-acquisition liability adjustment
Lease termination expense
Restructuring cost (benefit)(2)
Impairment of goodwill and other intangible assets(3)
(Gain) loss on sales and retirements of property and equipment
Total operating costs and expense
Loss from operations
Other (income) expense
Net loss
Less deemed dividend related to beneficial conversion feature(4)
Year Ended December 31,
2005
2004
2003
2002
2001
$153,717
$144,546
$138,580
$132,487
$ 117,404
81,958
10,670
4,864
25,864
20,096
14,737
577
60
–
–
44
–
(19)
158,851
(5,134)
(170)
(4,964)
–
76,990
10,180
6,412
23,411
24,772
15,461
579
–
–
–
3,644
–
(3)
78,200
9,483
6,982
21,491
16,711
33,869
3,352
390
(1,313)
–
1,084
–
(53)
85,734
12,913
7,447
21,641
20,907
49,659
5,626
260
–
804
(2,857)
–
3,722
101,545
21,480
12,233
38,151
44,787
48,576
38,116
4,217
–
–
62,974
195,986
2,802
161,446
170,196
205,856
570,867
(16,900)
1,162
(18,062)
–
(31,616)
2,985
(34,601)
(34,576)
(73,369)
2,299
(75,668)
–
(453,463)
26,465
(479,928)
–
Net loss attributable to common stockholders
$ (4,964)
$ (18,062)
$ (69,177)
$ (75,668) $(479,928)
Basic and diluted net loss per share
$ (0.01)
$
(0.06)
$ (0.40)
$
(0.49) $ (3.19)
Weighted average shares used in computing
basic and diluted net loss per share(4)
339,387
287,315
174,602
155,545
150,328
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SELECTED FINANCIAL DATA
(In thousands)
2005
2004
2003
2002
2001
As of December 31,
Consolidated Balance Sheet Data:
Cash, cash equivalents and short-term marketable investments
Non-current marketable investments
Total assets
Notes payable and capital lease obligations, less current portion
Series A convertible preferred stock (5)
Total stockholders’ equity
$ 40,494
–
155,369
7,903
–
109,728
$ 45,985
4,656
168,149
12,837
–
113,738
$ 18,885
–
135,839
12,742
–
70,524
$ 25,219
–
166,334
22,739
79,790
(4,228)
$ 82,306
–
279,294
11,184
86,314
63,429
Year Ended December 31,
(In thousands)
2005
2004
2003
2002
2001
Other Financial Data:
Purchases of property and equipment
Net cash provided by (used in) operating activities
Net cash (used in) provided by investing activities
Net cash (used in) provided by financing activities
$(10,161)
5,846
(9,781)
(5,454)
$(13,066)
(1,150)
(29,659)
45,747
$ (3,799)
(11,175)
561
4,280
$ (8,632) $ (32,094)
(123,105)
12,292
72,204
(40,331)
9,581
(7,582)
(1) We adopted Statement of Financial Accounting Standard (SFAS) No. 142, “Goodwill and Other Intangible Assets” during 2002. Accordingly, effective January 1, 2002,
goodwill is no longer amortized and is instead reviewed for impairment annually, or more frequently, if indications of impairment arise.
(2) Restructuring cost (benefit) relates to restructuring programs in which management determined to exit certain non-strategic real estate lease and license arrangements,
consolidate network access points and streamline the operating cost structure.
(3) In 2000, we acquired CO Space, Inc. and the purchase price was allocated to net tangible assets and identifiable intangible assets and goodwill. In 2001, the estimated
fair value of certain assets acquired was less than their recorded amounts, and an impairment charge was recorded for $196.0 million.
(4) In August 2003, we completed a private placement of our common stock which resulted in a decrease of the conversion price of our series A preferred stock to
$0.95 per share and an increase in the number of shares of common stock issuable upon conversion of all shares of series A preferred stock by 34.5 million shares.
We recorded a deemed dividend of $34.6 million in connection with the conversion price adjustment, which is attributable to the additional incremental number of
shares of common stock issuable upon conversion of our series A preferred stock.
(5) In July 2003, we amended the deemed liquidation provisions of our charter to eliminate the events that could result in payment to the series A preferred stockholders
such that the events giving rise to payment would be within our control. As a result, 2,887,661 shares of our series A preferred stock, with a recorded value of $78.6 mil-
lion, were reclassified from mezzanine financing to stockholders’ equity during 2003. Effective September 14, 2004, all shares of our outstanding series A convertible
preferred stock were mandatorily converted into common stock in accordance with the terms of our Certificate of Incorporation.
MD&A
Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read in conjunction with the
consolidated financial statements and accompanying notes of this
annual report.
OVERVIEW
We market products and services that provide managed and premise-
based IP and route optimization technologies that enable business-
critical applications such as e-commerce, CRM, video and audio
streaming, VoIP, VPNs, and supply chain management. Our product
and service offerings are complemented by IP access solutions such
as data center services, CDN and managed security. At December 31,
2005, we delivered services through our 38 network access points,
across North America, London, and the Asia-Pacific region including
Tokyo and Sydney, Australia. Internap’s Private Network Access Points
(P-NAP®) feature direct high-speed connections to major Internet
backbones such as AT&T, Sprint, Verizon (formerly MCI), Savvis,
Global Crossing Telecommunications and Level 3 Communications.
The key characteristic that differentiates us from our competition is our
portfolio of patented and patent-pending route optimization solutions
that address the inherent weaknesses of the Internet and overcome
the inefficiencies of traditional IP connectivity options. Our intelligent
routing technology can facilitate traffic over multiple carriers, as opposed
to just one carrier’s network, to ensure highly reliable performance
over the Internet.
We believe our unique carrier-neutral approach provides better performance,
control and reliability compared to conventional Internet connectivity alter-
natives. Our service level agreements guarantee performance across the
entire Internet in the United States, excluding local connections, whereas
providers of conventional Internet connectivity typically only guarantee
performance on their own network. Internap serves customers in a variety
of industries including financial services, entertainment and media, travel,
e-commerce, retail and technology. As of December 31, 2005, we provided
our services to approximately 2,100 customers in the United States and
abroad, including several Fortune 1000 and mid-tier enterprises.
HIGHLIGHTS AND OUTLOOK
• Due to the nature of the services we provide, we generally price our
Internet connectivity services at a premium to the services offered by
conventional Internet connectivity service providers. We believe
customers with business-critical Internet applications will continue to
demand the highest quality of service as their Internet connectivity
needs grow and become even more complex and, as such, will con-
tinue to pay a premium for our high performance managed Internet
connectivity services.
• Our success in executing our premium pricing strategy depends, to a
significant degree, on our ability to differentiate our connectivity solutions
from lower cost alternatives. The key measures of our success in
achieving this differentiation are revenue and customer growth. During
2005, we added more than 150 net new customers, bringing our total
to approximately 2,100 enterprise customers as of December 31,
2005. Revenue for the year ended December 31, 2005 increased 6%
to $153.7 million, compared to revenue of $144.5 million for the year
ended December 31, 2004.
• Solidified management team is focused on achieving profitability and
revenue by leveraging operating efficiencies. In November 2005, James
P. DeBlasio, a 20-year technology veteran and former Lucent executive,
was appointed CEO. Through a renewed emphasis on aggressive cost
containment our management team will focus on reducing net losses
and driving gross profit to improve shareholder value.
• We intend to increase revenue by leveraging the capabilities of our
existing network access points. In our existing markets, we realize
incremental margins as new customers are added. Additional volume in
an existing market allows improved utilization of existing facilities and
an improved ability to cost-effectively predict and acquire additional
network capacity. Conversely, decreases in the number of customers in
an established market lead to decreased facility utilization and increase
the possibility that direct network resources are not cost-efficiently
employed. These factors have a direct bearing on our financial position
and results of operations.
• We also intend to increase revenue by expanding our geographic
coverage in key markets in the United States and abroad. As we enter
new geographic markets, operating results will be affected by increased
expense for hiring, training and managing new employees, acquiring
and implementing new systems and expense for new facilities. Our
ability to generate increased revenue depends on the success of our
cost control measures as we expand our geographic coverage.
• We believe that our data center services will continue to be drivers of
revenue in 2006. During 2005, we focused on selling, investing in
and managing data center services. In order to meet the current and
future anticipated demand for our data center services, we invested
more than $10 million in 2005 to upgrade and expand our existing
facilities. Of the 85,064 total square feet of data center space
directly operated by Internap, approximately 71% was utilized as
of December 31, 2005. We have 38,894 total square feet of data
center space operated under agreements with third parties of which
approximately 87% was utilized as of December 31, 2005. During
the year, we also focused on bundling our IP and data center services.
Our approach to expanding data center capabilities is needs driven,
as it serves to enhance our customers’ access to Internap’s core
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Management’s Discussion and Analysis of Financial Condition and Results of Operations
IP services. We believe this bundling brings great value to our custom-
ers, as evidenced by the fact that approximately 95% of our data
center customers also purchase IP services.
the carrying values of assets and liabilities that are not readily apparent
from other sources. Actual results may differ materially from these
estimates under different assumptions or conditions.
• We sell approximately two-thirds of new monthly recurring revenue
to existing customers. Selling new monthly recurring revenue to
existing customers allows us to guard against customer loss.
Management believes the following critical accounting policies affect the
judgments and estimates used in the preparation of our consolidated
financial statements.
• While we have limited our execution of traditional advertising over the
past year, we are focused on increasing brand awareness through
appropriate marketing vehicles. We will continue to develop integrated
marketing campaigns that identify qualified leads, generate interest
and promote business benefits among key audiences. We will also
conduct public relations efforts focused on securing third party recogni-
tion of our products and services from the media and industry analysts.
Our marketing organization is also responsible for creating our product
strategy based upon primary and secondary market research and the
advancement of new technologies.
BUSINESS COMBINATIONS
On October 1, 2003, we completed our acquisition of netVmg, Inc.
(netVmg). The acquisition was recorded using the purchase method of
accounting under SFAS No. 141, “Business Combinations.” The aggre-
gate purchase price of the acquired company, plus related charges, was
$13.7 million and was comprised of 345,905 shares of our series A
preferred stock, acquisition costs and warrants to purchase 1.5 million
shares of our common stock.
On October 15, 2003, we completed our acquisition of Sockeye Net-
works, Inc. (Sockeye). The acquisition was recorded using the purchase
method of accounting under SFAS No. 141. The aggregate purchase
price of the acquired company, plus related charges, was $1.9 million
and was comprised of 1.4 million shares of our common stock and
acquisition costs.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which
have been prepared in accordance with accounting principles generally
accepted in the United States. The preparation of these financial state-
ments requires management to make estimates and judgments that
affect the reported amounts of assets, liabilities, revenue and expense,
and related disclosure of contingent assets and liabilities. On an ongoing
basis, we evaluate our estimates, including those summarized below.
We base our estimates on historical experience and on various other
assumptions that are believed to be reasonable under the circum-
stances, the results of which form the basis for making judgments about
Revenue recognition. The majority of our revenue is derived from high-
performance Internet connectivity and related data center services.
Our revenue is generated primarily from the sale of Internet connectivity
services at fixed rates or usage-based pricing to our customers that
desire a DS-3 or faster connection and other ancillary services. Ancillary
services include data center services, CDN, server management and
installation services, virtual private networking services, managed security
services, data backup, and remote storage and restoration services. We
also offer T-1 and fractional DS-3 connections at fixed rates.
We recognize revenue when persuasive evidence of an arrangement
exists, the service has been provided, the fees for the service rendered
are fixed or determinable and collectibility is probable. Contracts and
sales or purchase orders are generally used to determine the existence
of an arrangement. We test for availability or use shipping documents
when applicable to verify delivery of our product or service. We assess
whether the fee is fixed or determinable based on the payment terms
associated with the transaction and whether the sales price is subject
to refund or adjustment.
Deferred revenue consists of revenue for services to be delivered in the
future and consists primarily of advance billings, which are amortized
over the respective service period. Revenue associated with billings for
installation of customer network equipment are deferred and amortized
over the estimated life of the customer relationship (generally two
years), as the installation service is integral to our primary service
offering and does not have value to a customer on a stand-alone basis.
Deferred post-contract customer support (PCS) associated with sales of
our FCP solution and similar products are amortized ratably over the
contract period (generally one year).
Customer credit risk. We routinely review the creditworthiness of our
customers. If we determine that collection of service revenue is uncer-
tain, we do not recognize revenue until cash has been collected. Addi-
tionally, we maintain allowances for doubtful accounts resulting from the
inability of our customers to make required payments on accounts
receivable. The allowance for doubtful accounts is based upon specific
and general customer information, which also includes estimates based
on management’s best understanding of the customers’ ability to pay.
Customers’ ability to pay takes into consideration payment history, legal
status (i.e., bankruptcy), and the status of services we are providing.
MD&A
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Once all collection efforts have been exhausted, we write the uncollect-
ible balance off against the allowance for doubtful accounts. We also
estimate a reserve for sales adjustments, which reduces net accounts
receivable and revenue. The reserve for sales adjustments is based
upon specific and general customer information, including outstanding
promotional credits, customer disputes, credit adjustments not yet
processed through the billing system and historical activity. If the
financial condition of our customers were to deteriorate, or management
becomes aware of new information impacting a customer’s credit risk,
additional allowances may be required.
Accounting for leases and leasehold improvements. We record leases as
capital or operating leases and account for leasehold improvements in
accordance with SFAS No. 13, “Accounting for Leases” and related
literature. Rent expense for operating leases is recorded in accordance
with FASB Technical Bulletin Financial Accounting Standards Board
(FTB) No. 88-1, “Issues Relating to Accounting for Leases.” This FTB
requires lease agreements that include periods of free rent or other
incentives, specific escalating lease payments, or both, to be recorded
on a straight-line or other systematic basis over the initial lease term
and those renewal periods that are reasonably assured. The difference
between rent expense and rent paid is recorded as deferred rent in non-
current liabilities in the consolidated balance sheets.
Investments. We account for investments without readily determinable
fair values at historical cost, as determined by our initial investment. The
recorded value of cost-basis investments is periodically reviewed to
determine the propriety of the recorded basis. When a decline in the
value that is judged to be other than temporary has occurred, based on
available data, the cost basis is reduced and an investment loss is
recorded. We have a $1.2 million equity investment at December 31,
2005 in Aventail Corporation (Aventail), an early-stage, privately held
company, after having reduced the balance for an impairment loss of
$4.8 million in 2001. The carrying value of our investment in Aventail is
recorded in non-current investments in our consolidated balance sheet.
Investments in marketable securities primarily include high credit
quality corporate debt securities and U.S. Government Agency debt
securities. These investments are classified as available for sale and
are recorded at fair value with changes in fair value reflected in other
comprehensive income.
Goodwill. We recorded goodwill as a result of our acquisitions of CO
Space, VPNX.com, netVmg, and Sockeye. We account for goodwill under
SFAS No. 142, “Goodwill and Other Intangible Assets.” This statement
requires an impairment-only approach to accounting for goodwill. The
SFAS No. 142 goodwill impairment model is a two-step process. First,
it requires a comparison of the book value of net assets to the fair value
of the related operations that have goodwill assigned to them. If the fair
value is determined to be less than book value, a second step is performed
to compute the amount of the impairment. In this process, a fair value
for goodwill is estimated, based in part on the fair value of the operations
used in the first step, and is compared to the carrying value for goodwill.
Any shortfall of the fair value below carrying value represents the amount
of goodwill impairment. SFAS No. 142 requires goodwill to be tested for
impairment annually at the same time every year and when an event
occurs or circumstances change such that it is reasonably possible that
impairment may exist. We selected August 1 as our annual testing date.
To assist us in estimating the fair value for purposes of completing the
first step of the SFAS No. 142 analysis, we engaged a professional
business valuation and appraisal firm who utilized discounted cash flow
valuation methods and the guideline company method for reasonable-
ness. The forecasts of future cash flows was based on our best estimate
of future revenue, operating costs and general market conditions, and
was subject to review and approval by senior management. Both
approaches to determining fair value depend on our stock price since
market capitalization will impact the discount rate to be applied as well
as a market multiple analyses. Changes in the forecast could cause us
to either pass or fail the first step test and could result in the impairment
of goodwill.
We account for investments that provide us with the ability to exercise
significant influence, but not control, over an investee using the equity
method of accounting. Significant influence, but not control, is generally
deemed to exist if we have an ownership interest in the voting stock of
the investee of between 20% and 50%, although other factors, such as
minority interest protections, are considered in determining whether the
equity method of accounting is appropriate. As of December 31, 2005,
Internap Japan Co, Ltd. (Internap Japan), our joint venture with NTT-ME
Corporation of Japan and another NTT affiliate, qualifies for equity
method accounting. We record our proportional share of the income and
losses of Internap Japan one month in arrears on the consolidated
balance sheets as a component of non-current investments and as
other income, net on the consolidated statement of operations.
Accruals for disputed telecommunication costs. In delivering our services,
we rely on a number of Internet network, telecommunication and other
vendors. We work directly with these vendors to provision services such
as establishing, modifying or discontinuing services for our customers.
Because of the volume of activity, billing disputes inevitably arise. These
disputes typically stem from disagreements concerning the starting and
ending dates of service, quoted rates, usage and various other factors.
For potential billing errors made in the vendor’s favor, for example a
duplicate billing, we initiate a formal dispute with the vendor and record
the related cost and liability on a range of 5% to 100% of the disputed
amount, depending on our assessment of the likely outcome of the
dispute. Conversely, for billing errors in our favor, such as the vendor’s
failure to invoice us for new service, we record an estimate for the
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Management’s Discussion and Analysis of Financial Condition and Results of Operations
related cost and liability based on the full amount that we should have been
invoiced. Disputed costs, both in the vendors’ favor and our favor, are
researched and discussed with vendors on an ongoing basis until ultimately
resolved. Estimates are periodically reviewed by management and modified
in light of new information or developments, if any. Conversely, any resolved
disputes which will result in a credit over the disputed amounts are
recognized in the appropriate month when the resolution has been
determined. Because estimates regarding disputed costs include
assessments of uncertain outcomes, such estimates are inherently
vulnerable to changes due to unforeseen circumstances that could
materially and adversely affect our results of operations and cash flows.
