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2006 Annual Report
to win
our time is now
C o r p o r a t e H e a d q u a r t e r s
25 0 Williams Street
At lanta, GA 30303
40 4.302.9 700
w w w. i n t e r n a p . c o m
NA SDA Q: INAP
We ignite customer innovation. Internap is a leading Internet solutions provider that manages,
delivers and distributes applications and content with unsurpassed performance and reliability. With a global
platform of data centers, managed Internet Protocol (IP) services, content delivery networks (CDNs) and content
monetization services, Internap frees its customers to drive innovation inside their businesses and create new
revenue opportunities. Today, more than 3,000 companies across the globe trust Internap to help them achieve
their Internet business goals. Internap’s 450 employees are located in our Atlanta headquarters, as well as in
offices around the world, including major U.S. cities, Canada, London and Asia. Founded in 1996, Internap
trades on the NASDAQ Global Market under the ticker symbol INAP.
Our Value Proposition
Internap’s colocation and data center solutions manage the
complex applications and vital content that form the foundation
of our customers’ businesses. Our industry-leading IP services
ensure the reliable delivery of these Web-based assets, offering
levels of performance essential for growth and innovation in
their business. Internap’s leading-edge content delivery and
advertising solutions distribute our customers’ valued content
reliably and cost-effectively, so they can recognize new revenue
streams, connect with and engage their customers, partners,
employees and consumers across the globe.
a n a g e
M
D eliv e r
Distrib ute
o n etiz e
M
Stockholder Information
Financial Review 2006
Corporate Headquarters
Internap Network Services Corporation
250 Williams Street
Atlanta, GA 30303
404-302-9700
www.internap.com
Investor Relations
Andrew Albrecht
Vice President, Investor Relations
404-302-9841
Stock Trading Information
Internap’s common stock trades on the
NASDAQ under the ticker symbol: INAP.
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 2006 Annual Report on Form 10-K/A for the year ended
December 31, 2006, as fi led 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 NASDAQ Global Market under
the symbol “INAP” and has traded on the NASDAQ Global Market since
September 19, 2006. Our common stock traded on the American Stock
Exchange under the symbol “IIP” from February 18, 2004 through
September 18, 2006. Our common stock traded on the NASDAQ SmallCap
Market from October 4, 2002 through 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.
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On July 11, 2006, we implemented a 1-for-10 reverse stock split of our
common stock. The information in the following table has been adjusted to
refl ect these stock splits. Our fi scal year ends on December 31.
Year Ended December 31, 2006
Fourth Quarter
Third Quarter
Second Quarter
First Quarter
Year Ended December 31, 2005
Fourth Quarter
Third Quarter
Second Quarter
First Quarter
High
Low
$21.25
16.80
15.50
10.60
$ 5.20
5.90
6.30
11.00
$14.10
9.30
9.00
4.20
$ 3.60
4.20
4.10
5.10
As of April 20, 2007, the total number of benefi cial holders of our
common stock was 37,219.
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 fi nancial 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
Special Note Regarding Forward-Looking Statements:
Some of the statements contained in this Annual Report contain forward-looking statements that refl ect
our plans, beliefs and current views with respect to, among other things, future events and fi nancial
performance. We often identify these forward-looking statements by the use of words such as “believe,”
“expect,” “potential,” “continue,” “may,” “will,” “should,” “could,” “would,” “seek,” “predict,” “intend,” “plan,”
“estimate,” “anticipate,” or other comparable words.
Specifi cally, this Annual Report contains, among others, forward-looking statements regarding: our
ability to successfully integrate the operations of Internap and VitalStream; our ability to compete against
existing and future competitors; our ability to respond successfully to the evolution of the high performance
Internet connectivity, content delivery, streaming and related services industries; our ability to respond
successfully to technological change; the availability on favorable terms or at all of services from various
Internet network and other third parties on whom we rely to provide our services, and the failure of such
third party suppliers to deliver their products and services; failures in our network operations centers,
network access points or computer systems; our ability to complete successfully the integration of acquired
companies, including VitalStream; our ability to protect ourselves and our customers from security
breaches; our ability to protect our intellectual property; claims relating to intellectual property rights;
government regulation of the Internet; and the effects of natural disasters or terrorist activity.
Any forward-looking statements contained in this Annual Report are based upon our historical
performance and on our current plans, estimates and expectations. You should not regard the inclusion of
this forward-looking information as a representation by us or any other person that we will achieve the
future plans, estimates or expectations contained in this Annual Report. Such forward-looking statements
are subject to various risks and uncertainties. In addition, there are or will be important factors that could
cause our actual results to differ materially from those in the forward-looking statements. We believe these
factors include, but are not limited to, those described in Part I, Item IA. Risk Factors of our Annual Report
on Form 10-K/A.
You should not construe these cautionary statements as exhaustive and should read such statements
in conjunction with the other cautionary statements that are included in this Annual Report. Moreover, we
operate in a continually changing business environment, and new risks and uncertainties emerge from time
to time. We cannot predict these new risks or uncertainties, nor can we assess the impact, if any, that any
such risks or uncertainties may have on our business or the extent to which any factor, or combination of
factors, may cause actual results to differ from those projected in any forward-looking statement.
Accordingly, the risks and uncertainties to which we are subject can be expected to change over time, and
we undertake no obligation to update publicly or review the risks or uncertainties described in this Annual
Report. We also undertake no obligation to update publicly or review any of the forward-looking statements
made in this Annual Report, whether as a result of new information, future developments or otherwise. If
one or more of the risks or uncertainties referred to in this Annual Report materialize, or if our underlying
assumptions prove to be incorrect, actual results may vary materially from what we have projected. Any
forward-looking statements contained in this Annual Report refl ect our current views with respect to future
events and are subject to these and other risks, uncertainties and assumptions relating to our operations,
fi nancial condition, growth strategy, and liquidity. You should specifi cally consider the factors identifi ed in
this Annual Report that could cause actual results to differ. We qualify all of our forward-looking statements
by these cautionary statements. In addition, with respect to all of our forward-looking statements, we claim
the protection of the safe harbor for forward-looking statements contained in the Private Securities