Accrued liabilities. Similar to accruals for disputed telecommunications
costs above, it is necessary for us to estimate other significant costs
such as utilities and sales, use, telecommunications and other taxes.
These estimates are often necessary either because invoices for ser-
vices are not received on a timely basis from our vendors or by virtue of
the complexity surrounding the costs. In every instance in which an
estimate is necessary, we record the related cost and liability based on
all available facts and circumstances, including but not limited to histori-
cal trends, related usage, forecasts and quotes. Estimates are periodi-
cally reviewed by management and modified in light of new information
or developments, if any. Because estimates regarding accrued liabilities
include assessments of uncertain outcomes, such estimates are inher-
ently vulnerable to changes due to unforeseen circumstances that could
materially and adversely affect our results of operations and cash flows.
Restructuring liability. When circumstances warrant, we may elect to exit
certain business activities or change the manner in which we conduct
ongoing operations. When such a change is made, management will
estimate the costs to exit a business or restructure ongoing operations.
The components of the estimates may include estimates and assump-
tions regarding the timing and costs of future events and activities that
represent management’s best expectations based on known facts and
circumstances at the time of estimation. Management periodically
reviews its restructuring estimates and assumptions relative to new
information, if any, of which it becomes aware. Should circumstances
warrant, management will adjust its previous estimates to reflect what
it then believes to be a more accurate representation of expected future
costs. Because management’s estimates and assumptions regarding
restructuring costs include probabilities of future events, such estimates
are inherently vulnerable to changes due to unforeseen circumstances,
changes in market conditions, regulatory changes, changes in existing
business practices and other circumstances that could materially and
adversely affect our results of operations. A 10% change in our
restructuring estimates in a future period, compared to the $6.3 million
restructuring liability at December 31, 2005 would result in an $0.6 million
expense or benefit in the statement of operations during the period in
which the change in estimate occurred.
Deferred taxes. We record a valuation allowance to reduce our deferred
tax assets to the amount that is more likely than not to be realized. Since
inception we have recorded a valuation allowance equal to our net
deferred tax assets. Although we consider the potential for future taxable
income and ongoing prudent and feasible tax planning strategies in
assessing the need for the valuation allowance, in the event we determine
we would be able to realize our deferred tax assets in the future in excess
of our net recorded amount, an adjustment to the valuation allowance
would increase income in the period such determination was made.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2005, the FASB issued SFAS No. 154, “Accounting for Changes
and Error Corrections – A Replacement of APB Opinion No. 20 and FASB
Statement No.3” to prescribe the related accounting and disclosures.
The provisions of SFAS No. 154 are effective for changes and error
corrections made in fiscal years beginning after December 15, 2005.
We will adopt this pronouncement on January 1, 2006.
In December 2004, the FASB issued SFAS No. 123 (revised 2004),
“Share-Based Payment,” which is known as SFAS No. 123(R). SFAS
No. 123(R) replaces SFAS No. 123, “Accounting for Stock-Based
Compensation,” as amended by SFAS No. 148, “Accounting for Stock-
Based Compensation – Transition and Disclosure – an Amendment of
FASB Statement No. 123.” Among other things, SFAS No. 123(R)
eliminates the alternative to use the intrinsic value method of account-
ing for stock-based compensation. SFAS No. 123(R) requires public
entities to recognize compensation expense for awards of equity instru-
ments to employees based on the grant-date fair value of the awards.
On March 29, 2005, the SEC issued Staff Accounting Bulletin (SAB)
No. 107, providing the SEC Staff’s view regarding the interaction
between SFAS No. 123(R) and certain SEC rules and regulations, and
the valuation of share-based payment arrangements. On April 15, 2005,
the SEC amended Rule 4-01(a) of Regulation S-X, extending the effec-
tive date of SFAS No. 123(R) to the first annual reporting period of the
registrant’s first fiscal year beginning on or after June 15, 2005.
We will adopt the provisions of SFAS No. 123(R), subsequent FASB Staff
Positions, and guidance in SAB No. 107, beginning in the first quarter of
2006. We are evaluating the requirements under SFAS No. 123(R) and
expect the adoption to have a significant adverse impact on our consoli-
dated statements of operations and net income per share, comparable
to our pro forma disclosure under SFAS No. 123. However, the actual
effect on net income or loss and earnings or loss per share after adopting
SFAS No. 123(R) will vary depending upon the number of options granted
in 2006 compared to prior years. In addition, we will also recognize
compensation expense related to our employee stock purchase plan for
the six-month purchase period ending June 30, 2006. We have modi-
fied our employee stock purchase plan to make it a non-compensatory
MD&A
Management’s Discussion and Analysis of Financial Condition and Results of Operations
plan for all purchase periods subsequent to June 30, 2006. Based on
the level of participation and volatility of our stock in 2005, we estimate
that compensation expense will be less than $0.1 million per purchase
period in 2006.
enters the application development stage until implementation of the
software has been completed. All other product development costs are
expensed as incurred.
RESULTS OF OPERATIONS
Revenue is generated primarily from the sale of Internet connectivity
services at fixed rates or usage-based pricing to our customers that desire
a DS-3 or faster connection and related data center services. In addition to
our connectivity and data center services, we also provide premise-based
route optimization products and other ancillary services, such as CDN,
server management and installation services, virtual private networking
services, managed security services, data backup, remote storage and
restoration services.
Direct cost of revenue is comprised primarily of:
• costs for connecting to and accessing Internet network service
providers and competitive local exchange providers;
• costs related to operating and maintaining network access
points and data centers;
• costs incurred for providing additional third-party services
to our customers and;
• costs of Flow Control Platform solution and similar products sold.
To the extent a network access point is located a distance from the
respective Internet network service providers, we may incur additional
local loop charges on a recurring basis. Connectivity costs vary depend-
ing on customer demands and pricing variables while network access
point facility costs are generally fixed in nature. Direct cost of revenue
does not include compensation, depreciation or amortization.
Customer support costs consist primarily of employee compensation
costs for employees engaged in connecting customers to our network,
installing customer equipment into network access point facilities, and
servicing customers through our network operations centers. In addition,
facilities costs associated with the network operations center are
included in customer support costs.
Product development costs consist principally of compensation and other
personnel costs, consultant fees and prototype costs related to the
design, development and testing of our proprietary technology, enhance-
ment of our network management software and development of internal
systems. Costs for software to be sold, leased or otherwise marketed
are capitalized upon establishing technological feasibility and ending
when the software is available for general release to customers. Costs
associated with internal use software are capitalized when the software
Sales and marketing costs consist of compensation, commissions and
other costs for personnel engaged in marketing, sales and field service
support functions, as well as advertising, tradeshows, direct response
programs, new service point launch events, management of our website
and other promotional costs.
General and administrative costs consist primarily of compensation and
other expense for executive, finance, human resources and administra-
tive personnel, professional fees and other general corporate costs.
The revenue and income potential of our business and market is unproven,
and our limited operating history makes it difficult to evaluate our
prospects. Although we have been in existence since 1996, we have
incurred significant operational restructurings in recent years, which
have included substantial changes in our senior management team, a
reduction in headcount from a high of 860 employees to 334 employees
at December 31, 2005, streamlining our cost structure, consolidating
network access points, terminating certain non-strategic real estate
leases and license arrangements and moving our corporate office from
Seattle, Washington to Atlanta, Georgia to further reduce costs. We have
incurred net losses in each quarterly and annual period since we began
operations in May 1996. As of December 31, 2005, our accumulated
deficit was $860.1 million.
The following table sets forth, as a percentage of total revenue, selected
statement of operations data for the periods indicated:
Revenue
Costs and expense:
Direct cost of revenue, exclusive of
depreciation and amortization shown below
Customer support
Product development
Sales and marketing
General and administrative
Depreciation and amortization
Restructuring costs
Other operating expense
Year Ended December 31,
2005
2004
2003
100%
100%
100%
53
7
3
17
13
10
–
–
53
7
5
16
17
11
3
–
56
7
5
16
12
27
1
(1)
Total operating costs and expense
103
112
123
Loss from operations
Total other expense, net
Net loss
(3)
–
(12)
1
(23)
2
(3)%
(13)%
(25)%
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Management’s Discussion and Analysis of Financial Condition and Results of Operations
Years Ended December 31, 2005 and 2004
Revenue. Revenue for 2005 increased $9.1 million, or 6%, from $144.5
million for the year ended December 31, 2004 to $153.7 million for the
year ended December 31, 2005 summarized as follows (in thousands):
Revenue:
IP Services
Data Center Services
CDN, Edge Appliance and Other
Year Ended December 31,
2005
2004
$ 99,848 $101,103
25,737
17,706
36,226
17,643
$153,717 $144,546
The increase in total revenue was primarily attributable to increases in
data center services revenue of $10.5 million, or 41%, to $36.2 million.
This increase principally results from growth in new and existing custom-
ers as we have expanded our available data center space. A generally
positive technology services environment along with a continued focus
on selling and managing data center services also contributed to the
revenue increase compared to the year ended December 31, 2004.
Similar to past years, revenue for the three months ending December 31,
2005 was also modestly enhanced by our customers’ increased holiday
traffic, much of which was subject to “bursting rates” for exceeding rate
caps. Revenue from our Edge Appliance products contributed $4.2 million
of revenue for the year ended December 31, 2005 compared to $2.7 million
for the prior year. Offsetting the increase in revenue from data center
services and Edge Appliance products were decreases of $1.3 million
from IP connectivity services and decreases of $0.9 million in non-
recurring and other revenue. Although the number of IP customers
and volume has increased during the year ended December 31, 2005,
revenue from IP connectivity services continues to decrease as a result of
repricing of our customer base. Non-recurring and other revenue includes
termination fees and service revenue from VPN, managed security,
managing customer premise equipment, and data storage services.
Our customer base increased by more than 150 customers to approxi-
mately 2,100 at December 31, 2005, an 8% increase from December 31,
2004. While our customer base grew from a year ago, revenue per
customer continued to decrease due to price reductions in charges for
our Internet connectivity services necessitated by general market
conditions. We expect a continuing trend of future revenue increases
to include an increasing percentage of revenue from non-connectivity
products and services than in the past, particularly from data centers
and the sale of our FCP solution and other Edge Appliance technology.
One of our largest data center customer’s contract expired as of
December 31, 2005 and was not renewed due largely to the customer’s
financial constraints. Because of the customer’s financial status, sub-
stantially all of the customer’s uncollected 2005 revenue and accounts
receivable were reserved as services were invoiced. At December 31,
2005, we believe the financial statements accurately reflect collectible
revenue and accounts receivable for this customer. In spite of the loss
of this customer, we fully anticipate the lost revenue to be more than
replaced from new and existing customers.
Direct cost of revenue. Direct cost of revenue increased from $77.0 million
for the year ended December 31, 2004 to $82.0 million for the year ended
December 31, 2005, representing an increase of 6%. Our gross margins,
defined as revenue less direct cost of revenue excluding depreciation
and amortization expense, improved to $71.8 million for the year ended
December 31, 2005 compared to $67.6 million for the same period in
2004. This increase in gross margin is a result of our leveraging fixed
data center and other service point facility costs over an increased
customer base and negotiating lower rates with service providers.
The increase of $5.0 million in direct cost of revenues was primarily
due to increased costs related to expanded data centers, representing
$10.7 million, offset by decreases in costs from our IP connectivity
services of $3.5 million due to favorable contract negotiations with service
providers and improved network efficiencies. The increase was also
offset by decreased expenses related to P-NAP® facility costs and
decreased CDN expense of $1.1 million each.
Connectivity costs vary based upon customer traffic and other demand-
based pricing variables. Data center costs have substantial fixed cost
components, primarily for rent, but also significant demand-based
pricing variables. Edge Appliance and CDN and other costs associated
with reseller arrangements are generally variable in nature. We expect
all of these costs to continue to increase during 2006 as revenue
increases. Data center services are giving us access to new customers
in which we can bundle hosting and connectivity services together,
potentially generating greater combined gross margins. At December 31,
2005, we had approximately 124,000 square feet of data center space
with a utilization rate of approximately 76%.
Customer support. Customer support expense increased 5% from
$10.2 million for the year ended December 31, 2004 to $10.7 million
for the year ended December 31, 2005. This increase of $0.5 million is
comparable to revenue growth and was primarily driven by compensation
and benefits of $0.3 million for higher staffing levels, along with
increases of $0.2 million in costs for outside professional services.
Product development. Product development costs for the year ended
December 31, 2005 decreased 23% to $4.9 million from $6.4 million
for the year ended December 31, 2004. The decrease of $1.5 million
was primarily driven by a decrease of $1.6 million in compensation and
employee benefits, along with a $0.2 million decrease in office equip-
ment maintenance costs. The decrease in compensation and employee
MD&A
Management’s Discussion and Analysis of Financial Condition and Results of Operations
benefit costs were related to organizational changes that allowed us to
reprioritize projects and more efficiently utilize certain employees. The
decrease in product development costs is also attributed to the capital-
ization of certain project development costs in 2005. These decreases
were partially offset by an increase in outside professional service
expense of $0.3 million.
Sales and marketing. Sales and marketing costs for the year ended
December 31, 2005 increased 11% to $25.9 million from $23.4 million
for the year ended December 31, 2004 due to an increased focus for
marketing Edge Appliances and technology and expansion in the Asia-
Pacific region. The net increase of $2.5 million was primarily due to
increases in commissions and other compensation expense of $2.1 million
as well as increases in outside professional services totaling $0.4 million,
and a $0.5 million increase in facility expense. These increases were
partially offset by decreases in marketing-related expenses of $0.4 million.
General and administrative. General and administrative costs for the
year ended December 31, 2005 decreased 19% to $20.1 million from
$24.8 million for the year ended December 31, 2004. The decrease of
$4.7 million primarily reflects a $2.7 million gross reduction in taxes,
licenses, and fees, a $1.7 million decrease in outside professional
services, $1.3 million reduction in facility, communication, and office
equipment, repairs, and maintenance expense, and a $1.0 million
decrease in bad debt expense. These reductions were partially offset
by increases of $2.0 million in employee compensation and benefits.
The reduction in taxes, licenses and fees related to the combination of
(1) an accrual in July 2004 for an assessment from the New York State
Department of Taxation and Finance for $1.4 million, including interest
and penalties, resulting from an audit of our state franchise tax returns
for the years 2000–2002 and (2) a reduction of the accrual in April 2005
when we became aware that the assessment had been reduced to
$0.1 million, including interest and with penalties waived. The substan-
tial decrease from the original assessment was a result of including the
weighted averages of investment capital and subsidiary capital, along
with business capital, used in New York in determining the apportion-
ment factor. The original assessment was based solely on an apportion-
ment of business capital, while investment capital and subsidiary capital
both have significantly lower apportionment percentages to New York.
The decrease in outside professional services of $1.7 million is largely
due to substantially less use of consultants and contractors in 2005
compared to the Sarbanes-Oxley initiatives and implementation in 2004.
The improvement in facility and related costs are attributed to focused
cost controls and a much more centrally-managed purchasing function.
The reduction in bad debt expense is due largely to an accrual for a
large customer balance in 2004 along with more favorable collections
experience in 2005.
Depreciation and amortization. Depreciation and amortization, including
other intangible assets, for the year ended December 31, 2005 decreased
4% to $15.3 million compared to $16.0 million for the year ended
December 31, 2004. The decrease of $0.7 million was primarily due
to assets becoming fully depreciated during 2005, which were not
replaced by the same level of purchases of property and equipment as
during prior years.
Restructuring cost. For the year ended December 31, 2005 we incurred
less than $0.1 million of additional restructuring costs. These additional
costs were primarily the result of a change in estimated expenses related
to real estate obligations.
For the year ended December 31, 2004, the net charge of $3.6 million
to restructuring resulted from an increase of $5.3 million relating to
real estate obligations offset by a reduction of $1.7 million pertaining to
network infrastructure and other obligations. After reviewing the analysis
in the third quarter of 2004, management concluded that the facilities
remaining in the restructuring accrual were taking longer than expected
to sublease and those that were subleased resulted in lower than expected
sublease rates. Consequently, the projected obligations exceeded the
unadjusted liability by $5.3 million over the remaining lease terms. During
the quarter ended September 30, 2004, all remaining contractual
obligations for network infrastructure and other costs included in the
restructuring were satisfied and we reduced the remaining recorded
liability for the obligations from $1.7 million to zero.
Years Ended December 31, 2004 and 2003
Revenue:
IP Services
Data Center Services
CDN, Edge Appliance and Other
Year Ended December 31,
2004
2003
$101,103 $100,474
20,697
17,409
25,737
17,706
$144,546 $138,580
Revenue. Revenue for 2004 increased $5.9 million from $138.6 million
for the year ended December 31, 2003 to $144.5 million for the year
ended December 31, 2004, an increase of 4%. Our largest increase in
revenue came from data center services, which increased $5.0 million,
or 24%, to $25.7 million for 2004 compared to $20.7 million for 2003
and our Edge Appliance products contributed $2.7 million of revenue for
the year ended December 31, 2004 compared to $0.7 million for the
prior year. Revenue for IP connectivity services increased slightly to
$101.1 million from $100.5 million for the years ended December 31,
2004 and 2003, respectively, in spite of continued industry-wide
intense pricing pressures.
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Management’s Discussion and Analysis of Financial Condition and Results of Operations
These overall increases in revenue were primarily due to an increase in
our customer base of approximately 291 customers, a 16% increase.
While our customer base grew from a year ago, revenue per customer
decreased due to price reductions in charges for our Internet connectiv-
ity services necessitated by general market conditions. We expect the
composition of any future revenue increases will include an increasing
percentage of revenue from non-connectivity products and services
than in the past, particularly from the sale of our Edge Appliance tech-
nology, which includes our FCP solution.
Direct cost of revenue. Direct cost of revenue decreased from $78.2 million
for the year ended December 31, 2003 to $77.0 million for the year
ended December 31, 2004, representing a decrease of 2%. For the
year ended December 31, 2004, our revenue less direct cost of revenue
improved to $67.5 million compared to $60.4 million for the same
period in 2003. This increase is a result of our leveraging of fixed data
center and other service point facility costs over an increased customer
base and negotiating lower rates with service providers. The decrease
of $1.2 million in direct cost of revenues was due to reduced network
service provider costs and lower local loop pass-through costs of
$8.2 million. Off-setting the decrease in network service provider
costs and lower local loop pass-through costs were an increase in
data center services expense of $3.1 million due to the increased
usage of these services by our customers, along with increases in
channel, technology, and preferred colocation partner product cost of
$1.8 million. An additional increase of $1.5 million in direct cost of
revenue is attributed to resale of network equipment, resulting from
acquisitions completed by us in 2003, along with an increase of
$0.4 million pertaining to facilities costs.
Connectivity costs vary based upon customer traffic and other demand-
based pricing variables and are expected to continue to decrease during
2005, even with modest revenue growth, due to the full-year effect of
pricing improvements negotiated during 2004. CDN and other costs
associated with reseller arrangements are generally variable in
nature. We expect these costs to continue to increase during 2005
as revenue increases.
Customer support. Customer support expense increased 7% from
$9.5 million for the year ended December 31, 2003 to $10.2 million
for the year ended December 31, 2004. This increase of $0.7 million
was primarily driven by compensation and benefits of $0.8 million
for higher staffing levels, along with decreases of $0.2 million
in communications.
support to network support in general and administrative expense offset
by new hiring for other responsibilities.
Sales and marketing. Sales and marketing costs for the year ended
December 31, 2004 increased 9% to $23.4 million from $21.5 million
for the year ended December 31, 2003. This increase of $1.9 million
was primarily due to an increase in quota-bearing resources as well as
the commensurate expenses associated with the new hires. A portion
of these increases can also be attributed to increased training and
productivity improvements.
General and administrative. General and administrative costs for the year
ended December 31, 2004 increased 49% to $24.8 million from
$16.7 million for the year ended December 31, 2003. The increase of
$8.1 million primarily reflects increases of $4.2 million in outside
professional services, $1.3 million in office equipment repairs and
maintenance, $0.8 million in employee compensation, $0.4 million in
tax, license, and fees and $0.4 million in communications costs. Con-
sulting and outside professional services principally include compliance
costs related to the Sarbanes-Oxley Act of 2002. Also included in the
increase is the $1.7 million from redeployment of certain technical
resources from product development to network support.
Depreciation and amortization. Depreciation and amortization, including
other intangible assets, for the year ended December 31, 2004 decreased
57% to $16.0 million compared to $37.2 million for the year ended
December 31, 2003. The decrease of $21.2 million was primarily due to
assets becoming fully depreciated during 2004, which were not replaced
by the same level of purchases of property and equipment as during
prior years.
Restructuring cost (benefit). We incurred restructuring costs of $3.6 million
during the year ended December 31, 2004 as a result of a comprehen-
sive analysis of the remaining accrued restructuring liability. During the
quarter ended September 30, 2004, a new sublease was negotiated
on one abandoned property and new terms involving a reconfiguration
of usable and abandoned space were negotiated with the lessor on
another abandoned property, both of which were included in the original
restructuring. The last of our restructured network infrastructure obliga-
tions was also terminated during the quarter ended September 30,
2004. The net charge to restructuring resulted from an increase of
$5.3 million relating to real estate obligations offset by a reduction of
$1.7 million pertaining to network infrastructure and other obligations.
Product development. Product development costs for the year ended
December 31, 2004 decreased 9% to $6.4 million from $7.0 million for
the year ended December 31, 2003. The net decrease of $0.6 million
primarily reflects the redeployment of technical resources from product
After reviewing the analysis in the third quarter of 2004, management
concluded that the facilities remaining in the restructuring accrual are
taking longer than expected to sublease and those that were subleased
resulted in lower than expected sublease rates. Consequently, the
currently projected obligations exceeded the unadjusted liability by
MD&A
Management’s Discussion and Analysis of Financial Condition and Results of Operations
$5.3 million over the remaining lease terms, with the last commitment
expiring in July 2015. All of these leases arose from our 2000 acquisi-
tion of CO Space. The network infrastructure obligations represented
amounts to be incurred under contractual obligations in existence at
the time the restructuring plan was initiated.
During the quarter ended September 30, 2004, all other remaining
contractual obligations for network infrastructure and other costs
included in the restructuring were satisfied and we reduced the remain-
ing recorded liability for the obligations from $1.7 million to zero.
Restructuring costs were $1.1 million for 2003 reflecting non-cash
restructuring plan adjustments and write-downs net of additional 2003
restructuring and impairment charges.
Other expense, net. Other expense, net consists of interest income,
interest and financing expense, investment losses and other non-
operating expense. Other expense, net for the year ended December 31,
2004 decreased to $1.2 million from $3.0 million for the year ended
December 31, 2004. The decrease is due primarily to $1.0 million less
interest expense from carrying less debt than in the prior year.
LIQUIDITY AND CAPITAL RESOURCES
Cash Flow for the Years Ended December 31, 2005, 2004,
and 2003
Net cash from operating activities. Net cash provided by operating
activities was $5.8 million for the year ended December 31, 2005,
and was primarily due to the net loss of $5.0 million adjusted for non-
cash items of $20.1 million offset by changes in working capital items
of $9.3 million. The changes in working capital items include net use
of cash for accounts payable of $5.4 million, accounts receivable of
$3.6 million, accrued restructuring of $1.9 million, and $0.2 million of
inventory, prepaid expense and other assets. These were offset by net
sources of cash in accrued liabilities of $0.8 million and deferred revenue
of $1.0 million. The increase in receivables at December 31, 2005
compared to December 31, 2004 was related to the 6% increase in
revenue. The decrease in payables is primarily related to a general
decrease in expenses when compared to last year.
Net cash used in operating activities was $1.2 million for the year ended
December 31, 2004, and was primarily due to the net loss of $18.1 million
adjusted for non-cash items of $20.8 million offset by changes in working
capital items of $3.9 million. The changes in working capital items include
net use of cash for accounts receivable of $3.8 million, deferred revenue
of $1.7 million, and accrued liabilities of $1.3 million. These were offset
by net sources of cash in inventory, prepaid expense and other assets of
$1.6 million, accounts payable of $0.9 million and accrued restructuring
costs of $0.5 million. The increase in receivables at December 31, 2004
compared to December 31, 2003 was related to the 4% increase in
revenue compared to the prior year as day’s sales outstanding increased
to 41 from 39 days. The increase in payables is primarily related to more
stringent cash controls in 2004 compared to 2003.
Net cash used in operating activities was $11.2 million for the year
ended December 31, 2003, and was primarily due to the net loss of
$34.6 million adjusted for non-cash items of $41.7 million, offset by net
uses of cash for accrued restructuring costs of $6.7 million, accounts
payable of $5.9 million, deferred revenue of $4.5 million, accounts
receivable of $2.7 million and accrued liabilities of $1.1 million. These
uses of cash were offset by a $2.6 million decrease in inventory, prepaid
expense and other assets. The increase in receivables at December 31,
2003 compared to December 31, 2002 was related to the 5% increase
in revenue compared to the prior year as day’s sales outstanding remained
constant at 39 days. The decrease in payables is primarily related to a
lower overall level of operating expense in 2003 compared to 2002.
Net cash from investing activities. Net cash used in investing activities
for the year ended December 31, 2005 was $9.8 million primarily due
to capital expenditures of $10.2 million. Our capital expenditures were
principally comprised of leasehold improvements related to the upgrade
of several data center facilities.
Net cash used in investing activities for the year ended December 31, 2004
was $29.7 million and primarily consisted of capital expenditures of
$13.1 million and total investments in marketable securities of $16.8 million,
partially offset by proceeds from disposal of property and equipment and
a reduction in restricted cash of $0.1 million. Our capital expenditures
were principally comprised of the buy-out of capital leases from a primary
supplier of network equipment during the third quarter and build-outs of
data center and office space in the latter-half of the year.
Net cash provided by investing activities for the year ended December 31,
2003 was $0.6 million and primarily consisted of net cash received
from acquired businesses of $2.3 million and a reduction in restricted
cash of $2.1 million, partially offset by purchases of property and
equipment of $3.8 million. The purchase of property and equipment
related to the purchase of assets for our network infrastructure and the
cost related to the relocation of nine network access points.
Net cash from financing activities. Since our inception, we have financed
our operations primarily through the issuance of our equity securities,
capital leases and bank loans. See “Liquidity” below. Net cash used in
financing activities for the year ended December 31, 2005 was $5.4 million.
Cash used in financing activity included principal payments on notes
payable of $6.5 million and payments on capital lease obligations of
$0.5 million. These payments were partially offset by proceeds received
from the exercise of stock options of $1.5 million. As a result of these
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Management’s Discussion and Analysis of Financial Condition and Results of Operations
activities, we had $12.0 million in notes payable and $0.8 million in
capital lease obligations as of December 31, 2005 with $4.9 million
in notes payable and capital leases scheduled as due within the
next 12 months.
Net cash provided by financing activities for the year ended December 31,
2004 was $45.7 million. In September 2004, we negotiated the buy-out
of all remaining lease schedules under a master lease agreement with a
primary supplier of network equipment. Under the terms of the buy-out
agreement, we paid the supplier $19.7 million, representing remaining
capital lease payment obligations, end-of-lease asset values and sales
tax. The $19.7 million buy-out was paid with $2.2 million in cash on hand
and the proceeds from the new $17.5 million term loan from a bank.
On March 4, 2004, we sold 40.25 million shares of our common stock
in a public offering at a purchase price of $1.50 per share which resulted
in net proceeds to us of $55.9 million after deducting underwriting
discounts and commissions and offering expense. We continue to use
the net proceeds from the offering for general corporate purposes.
General corporate purposes primarily include capital investments in
our network access point infrastructure and systems, expansion of data
center facilities and repayment of debt and capital lease obligations.
General corporate purposes could also include potential acquisitions
of complementary businesses or technologies. In addition, we received
$5.0 million from the exercise of stock options and warrants during
the year ended December 31, 2004. Cash used in financing activities
included $24.3 million toward reducing our notes payable and afore-
mentioned capital lease obligations and $8.4 million to repay the
outstanding balance on our revolving credit facility.
Net cash provided by financing activities for the year ended December 31,
2003 was $4.3 million. Cash provided included net proceeds from
issuance of common stock of $9.3 million and proceeds from exercise
of stock options and warrants of $4.0 million. Net cash provided by
financing activities was reduced by principal payments on notes payable
of $4.6 million, payments on capital lease obligations of $2.8 million
and a $1.6 million net reduction in our revolving credit facility. The net
proceeds of $9.3 million from issuance of common stock was received
in August 2003 when we completed the sale, pursuant to a private
placement, of 10.65 million shares of our common stock, par value
$0.001 per share, at a price of $0.95 per share.
Capital equipment leases have been used since inception to finance the
majority of our networking equipment located in our network access
points other than leasehold improvements related to our data center
facilities. Payments under capital lease agreements totaled $0.6 million,
$20.3 million and $2.8 million for the years ended December 31, 2005,
2004 and 2003, respectively.
LIQUIDITY
We have a history of quarterly and annual period net losses. We
incurred net losses of $5.0 million, $18.1 million and $34.6 million for
the years ended December 31, 2005, 2004 and 2003, respectively. As
of December 31, 2005, our accumulated deficit was $860.1 million. We
may incur additional operating losses in the future. Given the competi-
tive and evolving nature of the industry in which we operate, we
cannot guarantee that we will sustain or increase profitability on a
quarterly or annual basis. Our failure to do so would adversely affect
our business, including our ability to raise additional funds.
Although we experienced positive operating cash flow for the year
ended December 31, 2005, we have a history of negative operating
cash flow and have depended upon equity and debt financings, as well
as borrowings under our credit facilities, to meet our cash requirements.
In 2006, we expect a steady increase in cash flows from operations
based on current projections in our 2006 business plan. We expect to
meet our cash requirements in 2006 through a combination of cash
from operating cash flows, existing cash, cash equivalents and short-
term investments in marketable securities, borrowings under our credit
facilities and proceeds from our public offering in March of 2004. Our
capital requirements depend on several factors, including the rate of
market acceptance of our services, the ability to expand and retain our
customer base, and other factors. If our cash requirements vary materi-
ally from those currently planned, if our cost reduction initiatives have
unanticipated adverse effects on our business, or if we fail to generate
sufficient cash flow from the sales of our services, we may require
additional financing sooner than anticipated. We cannot assure you that
we will be able to obtain additional financing on commercially favorable
terms, or at all. Provisions in our existing credit facility limit our ability to
incur additional indebtedness.
Revolving credit facility. At December 31, 2005, we had a $10.0 million
revolving credit facility and a $17.5 million term loan under a loan and
security agreement with a bank. The agreement was reviewed and
amended as of December 27, 2005 to reduce the amount available for
borrowing under the revolving credit agreement from $15.0 million to
$10.0 million, increase letter of credit sub-limit from $5.0 million
to $6.0 million, to extend the expiration date of the revolving credit
facility from December 27, 2005 to December 27, 2006 and update
loan covenants.
Availability under the revolving credit facility is based on 80% of eligible
accounts receivable plus 50% of unrestricted cash and marketable
investments. As of December 31, 2005, $4.1 million of letters of credit
were issued, and we had available $5.9 million in borrowing capacity
under the revolving credit facility.
MD&A
Management’s Discussion and Analysis of Financial Condition and Results of Operations
The credit facility contains certain covenants, including covenants that
restrict our ability to incur further indebtedness. The December 28, 2005
changes to the loan covenants include the elimination of the minimum
Cash EBITDA requirement, as defined by the agreement, and the addi-
tion of a minimum tangible net worth requirement.
As of December 31, 2005, we were in compliance with the various loan
covenants. We were in violation of a previous loan covenant that required
a minimum Cash EBITDA, as defined in the credit facility, for the three-
month period ended September 30, 2005 by $1.3 million. The violation
resulted primarily from our continued expansion of data center facilities
that caused the minimum Cash EBITDA for the period to be less than
the level required under the agreement. On November 3, 2005, we
received a formal waiver of the covenant violation. As discussed above,
the agreement was amended as of December 27, 2005 to eliminate
the minimum Cash EBITDA requirement.
Note payable to financial institutions. The $17.5 million term loan noted
with the revolving credit facility above has a fixed interest rate of 7.5%
and is due in 48 equal monthly installments of principal plus interest
through September 1, 2008. The balance outstanding at December 31,
2005 was $12.0 million. Proceeds from the loan were used to purchase
assets recorded as capital leases under a master agreement with a
primary supplier of networking equipment. The loan is secured by all of
our assets, except patents.
Commitments and other obligations. We have commitments and other
obligations that are contractual in nature and will represent a use of cash in
the future unless there are modifications to the terms of those agreements.
Network commitments primarily represent purchase commitments made
to our largest bandwidth vendors and contractual payments to license data
center space used for resale to customers. Our ability to improve cash used
in operations in the future would be negatively impacted if we do not grow
our business at a rate that would allow us to offset the service commit-
ments with corresponding revenue growth.
The following table summarizes our credit obligations and future contractual commitments as of December 31, 2005 (in thousands):
Note payable (1)
Capital lease obligations (2)
Operating lease commitments
Service commitments
Payments Due by Period
Less Than
1 year
$ 4,375
607
9,824
6,110
$20,916
1-3
Years
$ 7,656
253
19,389
5,534
$32,832
3-5
Years
$
–
–
12,008
2,032
$14,040
More Than
5 years
$
–
–
61,691
–
$61,691
Total
$ 12,031
860
102,912
13,676
$128,479
(1) Note payable does not include interest expense of $0.7 million and $0.5 million due in less than one year and between one and three years, respectively.
(2) Capital lease obligations include imputed interest expense of less than $0.1 million.
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Management’s Discussion and Analysis of Financial Condition and Results of Operations
Common and preferred stock. Effective September 14, 2004, all shares
of our outstanding series A convertible preferred stock were mandatorily
converted into common stock in accordance with the terms of our
Certificate of Incorporation. An aggregate of 1.8 million shares of con-
vertible preferred stock with a recorded value of $51.8 million was
converted into 56.2 million shares of common stock during the quarter
ended September 30, 2004. Accordingly, we had no shares of series A
convertible preferred stock outstanding subsequent to the mandatory
conversion. The mandatory conversion had no effect on the outstanding
warrants to purchase common stock that were issued in conjunction
with the series A preferred stock.
On March 4, 2004, we sold 40.25 million shares of our common stock
in a public offering at a purchase price of $1.50 per share which
resulted in net proceeds to us of $55.9 million, after deducting under-
writing discounts and commissions and offering expense. We continue
to use the net proceeds from the offering for general corporate purposes.
General corporate purposes primarily include capital investments in
our network access point infrastructure and systems, expansion of data
center facilities and repayment of debt and capital lease obligations.
General corporate purposes could also include potential acquisitions
of complementary businesses or technologies.
On August 22, 2003, we completed a private placement of 10.65 million
shares of our common stock at a price of $0.95 per share. We received
$9.5 million, net of issuance costs. Because we issued shares of our
common stock in the private placement at a price below the conversion
price of the series A preferred stock at that time, the number of shares
of common stock into which the outstanding shares of series A preferred
stock were convertible increased by 34.5 million shares. In accordance
with generally accepted accounting principles, we recorded a deemed
dividend of $34.6 million, which was attributable to the additional
incremental number of shares of common stock issuable upon conver-
sion of the series A preferred stock.
Lease facilities. Since our inception, we have financed the purchase
of substantial network routing equipment using capital leases with a
primary supplier. As discussed below, we negotiated the buy-out of all
remaining lease schedules under a master lease agreement with the
primary supplier in September 2004. Our future minimum lease pay-
ments on remaining capital lease obligations at December 31, 2005
totaled $0.9 million, with $0.8 million representing the present value
of minimum lease payments.
The negotiated buy-out of all remaining lease schedules under the
master lease agreement with the supplier of network equipment
included a cash payment of $19.7 million, comprising remaining capital
lease obligations as of September 30, 2004, along with end-of-lease
asset values and sales tax, resulting in a $2.2 million increase to fixed
assets. The $19.7 million buy-out was funded through $2.2 million in
cash on hand and the proceeds from the aforementioned $17.5 million
term loan from a bank. As of December 31, 2005, our other remaining
capital lease has an expiration date of June 2007.
RESTRUCTURING AND IMPAIRMENT COSTS
With overcapacity created in the Internet connectivity market and
IP services market, we implemented restructuring plans that resulted
in significant charges in 2001 and 2002 for real estate and network
infrastructure obligations, personnel and other charges. Additional
charges were also incurred during 2003 and 2004 as we continued
to evaluate our restructuring reserve. We may incur additional charges
in future periods.
2003 Restructuring costs. For the year ended December 31, 2003, we
incurred $1.1 million in restructuring costs which primarily represented
retention bonuses and moving expenses related to the relocation of our
corporate office to Atlanta, Georgia from Seattle, Washington.
2004 Restructuring costs. We incurred net additional restructuring costs
of $3.6 million during 2004 as a result of a comprehensive analysis of
the remaining accrued restructuring liability. After reviewing the analysis,
management concluded that the facilities remaining in the restructuring
accrual were taking longer than expected to sublease and those
that were subleased resulted in lower than expected sublease rates.
Consequently, the projected obligations exceeded the unadjusted
liability by $5.3 million over the remaining lease terms, with the last
commitment expiring in July 2015. During the quarter ended September 30,
2004, all other remaining contractual obligations for network infrastruc-
ture and other costs included in the restructuring were satisfied and
we reduced the remaining recorded liability for the obligations from
$1.7 million to zero.
2005 Restructuring costs. Restructuring charges totaling less than
$0.1 million during 2005 primarily resulted from a change in estimated
expenses related to real estate obligations.
MD&A
Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following table displays the activity and balances for restructuring and asset impairment activity for 2003 (in thousands):
Restructuring costs activity for 2001 restructuring charge:
Real estate obligations
Network infrastructure obligations
Other
Restructuring costs activity for 2002 restructuring charge:
Real estate obligations
Personnel
Other
Net asset write-downs for 2002 restructuring charge
December 31, 2002
Restructuring
Liability
Restructuring
Charge
Cash
Reductions
December 31, 2003
Restructuring
Liability
$10,319
1,297
1,008
1,800
–
100
14,524
(139)
$ –
–
–
1,084
–
1,084
–
$14,385
$1,084
$(4,476)
(172)
(141)
(1,800)
(1,084)
(100)
(7,773)
–
$(7,773)
$5,843
1,125
867
–
–
–
7,835
(139)
$7,696
The $1.1 million recorded during 2003 as restructuring reserves related to general and administrative costs.
The following table displays the activity and balances for restructuring and asset impairment activity for 2004 (in thousands):
Restructuring costs activity for 2001 restructuring charge:
Real estate obligations
Network infrastructure obligations
Other
Net asset write-downs for 2002 restructuring charge
December 31, 2003
Restructuring
Liability
Restructuring
Charge
(Benefit)
Cash
Reductions
December 31, 2004
Restructuring
Liability
$5,843
1,125
867
7,835
(139)
$7,696
$5,323
(951)
(867)
3,505
139
$3,644
$(3,013)
(174)
–
(3,187)
–
$(3,187)
$8,153
–
–
8,153
–
$8,153
Of the $5.3 million recorded during 2004 as additional real estate restructuring charges, $3.0 million related to the direct cost of revenue and
$2.3 million related to general and administrative costs.
The following table displays the activity and balances for restructuring and asset impairment activity for 2005 (in thousands):
Restructuring costs activity for 2001 restructuring charge:
Real estate obligations
$8,153
$44
$(1,920)
$6,277
December 31, 2004
Restructuring
Liability
Restructuring
Charge
Cash
Reductions
December 31, 2005
Restructuring
Liability
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Management’s Discussion and Analysis of Financial Condition and Results of Operations
OFF-BALANCE SHEET ARRANGEMENTS
As discussed in note 5 to the consolidated financial statements, we
maintain a 51% ownership interest in Internap Japan, a joint venture
with NTT-ME Corporation of Japan and another NTT affiliate. We are
unable to assert control over the joint venture’s operational and financial
policies and practices required to account for the joint venture as a
subsidiary whose assets, liabilities, revenue and expense would be
consolidated (due to certain minority interest protections afforded to
our joint venture partners).
As discussed in note 14 to the consolidated financial statements,
there were warrants outstanding to purchase 15.0 million shares
of our common stock at an exercise price of $0.95 per share as of
December 31, 2005.
QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
Cash and cash equivalents. We maintain cash and short-term deposits
at our financial institutions. Due to the short-term nature of our deposits,
they are recorded on the balance sheet at fair value. As of December 31,
2005, all of our cash equivalents mature within three months.
Other investments. We have a $1.2 million equity investment in Aventail,
an early stage, privately held company, after having reduced the balance
for an impairment loss of $4.8 million in 2001. This strategic investment
is inherently risky, in part because the market for the products or services
being offered or developed by Aventail has not been proven. Because
of risk associated with this investment, we could lose our entire initial
investment in Aventail. Furthermore we have invested $4.1 million in
Internap Japan, our joint venture with NTT-ME Corporation and another
NTT affiliate. This investment is accounted for using the equity-method
and to date we have recognized $3.6 million in equity-method losses,
representing our proportionate share of the aggregate joint venture
losses and income. Furthermore, the joint venture investment is
subject to foreign currency exchange rate risk. In addition, the market
for services being offered by Internap Japan has not been proven and
may never materialize.
Notes payable. As of December 31, 2005 we had notes payable recorded
at their present value of $12.0 million bearing a rate of interest which
we believe is commensurate with their associated market risk.
Capital leases. As of December 31, 2005 we had capital leases recorded
at $0.8 million reflecting the present value of future lease payments. We
believe the interest rates used in calculating the present values of these
lease payments are a reasonable approximation of fair value and their
associated market risk is minimal.
Credit facility. As of December 31, 2005 we had $5.9 million available
under our revolving credit facility with a bank, and the balance outstand-
ing under the $17.5 million term loan was $12.0 million. The interest
rate for the loan was fixed at 7.5%. The interest rate under the revolving
credit facility is variable and was 8% at December 31, 2005. We believe
these interest rates are reasonable approximations of fair value and the
market risk is minimal.
Interest rate risk. Our objective in managing interest rate risk is to
maintain favorable long-term fixed rate or a balance of fixed and variable
rate debt that will lower our overall borrowing costs within reasonable
risk parameters. Currently, our strategy for managing interest rate
risk does not include the use of derivative securities. The table below
presents principal cash flows by expected maturity dates for our debt
obligations that extend beyond one year as of December 31, 2005
(dollars in thousands):
Long-term debt:
Term loan
Interest rate
2006
2007
2008
Fair
Value
$4,375
$4,375
$3,281
$12,031
7.5%
7.5%
7.5%
7.5%
Foreign currency risk. Substantially all of our revenue is currently in
United States dollars and from customers primarily in the United States.
Therefore, we do not believe we currently have any significant direct
foreign currency exchange rate risk.
CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts)
ASSETS
Current assets:
Cash and cash equivalents
Restricted cash
Short-term investments in marketable securities
Accounts receivable, net of allowance of $963 and $1,124, respectively
Inventory
Prepaid expenses and other assets
Total current assets
Property and equipment, net
Investments
Intangible assets, net
Goodwill
Deposits and other assets
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Notes payable, current portion
Accounts payable
Accrued liabilities
Deferred revenue, current portion
Capital lease obligations, current portion
Restructuring liability, current portion
Total current liabilities
Notes payable, less current portion
Deferred revenue, less current portion
Capital lease obligations, less current portion
Restructuring liability, less current portion
Deferred rent
Other long-term liabilities
Total liabilities
Commitments and contingencies
Stockholders’ equity:
Series A convertible preferred stock, $0.001 par value, 3,500 shares designated,
no shares issued or outstanding
Common stock, $0.001 par value, 600,000 shares authorized, 341,677 and 338,148 shares
issued and outstanding, respectively
Additional paid-in capital
Deferred stock compensation
Accumulated deficit
Accumulated items of other comprehensive income
Total stockholders’ equity
The accompanying notes are an integral part of these consolidated financial statements.
December 31,
2005
2004
$ 24,434
–
16,060
19,128
779
2,957
63,358
50,072
1,999
2,329
36,314
1,297
$ 33,823
76
12,162
16,943
345
3,202
66,551
54,378
6,693
2,898
36,314
1,315
$155,369
$168,149
$ 4,375
5,766
7,267
2,737
559
1,202
21,906
7,656
533
247
5,075
9,185
1,039
45,641
$ 6,483
11,129
7,269
1,826
512
2,397
29,616
12,031
421
806
5,756
5,781
–
54,411
–
–
342
969,913
(420)
(860,112)
5
109,728
$155,369
338
967,951
–
(855,148)
597
113,738
$168,149
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Year Ended December 31,
2005
2004
2003
$153,717
$144,546
$138,580
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
Revenue
Costs and expense:
Direct cost of revenue, exclusive of depreciation and amortization, shown below
Customer support
Product development
Sales and marketing
General and administrative
Depreciation and amortization
Amortization of deferred stock compensation
Pre-acquisition liability adjustment
Restructuring costs
Gain on disposals of property and equipment
Total operating costs and expense
Loss from operations
Non-operating (income) expense:
Interest expense
Interest income
Other, net
Total non-operating (income) expense
Net loss
Less deemed dividend related to beneficial conversion feature
Net loss attributable to common stockholders
Basic and diluted net loss per share
81,958
10,670
4,864
25,864
20,096
15,314
60
–
44
(19)
158,851
(5,134)
1,373
(1,284)
(259)
(170)
(4,964)
–
$ (4,964)
$
(0.01)
Weighted average shares used in computing basic and diluted net loss per share
339,387
The accompanying notes are an integral part of these consolidated financial statements.
76,990
10,180
6,412
23,411
24,772
16,040
–
–
3,644
(3)
161,446
(16,900)
1,981
(665)
(154)
1,162
(18,062)
–
$ (18,062)
$
(0.06)
287,315
78,200
9,483
6,982
21,491
16,711
37,221
390
(1,313)
1,084
(53)
170,196
(31,616)
2,981
(823)
827
2,985
(34,601)
(34,576)
$ (69,177)
$
(0.40)
174,602
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
AND COMPREHENSIVE LOSS
For the Three Years Ended December 31, 2005
Series A
Convertible
Preferred Stock
Common Stock
Shares
Par
Value
Shares
Par
Value
Additional
Paid-In
Capital
Deferred
Stock
Compensation
Accumulated
Deficit
Accumulated
Items of
Comprehensive
Income (Loss)
Total
Stockholders’
Equity
–
$
–
160,094
$160
$798,344
$(396)
$ (802,485)
$ 149
$ (4,228)
–
–
–
–
–
–
–
–
–
–
–
–
(34,601)
–
–
151
(In thousands)
Balance, January 1, 2003
Net loss
Other comprehensive income
Total comprehensive loss
Conversion of Series A convertible preferred stock into
common stock before reclassification to stockholders’ equity
–
–
Reclassification of preferred stock to stockholders’ equity
2,888
78,589
953
–
1
–
1,201
–
Conversion of Series A convertible preferred stock into
common stock after reclassification to stockholders’ equity
(1,483)
(40,338)
49,668
50
40,288
Amortization of deferred stock compensation and reversal
for terminated employees
Stock compensation plans and warrant activity
Issuance of common stock to non-employees
–
–
–
–
–
–
Issuance of stock in conjunction with acquisitions
346
13,590
Record embedded beneficial conversion feature charge
related to Series A preferred stock
–
(34,576)
Amortize deemed dividend related to beneficial conversion feature
–
34,576
–
3,689
12,926
1,421
–
–
–
4
13
1
–
–
(6)
2,084
11,480
1,849
34,576
(34,576)
Balance, December 31, 2003
Net loss
Other comprehensive income
Total comprehensive loss
1,751
51,841
228,751
229
855,240
–
–
–
–
–
–
–
–
59
40
10
–
–
51,782
55,892
5,037
Conversion of Series A convertible preferred stock
(1,751)
(51,841)
Issuance of common stock, net of issuance cost
Stock compensation plans and warrant activity
Balance, December 31, 2004
Net loss
Other comprehensive loss
Total comprehensive loss
–
–
–
–
–
–
–
–
–
–
58,994
40,250
10,153
338,148
338
967,951
–
–
–
–
–
–
Deferred stock compensation grant
–
–
–
–
480
(34,601)
151
(34,450)
1,202
78,589
–
390
2,088
11,493
15,440
–
–
70,524
(18,062)
297
(17,765)
–
55,932
5,047
–
–
–
–
–
–
–
–
–
(837,086)
(18,062)
–
–
–
–
–
–
–
–
–
–
–
–
–
300
–
297
–
–
–
(855,148)
597
113,738
(4,964)
–
–
–
–
(592)
–
(4,964)
(592)
(5,556)
–
60
–
1,486
–
–
–
396
–
–
–
–
–
–
–
–
–
–
–
–
–
–
(480)
60
–
Amortization of deferred stock compensation
Stock compensation plans activity
Balance, December 31, 2005
–
–
3,529
4
1,482
– $
–
341,677
$342
$969,913
$(420)
$(860,112)
$
5
$109,728
The accompanying notes are an integral part of these consolidated financial statements.
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CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Cash flows from operating activities:
Net loss
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Depreciation and amortization
Gain on disposal of property and equipment, net
Provision for doubtful accounts
(Gain) loss on equity-method investment, net
Non-cash interest expense on capital lease obligations
Non-cash changes in deferred rent
Lease incentives
Pre-acquisition liability adjustment
Non-cash compensation expense
Other, net
Changes in operating assets and liabilities, net of the effect of acquisitions:
Accounts receivable
Inventory, prepaid expense and other assets
Accounts payable
Accrued liabilities
Deferred revenue
Accrued restructuring
Net cash flows provided by (used in) operating activities
Cash flows from investing activities:
Purchases of property and equipment
Proceeds from disposal of property and equipment
Reduction of restricted cash
Purchase of investments in marketable securities
Maturities of marketable securities
Net cash received from acquired businesses
Other, net
Net cash flows (used in) provided by investing activities
Cash flows from financing activities:
Change in revolving credit facility
Proceeds from notes payable
Principal payments on notes payable
Payments on capital lease obligations
Proceeds from issuance of common stock, net of issuance costs
Proceeds from stock options, employee stock purchase plan, and exercise of warrants
Other, net
Net cash flows (used in) provided by financing activities
Net (decrease) increase in cash and cash equivalents
Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period
Supplemental disclosure of cash flow information:
Cash paid for interest, net of amounts capitalized
Non-cash acquisition of property and equipment
Change in accounts payable attributable to purchases of property and equipment
Issuance of stock related to capital lease amendment
Deferred stock compensation grant
Conversion of preferred stock to common stock
Value of stock issued for acquisitions
The accompanying notes are an integral part of these consolidated financial statements.
Year Ended December 31,
2005
2004
2003
$ (4,964)
$(18,062)
$(34,601)
15,314
(19)
1,431
(83)
–
2,690
713
–
75
(44)
(3,616)
(170)
(5,433)
805
1,023
(1,876)
5,846
(10,161)
17
76
(18,710)
19,350
–
(353)
(9,781)
–
–
(6,483)
(512)
–
1,471
70
(5,454)
(9,389)
33,823
$ 24,434
$ 1,223
971
(381)
–
480
–
–
16,040
(3)
2,415
390
904
879
–
–
–
176
(3,771)
1,633
851
(1,316)
(1,743)
457
(1,150)
(13,066)
51
49
(16,753)
–
–
60
(29,659)
(8,392)
17,500
(4,051)
(20,289)
55,932
5,047
–
45,747
14,938
18,885
$ 33,823
$ 1,767
1,597
(2,733)
–
–
51,841
–
37,221
(53)
2,435
827
1,304
915
–
(1,313)
390
–
(2,704)
2,583
(5,941)
(1,115)
(4,461)
(6,662)
(11,175)
(3,799)
–
2,053
–
–
2,307
–
561
(1,608)
–
(4,645)
(2,801)
9,299
4,035
–
4,280
(6,334)
25,219
$ 18,885
$ 1,170
125
(7)
250
–
41,540
15,440
NOTES
Notes to Consolidated Financial Statements
1. DESCRIPTION OF THE COMPANY AND
NATURE OF OPERATIONS
Internap Network Services Corporation (“Internap,” “we,” “us,” “our” or
the “Company”) provides high performance, managed Internet connec-
tivity solutions to business customers who require guaranteed network
availability and high performance levels for business-critical applica-
tions, such as e-commerce, customer relationship management (CRM),
multimedia streaming, Voice over Internet Protocol (VoIP), virtual private
networks (VPNs) and supply chain management. We deliver services
through our 38 network access points, which feature multiple direct
high-speed connections to major Internet networks.
We have a limited operating history and our operations are subject to
certain risks and uncertainties frequently encountered by rapidly evolv-
ing markets. These risks include the failure to develop or supply tech-
nology or services, the ability to obtain adequate financing, competition
within the industry and technology trends.
We have significant net operating losses since inception. During 2005,
we incurred net losses of $5.0 million. As of December 31, 2005, we
have an accumulated deficit of $860.1 million. We have taken various
steps to control our costs, including decreasing the size of our work-
force, terminating certain real estate leases and commitments, making
process enhancements and renegotiating network contracts for more
favorable pricing and terms.
On March 4, 2004, we sold 40.25 million shares of our common stock
in a public offering at a purchase price of $1.50 per share which
resulted in net proceeds to us of $55.9 million, after deducting under-
writing discounts and commissions and offering expense. We continue
to use the net proceeds from the offering for general corporate pur-
poses. General corporate purposes primarily include capital investments
in our network access point infrastructure and systems, expansion of
data center facilities and repayment of debt and capital lease obliga-
tions. General corporate purposes could also include potential acquisi-
tions of complementary businesses or technologies.
Effective September 14, 2004, all shares of our outstanding series A
convertible preferred stock were mandatorily converted into common
stock in accordance with the terms of our Certificate of Incorporation.
An aggregate of 1.7 million shares of convertible preferred stock with a
recorded value of $49.6 million was converted into 56.2 million shares
of common stock upon the mandatory conversion. Accordingly, we had
no shares of series A convertible preferred stock outstanding subse-
quent to the mandatory conversion. The mandatory conversion had
no effect on the outstanding warrants to purchase common stock that
were issued in conjunction with the series A preferred stock.
Our liquidity and capital requirements depend on several factors, includ-
ing the rate of market acceptance of our services, the ability to expand
and retain our customer base, the rate of expansion of new data centers
and Private Network Access Points, (P-NAP®s), our ability to execute our
current business plan and other factors. If we fail to generate sufficient
cash flow from operations, we may require additional financing sooner
than anticipated. We cannot assure such financing will be available
on commercially favorable terms or at all.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Accounting principles
The consolidated financial statements and accompanying notes are pre-
pared in accordance with accounting principles generally accepted in the
United States of America. The consolidated financial statements include
the accounts of Internap and all majority owned subsidiaries. Significant
inter-company transactions have been eliminated in consolidation.
Estimates and assumptions
Our consolidated financial statements have been prepared in accordance
with accounting principles generally accepted in the United States of
America. The preparation of these financial statements requires manage-
ment to make estimates and judgments that affect the reported amounts
of assets, liabilities, revenue and expense, and related disclosure of
contingent assets and liabilities. On an ongoing basis, we evaluate our
estimates, including those related to revenue recognition, doubtful accounts,
cost-basis investments, intangible assets, income taxes, restructuring
costs, long-term service contracts, contingencies and litigation. We base
our estimates on historical experience and on various other assumptions
that are believed to be reasonable under the circumstances, the results
of which form the basis for making judgments about the carrying values
of assets and liabilities that are not readily apparent from other sources.
Actual results may differ materially from these estimates.
Cash and cash equivalents
We consider all highly liquid investments purchased with an original
maturity of three months or less at the date of purchase and money market
mutual funds to be cash equivalents. We invest our cash and cash equiva-
lents with major financial institutions and may at times exceed federally
insured limits. We believe that the risk of loss is minimal. To date, we have
not experienced any losses related to cash and cash equivalents.
At December 31, 2004 we had placed $0.1 million in restricted cash
accounts to collateralize letters of credit with financial institutions. These
amounts are reported separately as restricted cash and are classified as
current or non-current assets based on their respective maturity dates.
There were no restricted cash accounts as of December 31, 2005.
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NOTES
Notes to Consolidated Financial Statements
Investments in marketable securities
Fair value of financial instruments
Marketable securities primarily include high credit quality corporate
debt securities and U.S. Government Agency debt securities. Manage-
ment determines the appropriate classification of marketable securities
at the time of purchase. At December 31, 2005 and 2004, all market-
able securities are classified as available-for-sale. Available-for-sale
securities are carried at fair value, with the unrealized gains and losses
reported in other comprehensive income. Our marketable securities
are reviewed each reporting period for declines in value that are con-
sidered to be other-than temporary and, if appropriate, written down
to their estimated fair value. Realized gains and losses and declines in
value judged to be other-than-temporary on available-for-sale securities
are included in other non-operating income (expense) in the consolidated
statements of operations. The cost of securities sold is based on the
specific identification method. Interest and dividends on securities
classified as available-for-sale are included in interest income in the
consolidated statements of operations.
Our short-term financial instruments, including cash and cash equiva-
lents, accounts receivable, accounts payable, notes payable, and capital
lease obligations are carried at cost. The cost of our short-term financial
instruments approximate fair value due to their relatively short maturities.
Our marketable investments are designated as available for sale and are
recorded at fair value with changes in fair value reflected in other com-
prehensive income. The carrying value of our long-term financial instru-
ments, including notes payable and capital lease obligations, approximate
fair value as the interest rates approximate current market rates of similar
debt obligations.
Management evaluates outstanding accounts receivable each period for
collectibility. This evaluation involves assessing the aging of the amounts
due to the Company and reviewing the credit-worthiness of customers.
Based on this evaluation, we record an allowance for accounts receiv-
able that are estimated to not be collectible.
Other investments
Credit risk
We account for investments without readily determinable fair values at
historical cost, as determined by our initial investment. The recorded
value of cost basis investments is periodically reviewed to determine
the propriety of the recorded basis. When a decline in the value that is
judged to be other than temporary has occurred based on available
data, the cost basis is reduced and an investment loss is recorded.
We have a $1.2 million equity investment at December 31, 2005 in
Aventail Corporation (Aventail), an early stage, privately held company,
after having reduced the balance for an impairment loss of $4.8 million
in 2001. The carrying value of our investment in Aventail is recorded
in non-current investments in the accompanying consolidated
balance sheet.
Financial instruments that potentially subject us to a concentration of
credit risk principally consist of cash, cash equivalents, marketable
securities and trade receivables. We currently invest the majority of our
cash in money market funds and maintain them with financial institutions
with high credit ratings. We also invest in debt instruments of the U.S.
government and its agencies and corporate issuers with high credit
ratings. As part of our cash management process, we perform periodic
evaluations of the relative credit ratings of these financial institutions.
We have not experienced any credit losses on our cash, cash equiva-
lents or marketable securities.
Inventory
We account for investments that provide us with the ability to exercise
significant influence, but not control, over an investee using the equity
method of accounting. Significant influence, but not control, is gener-
ally deemed to exist if we have an ownership interest in the voting
stock of the investee of between 20% and 50%, although other factors,
such as minority interest protections, are considered in determining
whether the equity method of accounting is appropriate. As of Decem-
ber 31, 2005, Internap Japan Co. Ltd. (Internap Japan), our joint
venture with NTT-ME Corporation of Japan and another NTT affiliate,
qualifies for equity method accounting. We record our proportional
share of the income and losses of Internap Japan one month in arrears
on the consolidated balance sheets as a component of non-current
investments and our share of Internap Japan’s losses and income as
other income, net on the consolidated statement of operations.
Inventory is carried at the lower of cost or market using the first-in,
first-out method. Cost includes materials related to the production
of our Flow Control Platform (FCP) and our Flow Control Xcelerator
(FCX) solutions.
Property and equipment
Property and equipment are carried at original acquisition cost less
accumulated depreciation and amortization. Depreciation and amortiza-
tion are calculated on a straight-line basis over the lesser of the estimated
useful lives of the assets or the lease term. Estimated useful lives used
for network equipment are generally three years; furniture, equipment
and software are three to seven years; and leasehold improvements are
seven years or over the lease term, depending on the nature of the
improvement, but in no event beyond the lease term. The duration of
NOTES
Notes to Consolidated Financial Statements
lease obligations and commitments range from 24 months for certain
networking equipment to 240 months for certain facility leases. Addi-
tions and improvements that increase the value or extend the life of an
asset are capitalized. Maintenance and repairs are expensed as incurred.
Gains or losses from disposals of property and equipment are charged
to operations.
Leases and leasehold improvements
We record leases as capital or operating leases and account for lease-
hold improvements in accordance with Statement of Financial Accounting
Standards (SFAS) No. 13, “Accounting for Leases” and related literature.
Rent expense for operating leases is recorded in accordance with Finan-
cial Accounting Standards Board (FASB) Technical Bulletin (FTB) No. 88-1,
“Issues Relating to Accounting for Leases.” This FTB requires lease
agreements that include periods of free rent or other incentives, specific
escalating lease payments, or both, to be recorded on a straight-line or
other systematic basis over the initial lease term and those renewal
periods that are reasonably assured. The difference between rent
expense and rent paid is recorded as deferred rent in non-current
liabilities in the consolidated balance sheets.
Research and product development costs
Product development costs are primarily related to network engineering
costs associated with changes to the functionality of our proprietary ser-
vices and network architecture. Such costs that do not qualify for capi-
talization as software development are expensed as incurred. Research
and development costs, which are included in product development cost
and are expensed as incurred, primarily consist of compensation related
to our development and enhancement of IP Routing Technology, the FCP
and BusinessNet acceleration technologies. Research and development
costs were $2.9 million, $2.4 million and $1.5 million for the years
ended December 31, 2005, 2004 and 2003, respectively.
Costs of computer software development
For the year ended December 31, 2005 we capitalized $0.4 million
of costs for internally developed software in accordance with SFAS
No. 86, “Accounting for the Costs of Computer Software to Be Sold,
Leased or Otherwise Marketed.” No amounts were capitalized for the
year ended December 31, 2004 or 2003.
Goodwill and other intangible assets
In accordance with SFAS No. 142 “Goodwill and Other Intangible Assets,”
we review our goodwill for impairment annually, or more frequently,
if facts and circumstances warrant a review. The provisions of SFAS
No. 142 require that a two-step test be performed to assess goodwill
for impairment. First, the fair value of each reporting unit is compared
to its carrying value. If the fair value exceeds the carrying value, good-
will is not impaired and no further testing is performed. The second
step is performed if the carrying value exceeds the fair value. The implied
fair value of the reporting unit’s goodwill must be determined and com-
pared to the carrying value of the goodwill. If the carrying value of a
reporting unit’s goodwill exceeds its implied fair value, an impairment
loss equal to the difference will be recorded. We completed our annual
goodwill impairment test as of August 1, 2005 and determined that the
carrying amount of goodwill was not impaired.
Other acquired intangible assets, including developed technologies
and patents, have finite lives and we have recorded these assets at
cost less accumulated amortization. Amortization is calculated on a
straight-line basis over the estimated economic useful life of the
assets, which is three to seven years for developed technologies
and 15 years for patents.
Valuation of long-lived assets
Management periodically evaluates the carrying value of its long-lived
assets, including, but not limited to, property and equipment pursuant to
the guidance provided by SFAS No. 144, “Accounting for the Impairment
and Disposal of Long-Lived Assets”. The carrying value of a long-lived
asset is considered impaired when the undiscounted cash flow from
such asset is separately identifiable and is estimated to be less than its
carrying value. In that event, a loss is recognized based on the amount
by which the carrying value exceeds the fair value of the long-lived
asset. Fair value is determined primarily using the anticipated cash
flows discounted at a rate commensurate with the risk involved. Losses
on long-lived assets to be disposed of would be determined in a similar
manner, except that fair values would be reduced by the cost of dis-
posal. Losses due to impairment of long-lived assets are charged to
operations during the period in which the impairment is identified.
Income taxes
In accordance with the American Institute of Certified Public Accountants’
Statement of Position 98-1, “Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use,” we capitalize certain
direct costs incurred developing internal use software. We capitalized
$1.9 million in internal software development costs for the year ended
December 31, 2004. We did not capitalize any costs for the years ended
December 31, 2005 or 2003.
We account for income taxes under the liability method. Deferred tax
assets and liabilities are determined based on differences between
financial reporting and tax bases of assets and liabilities, and are
measured using the enacted tax rates and laws that will be in effect
when the differences are expected to reverse. We provide a valuation
allowance to reduce our deferred tax assets to their estimated
realizable value.
NOTES
Notes to Consolidated Financial Statements
Stock-based compensation
As of December 31, 2005, we had three active stock-based employee
compensation plans, which are described more fully in note 15. We
have adopted the disclosure only provisions of SFAS No. 123, “Account-
ing for Stock-Based Compensation” and therefore account for the plans
under the recognition and measurement principles of Accounting
Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to
Employees,” and related interpretations. The following table illustrates
the effect on net loss and loss per share if we had applied the fair value
recognition provisions of SFAS No. 123 to stock-based employee
compensation (in thousands, except per share amounts).
Year Ended December 31,
2005
2004
2003
$ (4,964) $(18,062) $(34,601)
Net loss, as reported
Add: stock-based employee
compensation expense included
in reported net loss
75
–
390
Adjust: total stock-based employee
compensation expense determined
under fair value based method
for all awards
Pro forma net loss
(9,678)
(15,364)
(8,362)
$(14,567) $(33,426) $(42,573)
Loss per share:
Basic and diluted – as reported
Basic and diluted – pro forma
$ (0.01) $ (0.06) $ (0.40)
(0.44)
(0.12)
(0.04)
As described in note 15, our newly appointed President and Chief Execu-
tive Officer was awarded 1.0 million shares of restricted stock on Septem-
ber 30, 2005. For the year ended December 31, 2005, the amortization
related to this restricted stock grant was $60,000. In conjunction with
providing transition services in December 2005, the Vice Chair of our
Board of Directors was granted 36,586 shares of fully-vested restricted
stock with an aggregate value of $15,000. The expense related to these
shares is included in general and administrative expenses on the consoli-
dated statement of income for the year ended December 31, 2005.
The $9.7 million, $15.4 million, and $8.4 million increases to the pro
forma employee compensation expense during 2005, 2004 and 2003,
respectively, were inclusive of reductions for the effect related to options
cancelled as a result of employee terminations, offset by amortization of
compensation determined under the fair-value based method.
The fair value of options granted in each year during the three years
ended December 31, 2005 was estimated at the date of grant using the
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Black-Scholes model assuming no expected dividends and the
following weighted average assumptions:
Risk free interest rate
Volatility
Expected life
Year Ended December 31,
2005
2004
2003
4.22%
118%
4 years
4.27%
142%
4 years
4.01%
144%
4 years
Revenue recognition and concentration of credit risk
The majority of our revenue is derived from high-performance Internet
connectivity and related data center services. Our revenues are generated
primarily from the sale of Internet connectivity services at fixed rates or
usage-based pricing to our customers that desire a DS-3 or faster con-
nection and other ancillary services, such as data center services, content
distribution, server management and installation services, virtual private
networking services, managed security services, data backup, remote
storage and restoration services, and video conferencing services. We
also offer T-1 and fractional DS-3 connections at fixed rates.
We recognize revenue when persuasive evidence of an arrangement exists,
the product, service or software license has been delivered, the fees are
fixed or determinable and collectibility is probable. Contracts and sales or
purchase orders are used to determine the existence of an arrangement.
We test for availability or use shipping documents when applicable to verify
delivery of our services, products or software licenses. We assess whether
the fee is fixed or determinable based on the payment terms associated with
the transaction and whether the sales price is subject to refund or adjustment.
Deferred revenue consists of revenue for services to be delivered in the
future and consists primarily of advance billings, which are amortized over
the respective service period. Revenue associated with billings for installa-
tion of customer network equipment are deferred and amortized over the
estimated life of the customer relationship (generally two years), as the
installation service is integral to our primary service offering and does not
have value to a customer on a stand-alone basis. Deferred post-contract
customer support associated with sales of our FCP solution and similar
products are amortized ratably over the contract period (generally one year).
We routinely review the creditworthiness of our customers. If we deter-
mine that collection of service revenue is uncertain, we do not recognize
revenue until cash has been collected. Additionally, we maintain allowances
for doubtful accounts resulting from the inability of our customers to make
required payments on accounts receivable. The allowance for doubtful
accounts is based upon specific and general customer information,
NOTES
Notes to Consolidated Financial Statements
which also includes estimates based on management’s best understand-
ing of our customers’ ability to pay. Customers’ ability to pay takes into
consideration payment history, legal status (i.e., bankruptcy), and the
status of services we are providing. Once all collection efforts have been
exhausted, we write the uncollectible balance off against the allowance
for doubtful accounts. We also estimate a reserve for sales adjustments,
which reduces net accounts receivable and revenue. The reserve for
sales adjustments is based upon specific and general customer infor-
mation, including outstanding promotional credits, customer disputes,
credit adjustments not yet processed through the billing system and
historical activity. If the financial condition of our customers were to
deteriorate, or management becomes aware of new information impact-
ing a customer’s credit risk, additional allowances may be required.
Advertising costs
We expense all advertising costs as they are incurred. Advertising costs
for 2005, 2004 and 2003 were $0.2 million, $1.3 million and $0.9 mil-
lion, respectively.
Net loss per share
Basic and diluted net loss per share has been computed using the
weighted average number of shares of common stock outstanding
during the period. We have excluded all outstanding convertible
preferred stock and outstanding options and warrants to purchase
common stock from the calculation of diluted net loss per share,
as such securities are anti-dilutive for all periods presented
(in thousands, except per share amounts).
Net loss
Less deemed dividend related to
beneficial conversion feature
Net loss attributable to common
stockholders
Basic and diluted:
Weighted average shares of common
stock outstanding used in computing
basic and diluted net loss per share
Year Ended December 31,
2005
2004
2003
$ (4,964) $(18,062) $(34,601)
–
–
(34,576)
$ (4,964) $(18,062) $(69,177)
339,387 287,315 174,602
Basic and diluted net loss per share
$ (0.01) $ (0.06) $ (0.40)
Anti-dilutive securities not included
in diluted net loss per share calculation:
Series A convertible preferred stock
Options to purchase common stock
Restricted stock
Warrants to purchase common stock
–
35,562
1,000
14,998
–
43,949
–
14,998
58,994
39,161
–
17,133
51,560
58,947
115,288
Segment information
We use the management approach for determining which, if any, of our
products and services, locations, customers or management structures
constitute a reportable business segment. The management approach
designates the internal organization that is used by management for
making operating decisions and assessing performance as the source
of any reportable segments. Management uses one measurement of
profitability and does not disaggregate its business for internal reporting
and therefore operates in a single business segment. Through Decem-
ber 31, 2005, product revenue was not significant nor were long-lived
assets located and revenue generated outside the United States.
Recent accounting pronouncements
In June 2005, FASB issued SFAS No. 154, “Accounting for Changes
and Error Corrections – A Replacement of APB Opinion No. 20 and
FASB Statement No.3” to prescribe the related accounting and disclo-
sures. The provisions of SFAS No. 154 are effective for changes and
error corrections made in fiscal years beginning after December 15, 2005.
We will adopt this pronouncement on January 1, 2006.
In December 2004, FASB issued SFAS No. 123 (revised 2004), “Share-
Based Payment,” which is known as SFAS No. 123(R). SFAS No. 123(R)
replaces SFAS No. 123, as amended by SFAS No. 148, “Accounting
for Stock-Based Compensation – Transition and Disclosure – an
Amendment of FASB Statement No. 123.” Among other things, SFAS
No. 123(R) eliminates the alternative to use the intrinsic value method
of accounting for stock-based compensation. SFAS No. 123(R) requires
public entities to recognize compensation expense for awards of equity
instruments to employees based on the grant-date fair value of the
awards. On March 29, 2005, the SEC issued Staff Accounting Bulletin
(SAB) No. 107, providing the SEC Staff’s view regarding the interaction
between SFAS No. 123(R) and certain SEC rules and regulations, and
the valuation of share-based payment arrangements. On April 15, 2005,
the SEC amended Rule 4-01(a) of Regulation S-X, extending the effec-
tive date of SFAS No. 123(R) to the first annual reporting period of the
registrant’s first fiscal year beginning on or after June 15, 2005.
We will adopt the provisions of SFAS No. 123(R), subsequent FASB
Staff Positions, and guidance in SAB No. 107, beginning in the first
quarter of 2006. We are evaluating the requirements under SFAS No.
123(R) and expect the adoption to have a significant adverse impact on
our consolidated statements of operations and net income per share,
comparable to our pro forma disclosure under SFAS No. 123. See
“Stock-Based Compensation” above for the pro forma net loss and net
loss per share amounts, for years 2003 through 2005, as if we had
used a fair-value-based method similar to the methods required under
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NOTES
Notes to Consolidated Financial Statements
SFAS No. 123(R) to measure compensation expense for employee
stock incentive awards. However, the actual effect on net income or
loss and earnings or loss per share after adopting SFAS No. 123(R) will
vary depending upon the number of options granted in 2006 compared
to prior years. In addition, we will also recognize compensation expense
related to our employee stock purchase plan for the six-month purchase
period ending June 30, 2006. We have modified our employee stock
purchase plan to make it a non-compensatory plan for all purchase
periods subsequent to June 30, 2006.
3. IMPAIRMENT AND RESTRUCTURING COSTS
With overcapacity created in the Internet connectivity market and IP
Services market, we implemented restructuring plans that resulted in
significant charges in 2001 and 2002. Additional charges were also
incurred during 2003 and 2004 as we continued to evaluate our
restructuring reserve.
For the year ended December 31, 2003, we incurred $1.1 million in
restructuring costs which primarily represented retention bonuses and
moving expense related to the relocation of our corporate office to
Atlanta, Georgia from Seattle, Washington.
We incurred net additional restructuring costs of $3.6 million during
2004 as a result of a comprehensive analysis of the remaining accrued
restructuring liability. After reviewing the analysis, management concluded
that the facilities remaining in the restructuring accrual were taking lon-
ger than expected to sublease and those that were subleased resulted
in lower than expected sublease rates. Consequently, the projected
obligations exceeded the unadjusted liability by $5.3 million over the
remaining lease terms, with the last commitment expiring in July 2015.
During the quarter ended September 30, 2004, all other remaining
contractual obligations for network infrastructure and other costs
included in the restructuring were satisfied and we reduced the remain-
ing recorded liability for the obligations from $1.7 million to zero.
The following table displays the activity and balances for restructuring and asset impairment activity for 2003 (in thousands):
Restructuring costs activity for 2001 restructuring charge:
Real estate obligations
Network infrastructure obligations
Other
Restructuring costs activity for 2002 restructuring charge:
Real estate obligations
Personnel
Other
Net asset write-downs for 2002 restructuring charge
December 31, 2002
Restructuring
Liability
Restructuring
Charge
Cash
Reductions
December 31, 2003
Restructuring
Liability
$10,319
1,297
1,008
1,800
–
100
14,524
(139)
$ –
–
–
1,084
–
1,084
–
$14,385
$1,084
$(4,476)
(172)
(141)
(1,800)
(1,084)
(100)
(7,773)
–
$(7,773)
$5,843
1,125
867
–
–
–
7,835
(139)
$7,696
The $1.1 million recorded during 2003 as restructuring reserves related to general and administrative costs.
The following table displays the activity and balances for restructuring and asset impairment activity for 2004 (in thousands):
Restructuring costs activity for 2001 restructuring charge:
Real estate obligations
Network infrastructure obligations
Other
Net asset write-downs for 2002 restructuring charge
December 31, 2003
Restructuring
Liability
Restructuring
Charge
(Benefit)
Cash
Reductions
December 31, 2004
Restructuring
Liability
$5,843
1,125
867
7,835
(139)
$7,696
$5,323
(951)
(867)
3,505
139
$3,644
$(3,013)
(174)
–
(3,187)
–
$(3,187)
$8,153
–
–
8,153
–
$8,153
Of the $5.3 million recorded during 2004 as additional real estate restructuring charges, $3.0 million related to the direct cost of revenue and
$2.3 million related to general and administrative costs.
NOTES
Notes to Consolidated Financial Statements
The following table displays the activity and balances for restructuring and asset impairment activity for 2005 (in thousands):
December 31, 2004
Restructuring
Liability
Restructuring
Charge
Cash
Reductions
December 31, 2005
Restructuring
Liability
Restructuring costs activity for 2001 restructuring charge:
Real estate obligations
$8,153
$44
$(1,920)
$6,277
Restructuring charges totaling less than $0.1 million during 2005 primarily resulted from a change in estimated expenses related to real estate obligations.
4. BUSINESS COMBINATIONS
The purchase price allocation for Sockeye was as follows (in thousands):
$ 864
20
291
109
1,284
926
$2,210
$ 79
281
1,850
$2,210
On October 1, 2003, we completed our acquisition of netVmg, Inc. (netVmg)
which enables customers to manage Internet traffic cost, performance and
operations decisions directly from their corporate locations. The acquisition
was recorded using the purchase method of accounting under SFAS
No. 141, “Business Combinations.” The aggregate purchase price of the
acquired company, plus related charges, was $13.7 million and was
comprised of 0.3 million shares of our preferred stock, acquisition costs
and warrants to purchase 1.5 million shares of our common stock.
The purchase price allocation for netVmg was as follows (in thousands):
Cash acquired
Restricted cash
Property and equipment
Other tangible assets
Tangible assets acquired
Goodwill
Total assets acquired
Acquisition expense incurred
Liabilities assumed
Value of stock issued
Cash acquired
Restricted cash
Inventory
Property and equipment
Other tangible assets
Tangible assets acquired
Product technology
Goodwill
Intangible assets acquired
Total assets acquired
Acquisition expense incurred
Liabilities assumed
Value of stock issued
$ 1,443
105
421
531
80
2,580
3,311
8,216
11,527
$14,107
$ 79
438
13,590
Total liabilities assumed and preferred stock issued
$14,107
On October 15, 2003, we completed our acquisition of Sockeye Networks,
Inc., (Sockeye). The acquisition was recorded using the purchase method
of accounting under SFAS No. 141. The aggregate purchase price of the
acquired company, plus related charges, was $1.9 million and was com-
prised of 1,420,775 shares of our common stock and acquisition costs.
Total liabilities assumed and common stock issued
In accordance with SFAS No. 141, all identifiable assets were assigned a
portion of the purchase price of the acquired companies on the basis of
their respective fair values. Intangible assets other than goodwill are
amortized over their average estimated useful lives of three to seven years
(with a weighted-average life of 6.5 years). The value assigned to the
identifiable intangible assets was based on an analysis performed by an
independent third party as of the date of the acquisitions. Pro forma results
of operations have not been presented because the effects of these
acquisitions were not material on either an individual or aggregate basis
to our results of operations. Goodwill is not deductible for tax purposes
from either of the acquisitions.
As part of our acquisition of CO Space, Inc (CO Space) on June 20, 2000,
we recorded a pre-acquisition liability of $1.3 million for network equip-
ment purchased by CO Space. During 2003, we reevaluated the likelihood
of settling the liability related to this equipment and concluded that a
contingent obligation no longer exists. Therefore, the liability was eliminated
resulting in a one-time reduction in costs and expense of $1.3 million.
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Notes to Consolidated Financial Statements
5. INVESTMENTS
We maintain a 51% ownership interest in Internap Japan, a joint venture
with NTT-ME Corporation of Japan and another NTT affiliate. We are unable
to assert control over the joint venture’s operational and financial policies
and practices required to account for the joint venture as a subsidiary
whose assets, liabilities, revenue and expense would be consolidated (due
to certain minority interest protections afforded to our joint venture partners).
We are, however, able to assert significant influence over the joint venture
and, therefore, account for our joint venture investment using the equity-
method of accounting pursuant to APB Opinion No. 18 “The Equity Method
of Accounting for Investments in Common Stock” and consistent with
Emerging Issues Task Force No. 96-16 “Investor’s Accounting for an
Investee When the Investor Has a Majority of the Voting Interest but the
Minority Shareholder or Shareholders Have Certain Approval or Veto Rights.”
Our investment activity in the joint venture is as follows (in thousands):
Summaries of our investments in marketable securities are as follows
(in thousands):
Short-term investments in
marketable securities
Short-term investments in
marketable securities
Investments in marketable securities,
non-current
As of December 31, 2005
Cost Unrealized Recorded
Value
Loss
Basis
$16,113
$(53) $16,060
As of December 31, 2004
Cost Unrealized Recorded
Value
Basis Gain (Loss)
$12,083
$ 79
$12,162
4,671
(15)
4,656
$16,754
$ 64
$16,818
Investment balance, January 1,
Proportional share of net income (loss)
Unrealized foreign currency
translation (loss) gain, net
2005
$861
83
2004
2003
$1,195
(390)
$1,870
(827)
During the years ended December 31, 2005 and 2004, we recorded a
net unrealized holding loss of $0.1 million and a net unrealized holding
gain of less than $0.1 million, respectively.
(121)
56
152
6. PROPERTY AND EQUIPMENT
Investment balance, December 31,
$823
$ 861
$1,195
We account for investments without readily determinable fair values at
cost. Realized gains and losses and declines in value of securities judged
to be other than temporary are included in other expense. On February 22,
2000, pursuant to an investment agreement, we purchased 588,236
shares of Aventail series D preferred stock at $10.20 per share for a total
cash investment of $6.0 million. Aventail is a privately held enterprise
for which no active market for its securities exists. In connection with
Aventail’s 2001 round of financing, we concluded that our investment
in Aventail had experienced a decline in value that was other than
temporary. As a result, during 2001 we recognized a $4.8 million loss
on investment when we reduced its recorded basis to $1.2 million,
which remains its estimated value as of December 31, 2005.
Investments in marketable securities primarily include high credit
quality corporate debt securities and U.S. Government Agency debt
securities. These investments are classified as available for sale and
are recorded at fair value with changes in fair value reflected in other
comprehensive income. All proceeds were from the maturity of the
securities, not from sales. Accordingly, we have not recognized any
realized gains or losses.
Property and equipment consists of the following (in thousands):
Network equipment
Network equipment under capital lease
Furniture, equipment and software
Leasehold improvements
December 31,
2005
2004
$ 87,467 $ 95,149
1,596
32,319
63,314
1,596
31,571
73,124
Property and equipment, gross
Less: Accumulated depreciation and amortization
($843 and $310 related to capital leases at
December 31, 2005 and 2004, respectively)
193,758
192,378
(143,686)
(138,000)
$ 50,072 $ 54,378
During 2005 and 2004, $8.4 million and $3.5 million of fully
depreciated assets were retired. Depreciation and amortization
expense for property and equipment was $14.7 million, $15.5 million,
and $33.9 million during 2005, 2004, and 2003, respectively.
NOTES
Notes to Consolidated Financial Statements
7. GOODWILL AND OTHER INTANGIBLE ASSETS
8. ACCRUED LIABILITIES
We perform our annual goodwill impairment test as of August 1 of each
calendar year. With the assistance of a third party valuation expert, we
estimated the fair value of our reporting units utilizing a discounted cash
flow method. Based on the results of these analyses our goodwill was
not impaired as of August 1, 2005.
The assumptions, inputs and judgments used in performing the valua-
tion analysis are inherently subjective and reflect estimates based on
known facts and circumstances at the time the valuation is performed.
The use of different assumptions, inputs and judgments, or changes in
circumstances, could materially affect the results of the valuation.
Adverse changes in the valuation would necessitate an impairment
charge for the goodwill held by us. As of December 31, 2005 and
2004, the recorded amount of goodwill totaled $36.3 million.
Generally, any adjustments made as a result of the impairment testing
are required to be recognized as operating expense. We will continue to
perform our annual impairment testing as of August 1 each year absent
any impairment indicators that may cause more frequent analysis, as
required by SFAS No. 142 “Goodwill and Other Intangible Assets.”
The components of our amortizing intangible assets are as follows
(in thousands):
December 31, 2005
December 31, 2004
Gross
Gross
Carrying Accumulated
Amount Amortization
Carrying Accumulated
Amount Amortization
Contract based
Technology based
$14,518
5,911
$(14,263)
(3,837)
$14,518
5,911
$(14,234)
(3,297)
$20,429
$(18,100)
$20,429
$(17,531)
Amortization expense for identifiable intangible assets during 2005,
2004 and 2003 was $0.6 million, $0.6 million and $3.4 million,
respectively. Estimated amortization expense for the next five years
and thereafter is as follows as of December 31, 2005 (in thousands):
2006
2007
2008
2009
2010
Thereafter
$ 544
443
443
443
339
117
$2,329
Accrued liabilities consist of the following (in thousands):
Taxes
Compensation payable
Network commitments
Insurance payable
Other
December 31,
2005
2004
$1,753
2,463
305
639
2,107
$4,051
1,225
608
303
1,082
$7,267
$7,269
9. REVOLVING CREDIT FACILITY AND NOTES PAYABLE
Notes payable consist of the following (in thousands):
Notes payable to financial institutions
Notes payable to vendors
Notes payable
December 31,
2005
2004
$12,031
–
$18,073
441
$12,031
$18,514
At December 31, 2005, we had a $10.0 million revolving credit facility
and a $17.5 million term loan under a loan and security agreement with
a bank. The agreement was amended as of December 27, 2005, to reduce
the amount available for borrowing under the revolving credit agreement
from $15.0 million to $10.0 million, increase letter of credit sub-limit from
$5.0 million to $6.0 million, to extend the expiration date of the revolving
credit facility from December 28, 2005 to December 27, 2006 and
update loan covenants.
Availability under the revolving credit facility is based on 80% of eligible
accounts receivable plus 50% of unrestricted cash and marketable
investments. As of December 31, 2005, $4.1 million of letters of credit
were issued, and we had available $5.9 million in borrowing capacity
under the revolving credit facility.
The credit facility contains certain covenants, including covenants that
restrict our ability to incur further indebtedness. The December 27, 2005
changes to the loan covenants include the elimination of the minimum
Cash EBITDA requirement, as defined by the agreement, and the addition
of a minimum tangible net worth requirement.
As of December 31, 2005, we were in compliance with the various
loan covenants.
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Future minimum capital lease payments together with the present
value of the minimum lease payments as of December 31, 2005,
are as follows (in thousands):
2006
2007
Remaining capital lease payments
Less: amounts representing imputed interest
Present value of minimum lease payments
Less: current portion
$ 607
253
860
(54)
806
(559)
$ 247
11. INCOME TAXES
We account for income taxes under the liability method. Deferred tax assets
and liabilities are determined based on differences between financial
reporting and tax bases of assets and liabilities, and are measured using the
enacted tax rates and laws that will be in effect when the differences are
expected to reverse. We provide a valuation allowance to reduce our deferred
tax assets to their estimated realizable value.
Reconciliations of the provision (benefit) for income taxes to the amount
compiled by applying the statutory federal income tax rate to loss before
income taxes is as follows:
Year Ended December 31,
2005
2004
2003
Federal income tax benefit
at statutory rates
State income tax benefit at statutory rates
Foreign operating losses at statutory rates
Stock compensation expense
Other, net
Change in valuation allowance
(34)%
(4)
–
–
1
37
(34)%
(4)
–
–
1
37
Effective tax rate
0%
0%
(34)%
(4)
1
(1)
1
37
0%
NOTES
Notes to Consolidated Financial Statements
We were in violation of a previous loan covenant that required a
minimum Cash EBITDA, as defined in the credit facility, for the three-
month period ended September 30, 2005 by $1.3 million. The violation
resulted primarily from our continued expansion of data center facilities
that caused the minimum Cash EBITDA for the period to be less than
the level required under the agreement. On November 3, 2005, we
received a formal waiver of the covenant violation. As discussed above,
the agreement was amended as of December 27, 2005 to eliminate
the minimum Cash EBITDA requirement.
The term loan under the security agreement noted above has a fixed
interest rate of 7.5% and is due in 48 equal monthly installments of
principal plus interest through September 1, 2008. The balance out-
standing under the term loan was $12.0 million and $16.4 million at
December 31, 2005 and 2004, respectively. The loan was used to
purchase assets previously recorded as capital leases under a master
agreement with a primary supplier of networking equipment. At Decem-
ber 31, 2004, an additional $2.1 million was outstanding under other
loan agreements that were subsequently repaid during 2005. The loan
is secured by all of our assets, except patents.
The maturity of the term loan at December 31, 2005 is as follows
(in thousands):
2006
2007
2008
Total maturities and principal payments
Less: current portion
$ 4,375
4,375
3,281
12,031
(4,375)
$ 7,656
The carrying value of our notes payable as of December 31, 2005,
approximates fair value as the interest rates approximate current market
rates of similar debt obligations.
10. CAPITAL LEASES
Capital lease obligations and the leased property and equipment are
recorded at acquisition at the present value of future lease payments
based upon the terms of the related lease agreement. On September 30,
2004, management negotiated the buy-out of all remaining lease sched-
ules under a master lease agreement with a primary supplier of network
equipment. Under the terms of the buy-out agreement, we paid $19.7 mil-
lion, comprising remaining capital lease obligations as of September 30,
2004, along with end-of-lease asset values and sales tax, resulting in a
$2.2 million increase to fixed assets. The $19.7 million buy-out was funded
through $2.2 million in cash on hand and the proceeds from a $17.5 mil-
lion term loan from a bank (note 9). As of December 31, 2005, our other
remaining capital lease has an expiration date of June 2007.
NOTES
Notes to Consolidated Financial Statements
Temporary differences between the financial statement carrying amounts
and tax bases of assets and liabilities that give rise to significant portions
of deferred taxes relate to the following at December 31 (in thousands):
Current deferred income tax assets:
Provision for doubtful accounts
Deferred revenue
Accrued compensation
Restructuring costs
Capital loss carryforwards
Other
Current deferred income tax assets
Less: Valuation allowance
Non-current deferred income tax assets:
Net operating loss carryforwards
Capital loss carryforwards
Property and equipment
Investments
Deferred revenue, less current portion
Restructuring costs, less current portion
Deferred rent
$
2005
2004
329 $
860
433
457
5,383
854
8,316
(8,263)
402
682
157
911
–
672
2,824
(2,806)
53
18
133,917 132,181
5,383
–
23,372
22,738
1,824
1,824
150
367
2,187
1,438
2,120
3,413
Non-current deferred income tax assets
Less: Valuation allowance
163,697
(162,667)
167,217
(166,176)
Non-current deferred income tax liabilities:
Purchased intangibles
1,030
1,041
(1,083)
(1,059)
Non-current deferred income tax liabilities, net
(53)
Net deferred tax assets (liabilities)
$
– $
(18)
–
Current and non-current deferred taxes have been recorded on a net basis
in the accompanying balance sheet. As of December 31, 2005 we have
net operating loss carryforwards and capital loss carryforwards of approxi-
mately $560.6 million and $14.0 million, respectively. The net operating
loss carryforwards expire from 2012 through 2025. The capital loss carry-
forwards expire in 2006. Utilization of net operating losses and capital loss
carryforwards are subject to the limitations imposed by Section 382 of the
Internal Revenue Code. Under this provision, we will be precluded from
utilizing approximately $222.1 million of our net operating and capital
losses. The occurrence of additional changes in ownership pursuant to
Section 382 of the Internal Revenue Code may have the impact of additional
limitations on the use of our net operating losses. We have placed a valua-
tion allowance against our deferred tax assets in excess of deferred tax
liabilities due to the uncertainty surrounding the realization of such excess
tax assets. Management periodically evaluates the recoverability of the
deferred tax assets and the level of the valuation allowance. At such time
as it is determined that it is more likely than not that the deferred tax
assets are realizable, the valuation allowance will be reduced.
12. EMPLOYEE RETIREMENT PLAN
We sponsor a defined contribution retirement savings plan that qualifies
under Section 401(k) of the Internal Revenue Code. Plan participants
may elect to have a portion of their pre-tax compensation contributed to
the plan, subject to certain guidelines issued by the Internal Revenue
Service. Employer contributions are discretionary and were $0.6 million
and $0.2 million for 2005 and 2004, respectively. No employer contri-
butions were made during 2003.
13. COMMITMENTS, CONTINGENCIES, CONCENTRATIONS
OF RISK AND LITIGATION
Operating leases
We, as a lessee, have entered into leasing arrangements relating to
office and service point rental space and office equipment that are
classified as operating leases. Future minimum lease payments on
non-cancelable operating leases are as follows at December 31, 2005
(in thousands):
2006
2007
2008
2009
2010
Thereafter
$ 9,824
9,828
9,561
7,486
4,522
61,691
$102,912
Rent expense was $13.6 million, $12.9 million and $13.1 million for
the years ended December 31, 2005, 2004 and 2003, respectively.
Sub-lease income, recorded as a reduction of rent expense, was $0.2 mil-
lion, $0.3 million and $0.3 million during the years ended December 31,
2005, 2004 and 2003, respectively.
Service commitments
We have entered into service commitment contracts with Internet network
service providers to provide interconnection services and data center
providers to provide space for our customers. In conjunction with rate
negotiations during 2005, we eliminated several long-term minimum
commitments compared to prior years. Future minimum payments under
these service commitments having terms in excess of one year are as
follows at December 31, 2005 (in thousands):
2006
2007
2008
2009
$ 6,110
2,765
2,769
2,032
$13,676
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Notes to Consolidated Financial Statements
Vendor disputes
In delivering our services, we rely on a number of Internet network,
telecommunication and other vendors. We work directly with these
vendors to provision services such as establishing, modifying or discon-
tinuing services for our customers. Because of the volume of activity,
billing disputes inevitably arise. These disputes typically stem from
disagreements concerning the starting and ending dates of service,
quoted rates, usage and various other factors. Disputed costs, both
in the vendors’ favor and our favor, are researched and discussed with
vendors on an ongoing basis until ultimately resolved. We record the
cost and a liability based on our estimate of the most likely outcome of
the dispute. These estimates are periodically reviewed by management
and modified in light of new information or developments, if any.
Because estimates regarding disputed costs include assessments
of uncertain outcomes, such estimates are inherently vulnerable to
changes due to unforeseen circumstances that could materially and
adversely affect our results of operations and cash flows.
Concentrations of risk
We participate in a highly volatile industry that is characterized by strong
competition for market share. We, and others in the industry encounter
aggressive pricing practices, evolving customer demands and continual
technological developments. Our operating results could be negatively
affected should we not be able to adequately address pricing strategies,
customers’ demands, and technological advancements.
We depend on other companies to supply various key elements of our
infrastructure including the network access local loops between our
network access points and our Internet network service providers and
the local loops between our network access points and our customers’
networks. In addition, the routers and switches used in our network
infrastructure are currently supplied by a limited number of vendors.
Furthermore, we do not carry significant inventories of the products
we purchase, and we have no guaranteed supply arrangements with
our vendors. A loss of a significant vendor could delay build-out of our
infrastructure and increase our costs. If our limited source of suppliers
fails to provide products or services that comply with evolving Internet
standards or that interoperate with other products or services we use in
our network infrastructure, we may be unable to meet all or a portion of
our customer service commitments, which could adversely affect our
business, results of operations and financial condition.
Litigation
We may be subject to legal proceedings, claims and litigation arising in
the ordinary course of business. Although the outcome of these matters
is currently not determinable, we do not expect that the ultimate costs to
resolve these matters will have a material adverse effect on our financial
condition, results of operations or cash flows.
In July 2004, we received an assessment from the New York State
Department of Taxation and Finance for $1.4 million, including interest
and penalties, resulting from an audit of our state franchise tax returns
for the years 2000–2002. The assessment related to an unpaid license
fee due upon our entry into the state for the privilege of doing business in
the state. Management recorded its best estimate of the probable liability
resulting from the assessment in accrued liabilities and general and
administrative expense as of June 30, 2004 and engaged a professional
service provider to initiate an appeal. In April 2005, management became
aware that the assessment had been reduced to $0.1 million including
interest and with penalties waived. The substantial decrease from the
original assessment resulted from including the weighted averages of
investment capital and subsidiary capital, along with business capital,
used in New York in determining the apportionment factor. The original
assessment was based solely on an apportionment of business capital,
while investment capital and subsidiary capital both have significantly
lower apportionment percentages to New York. The adjustment for the
revised New York assessment, as well as other tax accruals based on our
best estimate of probable liabilities, resulted in a reduction of non-income
based tax expenses of approximately $1.7 million as of March 31, 2005.
These tax adjustments are reflected in accrued liabilities and general and
administrative expense in the accompanying financial statements.
14. CONVERTIBLE PREFERRED STOCK AND
STOCKHOLDERS’ EQUITY
Convertible preferred stock
Effective September 14, 2004, all shares of our outstanding series A
convertible preferred stock were mandatorily converted into common
stock in accordance with the terms of our Certificate of Incorporation.
An aggregate of 1.7 million shares of convertible preferred stock with
a recorded value of $49.6 million was converted into 56.2 million
shares of common stock. Accordingly, as of December 31, 2004, we
had no shares of series A convertible preferred stock outstanding.
The mandatory conversion had no effect on the outstanding warrants
to purchase common stock that were issued in conjunction with the
series A preferred stock.
The series A preferred stock was initially reported as mezzanine
financing because holders of the series A preferred stock had rights to
receive payment of shares under specific circumstances which were
deemed to be outside our control. In July 2003, we amended the
deemed liquidation provisions of our charter to eliminate the events
that could result in payment to the series A preferred stockholders
such that the events giving rise to payment would be within our control.
As a result, 2.9 million shares of our series A preferred stock, with a
recorded value of $78.6 million, were reclassified from mezzanine
financing to stockholders’ equity during 2003.
NOTES
Notes to Consolidated Financial Statements
The August 2003 common stock private placement discussed below
resulted in a decrease of the conversion price of our series A preferred
stock to $0.95 per share and an increase in the number of shares of
common stock issuable upon conversion of all shares of series A pre-
ferred stock by 34.5 million shares. We recorded a deemed dividend of
$34.6 million in 2003, which is attributable to the additional incremental
number of shares the series A preferred stock convertible into common
stock. Also as a result of the private placement, under the terms of the
common stock warrants issued on September 14, 2001 by us in connec-
tion with issuance of the series A preferred stock, the exercise price for
the warrants to purchase 17.3 million shares of our common stock was
adjusted from $1.48 per share of common stock to $0.95 per share.
During 2003, series A stockholders converted 1.5 million shares of
series A preferred stock into 50.6 million shares of common stock at a
recorded value of $41.5 million. Including the mandatory conversion
on September 14, 2004, 1.8 million shares of series A preferred stock
were converted in to 59.0 million shares of common stock at a
recorded value of $51.8 million during 2004.
Common stock
On February 18, 2004, our common stock began trading on the American
Stock Exchange (AMEX), under the symbol “IIP.” We voluntarily delisted
our common stock from the NASDAQ SmallCap Market effective
February 17, 2004.
On March 4, 2004, we sold 40.25 million shares of our common stock
in a public offering at a purchase price of $1.50 per share which resulted
in net proceeds to us of $55.9 million, after deducting underwriting
discounts and commissions and offering expense. We continue to use the
net proceeds from the offering for general corporate purposes. General
corporate purposes primarily include capital investments in our network
access point infrastructure and systems, expansion of data center facilities
and repayment of debt and capital lease obligations. General corporate
purposes could also include potential acquisitions of complementary
businesses or technologies.
On August 22, 2003, we issued 10.65 million shares of our common
stock in a private placement at a price of $0.95 per share. We received
$9.5 million, net of issuance cost. In addition, in connection with the
amendment of a former equipment lease, we issued 0.2 million shares
of common stock to the equipment supplier.
On October 15, 2003, in connection with our acquisition of Sockeye
and as discussed in note 4, we issued an aggregate of 1.4 million
shares of our common stock in a private placement to the stockholders
of Sockeye.
Warrants to purchase common stock
As of December 31, 2005, there were warrants outstanding to
purchase 15.0 million shares of our common stock at an exercise
price of $0.95 per share.
On September 14, 2001, in conjunction with our series A preferred stock
financing, we issued warrants to purchase up to 17.1 million shares of
common stock at $1.48256 per share for a period of five years. The
value allocated to these warrants was estimated to be $9.3 million based
upon the Black-Scholes model. As a result of the private placement of
our common stock in August 2003, the exercise price of the warrants
was adjusted to $0.95 per share.
On October 20, 2003, we issued warrants to purchase 0.4 million
shares of common stock at an exercise price of $0.95 in connection
with a private placement of our common stock. These warrants expire
on August 22, 2008.
In connection with our acquisition of netVmg, we granted warrants to
purchase an aggregate of 1.5 million shares of our common stock to
stockholders of netVmg. These warrants are exercisable if netVmg
stockholders participate in a private placement of shares of our common
or preferred stock and their participation is in an amount equal to or
greater than $4.4 million. Each warrant is exercisable for one share of
our common stock at an exercise price of $0.95 per share and expires
on October 1, 2006. There was no value allocated to these warrants as
of December 31, 2005 or 2004.
Outstanding warrants to purchase shares of common stock at
December 31, 2005, are as follows (shares in thousands):
Year of Expiration
2006
2007
2008
Weighted
Average
Exercise
Price
$0.95
–
0.95
Shares
14,657
–
341
$0.95
14,998
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Notes to Consolidated Financial Statements
15. STOCK-BASED COMPENSATION PLANS
We have adopted the disclosure only provisions of SFAS No. 123,
“Accounting for Stock-Based Compensation.” Pro forma information
regarding the net loss is required by SFAS No. 123, and has been
determined as if we had accounted for employee stock options
under the fair value method as described in note 2.
Stock compensation and option plans
On June 23, 2005, we adopted the Internap Network Services Corpora-
tion 2005 Stock Compensation Plan (2005 Plan). The 2005 Plan provides
for the issuance of stock options, stock appreciation rights, stock grants
and stock unit grants to eligible employees and directors and is adminis-
tered by the compensation committee of the board of directors. A total
of 67.9 million shares of stock are reserved for issuance under the 2005
Plan, comprised of 20.0 million shares designated in the 2005 Plan plus
9.7 million shares which remain available for issuance of options and
awards and 38.2 million shares of unexercised options under certain
preexisting plans. No further grants shall be made under the specified
preexisting plans however, each of the specified preexisting plans were
made a part of the 2005 Plan so that the shares available for issuance
under the 2005 Plan may be issued in connection with grants made
under those plans. As of December 31, 2005, there were 34.4 million
options outstanding and 31.7 million options available for issuance.
The 2005 Plan also provides that in any calendar year, no eligible
employee or director shall be granted an option to purchase more than
5.0 million shares of stock or a stock appreciation right based on the
appreciation with respect to more than 5.0 million shares of stock, and
no stock grant or stock unit grant shall be made to any eligible employee
or director in any calendar year where the fair market value of the stock
subject to such grant on the date of the grant exceeds $10.0 million.
Furthermore, no more than 5.0 million non-forfeitable shares of stock
shall be issued pursuant to stock grants.
The option price for each share of stock subject to an option shall be no
less than the fair market value of a share of stock on the date the option
is granted; provided, however, if the option is an incentive stock option
(ISO) granted to an eligible employee who is a 10% shareholder, the
option price for each share of stock subject to such ISO shall be no less
than 110% of the fair market value of a share of stock on the date such
ISO is granted. Stock options have a maximum term of ten years from
the date of grant, except for ISO’s granted to an eligible employee who
is a 10% shareholder, in which case the maximum term is five years
from the date of grant. ISO’s may be granted only to eligible employees.
Terms for stock appreciation rights are similar to those of options. Upon
exercise of a stock appreciation right, the compensation committee of
the board of directors shall determine the form of payment as cash,
shares of stock issued under the 2005 Plan based on the fair market
value of a share of stock on the date of exercise, or a combination of
cash and shares.
During July 1999, we adopted the 1999 Non-Employee Directors’ Stock
Option Plan (the Director Plan). The Director Plan provides for the grant
of non-qualified stock options to non-employee directors. A total of
4.0 million shares of Internap’s common stock have been reserved for
issuance under the Director Plan. Under the terms of the Director Plan,
fully-vested and exercisable initial grants of 80,000 shares of our
common stock are to be made to all non-employee directors on the
date such person is first elected or appointed as a non-employee
director. On the day after each of our annual stockholder meetings,
starting with the annual meeting in 2000, each non-employee director
will automatically be granted a fully vested and exercisable option for
20,000 shares, provided such person has been a non-employee
director for at least the prior six months. The options are exercisable
as long as the non-employee director continues to serve as a director,
employee or consultant of Internap or any of its affiliates. As of Decem-
ber 31, 2005, there were 1.1 million options outstanding and 2.7 mil-
lion options available for grant pursuant to the Director Plan.
Options and stock appreciation rights become exercisable in whole
or in part from time to time as determined at the date of grant by the
compensation committee of the board of directors. Stock options
generally vest 25% after one year and ratably over the following three
years, except for non-employee directors who usually receive immedi-
ately exercisable options. Similarly, conditions, if any, under which
stock will be issued under stock grants or cash will be paid under
stock unit grants and the conditions under which the interest in any
stock that has been issued will become non-forfeitable are determined
at the date of grant by the compensation committee. If the only condi-
tion to the forfeiture of a stock grant or stock unit grant is the completion
of a period of service, the minimum period of service will generally be
three years from the date of grant.
On September 30, 2005, pursuant to an employment agreement, our
newly appointed President and Chief Operating Officer was granted an
option to purchase 5.0 million shares of our common stock and 1.0 million
restricted shares of common stock, further discussed below. The exercise
price of the option is $0.48 per share, the closing price of our common
stock as of the grant date. The option was immediately vested 25% as
of the grant date, September 30, 2005, but is restricted from exercise
unless and until the executive remains continuously employed with the
Company through September 30, 2006. The remaining unvested portion
of the option becomes exercisable in four equal annual installments, with
the first such annual installment being September 30, 2006.
NOTES
Notes to Consolidated Financial Statements
We have elected to account for stock-based compensation using the
intrinsic value method prescribed in APB Opinion No. 25. Accordingly,
compensation cost for stock options is measured as the excess, if any,
of the fair value of our common stock at the date of grant over the
exercise price to be paid to acquire the stock.
On January 6, 2003, under the terms of a related tender offer to allow
domestic employees to cancel certain outstanding stock option grants,
we accepted cancellation of 2.0 million options to purchase shares of
common stock. On that date, we agreed to grant the same employees
options to purchase 2.0 million shares of common stock to be granted
six months and one day after the cancellation, or subsequent to June 7,
2003. The tender offer provided, however, that (i) the exercise price of
the future grant must be the fair value of our common stock on the date
of grant; the participating employees must also cancel all options
granted six months prior to November 18, 2002, offer exchange date;
(ii) the participating employees must not receive any additional grants of
options prior to the future grant date; and (iii) the participating employees
must be domestic common law employees of the Company on the date
of grant. Since we account for stock-based compensation using the
intrinsic value method prescribed by APB Opinion No. 25, compensation
cost for stock options is measured as the excess, if any, of the fair value
of our stock at the date of grant over the exercise price to be paid to
acquire the stock. Therefore, we did not recognize compensation
expense related to the grant of the new options.
Option activity for each of the three years ended 2005 under all of our
stock option plans is as follows (shares in thousands):
Balance, January 1, 2003
Granted
Exercised
Cancelled
Balance, December 31, 2003
Granted
Exercised
Cancelled
Balance, December 31, 2004
Granted
Exercised
Cancelled
Weighted
Average
Exercise
Price
Shares
23,321
25,499
(1,974)
(7,685)
39,161
16,376
(7,502)
(4,086)
43,949
9,476
(2,017)
(15,846)
$2.43
1.22
0.89
3.47
1.52
1.74
0.57
2.25
1.70
0.48
0.45
1.91
Balance, December 31, 2005
35,562
$1.35
Options cancelled during the year ended December 31, 2005 included
10.2 million shares for our former Chief Executive Officer and other
former members of the executive management team.
The following table summarizes information about options outstanding
at December 31, 2005 (shares in thousands):
Options Outstanding
Options Exercisable
Weighted
Average
Remaining
Number Contractual
of Shares Life (in Years)
Exercise
Price
$0.03–$0.46
$0.47–$0.52
$0.53–$1.23
$1.27–$2.00
$2.15–$2.78
$5.00–$69.88
5,483
9,320
6,315
5,777
8,211
456
$0.03–$69.88
35,562
Weighted
Average
Exercise
Price
$0.34
0.48
0.94
1.50
2.25
19.07
$1.63
Number
of Shares
4,752
1,138
4,549
4,924
5,315
455
21,133
6.9
6.7
7.3
7.1
8.0
4.0
7.2
None of our stock options or the underlying shares are subject to any
right to repurchase by the Company.
Employee stock purchase plans
Effective June 15, 2004, we adopted the 2004 Internap Network Services
Corporation Employee Stock Purchase Plan (the 2004 ESPP). The purpose
of the Plan is to encourage ownership of our common stock by each of
our eligible employees by permitting eligible employees to purchase our
common stock at a discount. Eligible employees may elect to participate
in the Plan for two consecutive calendar quarters, referred to as a
“purchase period,” at any time during a designated period immediately
preceding the purchase period. Purchase periods have been established
as the six-month periods ending June 30 and December 31 of each
year. A participation election is in effect until it is amended or revoked by
the participating employee, which may be done at any time on or before
the last day of the purchase period. Participants must authorize us to
withhold a minimum of $10.00 per pay period of his or her compensa-
tion during the purchase period, subject to a maximum of $12,500
during any purchase period. Contributions under the Plan are permitted
only through payroll deductions.
On the last day of each purchase period, participating employee’s payroll
deductions are automatically used to exercise an “option” to purchase
shares of our common stock from us at the purchase price, up to the
maximum number of shares permitted under the Plan. In accordance
with section 423 of the Internal Revenue Code of 1985, in no event may
a participating employee purchase more than $25,000 of common stock
under the Plan during any calendar year. The purchase price for shares
of common stock under the Plan for a purchase period is the lesser of
85% of the closing sale price per share of common stock on the first day
of the offering period or 85% of such closing price on the last day of the
purchase period. A total of 1.4 million and 0.5 million shares were issued
under the 2004 ESPP during 2005 and 2004, respectively.
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Notes to Consolidated Financial Statements
The 2004 ESPP was intended to be a non-compensatory plan for
both tax and financial reporting purposes. However upon our adoption
of SFAS No. 123(R) in the first quarter of 2006, we will recognize
compensation expense for the amount of the discount offered on
shares purchased in the plan. In January 2006, the plan was
amended to change the purchase price from 85% to 95% of the
closing sale price per share of common stock on the last day of the
purchase period and to eliminate the alternative to use the first day
of the offering period as a basis for determining the purchase price.
This amendment restores the plan to being non-compensatory for
financial reporting purposes and will be effective for the purchase
period ending December 31, 2006.
Previously, eligible employees could elect to participate in the 1999
Employee Stock Purchase Plan, which had similar terms to the 2004
ESPP. A total of 6.0 million shares of common stock were reserved for
issuance pursuant to the 1999 ESPP, as increased annually, and 6.0 million
shares have been issued since adoption. During the years ended
December 31, 2004 and 2003, a total of 1.0 million and 1.7 million
shares, respectively, were issued under the 1999 ESPP.
16. RELATED PARTY TRANSACTIONS
As discussed in note 5, we have an investment in Aventail, who is also a
customer for data center and connectivity services. We invoiced Aventail
$0.3 million each year from 2003 through 2005. As of December 31, 2005
and 2004, our outstanding receivable balances with Aventail were less
than $0.1 million.
In 2003 and 2004, we engaged Korn/Ferry International, a national
executive recruiting firm, to assist in the identification and recruitment
of senior executives. For 2003 and 2004 we paid Korn/Ferry $3,178
and $75,000, respectively, in connection with executive placements.
Our former president and chief executive officer is the son-in-law of
a managing director of Korn/Ferry.
We have entered into indemnification agreements with our directors
and executive officers for the indemnification of and advancement of
expense to such persons to the fullest extent permitted by law. We
also intend to enter into these agreements with our future directors
and executive officers.
Deferred stock compensation
17. UNAUDITED QUARTERLY RESULTS
In addition to stock options, our newly appointed President and Chief
Executive Officer was also awarded 1.0 million shares of restricted stock
on September 30, 2005. The shares of restricted stock vest 50% as of
September 30, 2006 so long as the executive remains continuously
employed by the Company through September 30, 2006. The remaining
restricted shares vest in three equal annual installments, with the first
such annual installment being September 30, 2007. The fair value of the
restricted stock was $0.5 million as of the grant date, September 30,
2005, and has been reflected as deferred stock compensation in stock-
holders’ equity in the accompanying balance sheet. Compensation
expense will be recognized ratably in accordance with the terms of
vesting. The executive’s employment agreement provides for accelerated
vesting of the restricted stock under certain events of termination of the
executive’s employment. Amortization of deferred stock compensation
was less than $0.1 million for the year ended December 31, 2005.
For the year ended December 31, 2003, amortization of deferred
stock compensation was $0.4 million, related to stock options granted
to certain employees with exercise prices below the deemed fair value
of the stock option. No deferred stock compensation was recognized
for the year ended December 31, 2004.
The following table sets forth selected unaudited quarterly data for the
years ended December 31, 2005 and 2004. In the opinion of manage-
ment, this information has been prepared on the same basis as the
audited financial statements and all necessary adjustments, consisting
of only normal recurring adjustments, have been included in the amounts
stated below to present fairly, in all material respects, the quarterly infor-
mation when read in conjunction with the audited financial statements
and notes thereto included elsewhere in this annual report. The quarterly
operating results below are not necessarily indicative of those of future
periods (in thousands, except for per share data).
Quarter Ended
March 31
June 30
September 30 December 31
2005
Revenue
Net loss
Basic and diluted
net loss per share $ (0.00)
$37,855
(570)
$37,571
(1,046)
$37,999
(3,171)
$40,292
(177)
$ (0.00)
$ (0.01)
$ (0.00)
Quarter Ended
March 31
June 30
September 30 December 31
2004
Revenue
Net loss
Basic and diluted
net loss per share
$36,250
(2,645)
$35,999
(4,271)
$35,151
(7,877)
$37,146
(3,269)
$ (0.01)
$ (0.02)
$ (0.03)
$ (0.01)
REPORT OF INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Internap Network Services Corporation
We have completed integrated audits of Internap Network Services
Corporation’s 2005 and 2004 consolidated financial statements and of
its internal control over financial reporting as of December 31, 2005,
and an audit of its 2003 consolidated financial statements in accordance
with the standards of the Public Company Accounting Oversight Board
(United States). Our opinions, based on our audits, are presented below.
Consolidated financial statements
In our opinion, the accompanying consolidated balance sheets and
the related consolidated statements of operations, stockholders’ equity
and comprehensive loss, and cash flows present fairly, in all material
respects, the financial position of Internap Network Services Corporation
and its subsidiaries at December 31, 2005 and 2004, and the results of
their operations and their cash flows for each of the three years in the
period ended December 31, 2005 in conformity with accounting princi-
ples generally accepted in the United States of America. These financial
statements are the responsibility of the Company’s management. Our
responsibility is to express an opinion on these financial statements
based on our audits. We conducted our audits of these statements in
accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit of finan-
cial statements includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by manage-
ment, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion.
Internal control over financial reporting
Also, in our opinion, management’s assessment, included in the
accompanying Management’s Report on Internal Control Over Financial
Reporting, that the Company maintained effective internal control over
financial reporting as of December 31, 2005 based on criteria estab-
lished in Internal Control – Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission
(COSO), is fairly stated, in all material respects, based on those criteria.
Furthermore, in our opinion, the Company maintained, in all material
respects, effective internal control over financial reporting as of
December 31, 2005, based on criteria established in Internal Control –
Integrated Framework issued by the COSO. The Company’s management
is responsible for maintaining effective internal control over financial
reporting and for its assessment of the effectiveness of internal control
over financial reporting. Our responsibility is to express opinions on
management’s assessment and on the effectiveness of the Company’s
internal control over financial reporting based on our audit. We con-
ducted our audit of internal control over financial reporting in accordance
with the standards of the Public Company Accounting Oversight Board
(United States). Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether effective internal
control over financial reporting was maintained in all material respects.
An audit of internal control over financial reporting includes obtaining an
understanding of internal control over financial reporting, evaluating man-
agement’s assessment, testing and evaluating the design and operating
effectiveness of internal control, and performing such other procedures
as we consider necessary in the circumstances. We believe that our audit
provides a reasonable basis for our opinions.
A company’s internal control over financial reporting is a process
designed to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for
external purposes in accordance with generally accepted accounting
principles. A company’s internal control over financial reporting includes
those policies and procedures that (i) pertain to the maintenance of
records that, in reasonable detail, accurately and fairly reflect the
transactions and dispositions of the assets of the company; (ii) provide
reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally
accepted accounting principles, and that receipts and expenditures of
the company are being made only in accordance with authorizations of
management and directors of the company; and (iii) provide reasonable
assurance regarding prevention or timely detection of unauthorized
acquisition, use, or disposition of the company’s assets that could have
a material effect on the financial statements.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections
of any evaluation of effectiveness to future periods are subject to
the risk that controls may become inadequate because of changes
in conditions, or that the degree of compliance with the policies or
procedures may deteriorate.
PricewaterhouseCoopers LLP
Atlanta, Georgia
March 6, 2006
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MANAGEMENT’S REPORT ON INTERNAL CONTROL
OVER FINANCIAL REPORTING
Our management is responsible for establishing and maintaining
adequate internal control over financial reporting, as such term is
defined in Exchange Act Rule 13a-15(f). Under the supervision and
with the participation of our management, including our Chief Executive
Officer and Chief Financial Officer, we conducted an evaluation of the
effectiveness of our internal control over financial reporting based on
the framework in Internal Control – Integrated Framework issued by
the Committee of Sponsoring Organizations of the Treadway
Commission (COSO).
Based on our evaluation under the framework in Internal Control –
Integrated Framework issued by COSO, our management concluded
that our internal control over financial reporting was effective as of
December 31, 2005. Our management’s assessment of the effective-
ness of our internal control over financial reporting as of December 31,
2005 has been audited by PricewaterhouseCoopers LLP, an indepen-
dent registered public accounting firm, as stated in their report which
is included herein.
STOCKHOLDER INFORMATION
Internap 2005 Annual Report
Corporate Headquarters
Internap Network Services Corporation
250 Williams Street
Atlanta, GA 30303
404-302-9700
www.internap.com
Investor Relations
Andrew S. Albrecht
Vice President, Corporate Development/Investor Relations
404-302-9841
Stock Trading Information
Internap’s common stock trades on the
American Stock Exchange under the
ticker symbol: IIP.
Independent Registered Public Accounting Firm
PricewaterhouseCoopers LLP
10 Tenth Street, Suite 1400
Atlanta, GA 30309
678-419-1000
Transfer Agent
American Stock Transfer & Trust Company
59 Maiden Lane
New York, NY 10038
800-937-5449
info@amstock.com
Form 10-K
A copy of Internap’s 2005 Annual Report on Form 10-K for the year
ended December 31, 2005, as filed with the Securities and Exchange
Commission, is posted to the investor relations section of our website,
www.internap.com. A printed copy is available without charge to
stockholders upon written request by contacting Investor Relations
at our headquarters address.
Product/Services Information
Information on Internap’s products and services can be obtained by
contacting our corporate headquarters or visiting our website at:
www.internap.com.
Market and Dividend Information
Internap’s common stock is listed on the AMEX under the symbol “IIP”
and has traded on the AMEX since February 18, 2004. Our common
stock traded on the NASDAQ SmallCap Market from October 4, 2002
until February 17, 2004. Prior to that, our common stock traded on
the NASDAQ National Market from September 29, 1999, the date of
our initial public offering, until October 4, 2002, when we fell below
certain listing criteria of the NASDAQ National Market.
The following table sets forth on a per share basis the high and low
closing prices for our common stock on the AMEX or the NASDAQ
SmallCap Market, as applicable, during the periods indicated.
Year Ended December 31, 2005
Fourth Quarter
Third Quarter
Second Quarter
First Quarter
Year Ended December 31, 2004
Fourth Quarter
Third Quarter
Second Quarter
First Quarter
High
Low
$0.51
0.57
0.60
0.94
$1.04
1.22
1.96
2.71
$0.37
0.44
0.42
0.52
$0.50
0.52
1.05
1.47
The Internap beneficial holders as of March 1, 2006 were 36,757.
We have never declared or paid any cash dividends on our capital stock, and we do not
anticipate paying cash dividends in the foreseeable future. We are prohibited from paying
cash dividends under covenants contained in our current credit agreement. We currently
intend to retain our earnings, if any, for future growth. Future dividends on our common
stock, if any, will be at the discretion of our board of directors and will depend on, among
other things, our operations, capital requirements and surplus, general financial condition,
contractual restrictions and such other factors as our board of directors may deem relevant.
Safe Harbor Statement Under the Private Securities
Litigation Reform Act of 1995
All statements included or incorporated by reference in this 2005 Annual
Report, other than statements or characterizations of historical fact,
including, but not limited to, statements regarding our future business
prospects, financial position, business strategy, projected levels of growth,
projected costs and projected financing needs, are forward-looking
statements within the meaning of the Private Securities Litigation Reform
Act of 1995. Those statements are based on the current intent, belief or
expectations of Internap and members of our management team and
certain assumptions made by us and can often be identified by the
use of words such as “may,” “will,” “seeks,” “anticipates,” “believes,”
“estimates,” “expects,” “projects,” “forecasts,” “plans,” “intends,”
“should” or similar expressions. Forward-looking statements are not
guarantees of future performance and involve risks, uncertainties and
assumptions that are difficult to predict. Therefore, our actual results
may differ materially from those contemplated by forward-looking
statements. Our Annual Report on Form 10-K and other filings with the
Securities and Exchange Commission discuss some of the important risk
factors that could contribute to such differences or otherwise affect our
business, results of operations and financial condition. The forward-
looking statements speak only as of the date of this Annual Report. We
undertake no obligation to revise or update publicly any forward-looking
statement for any reason.
BOARD OF DIRECTORS AND EXECUTIVE MANAGEMENT TEAM
Internap 2005 Annual Report
BOARD OF DIRECTORS
Eugene Eidenberg
Chairman
Strategic Advisor, Granite Venture
Associates LLC; and Principal,
Hambrecht Quist Venture Associates
Director since: 1997
James P. DeBlasio
President and Chief Executive Officer, Internap
Director since: 2003
Charles B. Coe
Former President, BellSouth Network Services
Director since: 2003
William J. Harding
Managing Member,
Morgan Stanley Venture Partners
Director since: 1999
Fredric W. Harman
General Partner,
Oak Investment Partners
Director since: 1999
Patricia L. Higgins
Former President and Chief Executive Officer,
Switch and Data
Director since: 2004
Kevin L. Ober
Managing Partner,
Divergent Venture Partners
Director since: 1997
Dr. Daniel C. Stanzione
President Emeritus, Bell Laboratories and
former Chief Operating Officer, Lucent Technologies
Director since: 2004
EXECUTIVE MANAGEMENT TEAM
James P. DeBlasio
President and Chief Executive Officer
David A. Buckel
Vice President and Chief Financial Officer
David L. Abrahamson
Vice President, Sales
Dorothy C. An
Vice President and General Counsel
Robert P. Smith
Vice President and Chief Marketing Officer
J. Eric Klinker
Vice President, Chief Technology Officer and Chief Information Officer
Eric Suddith
Vice President, Operations
Andrew S. Albrecht
Vice President, Corporate Development
and Investor Relations
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thrive
Corpora te Headquarters
250 W illiams Str eet
At lant a, GA 30303
404 .302.9700
ww w. interna p.com
AM EX: IIP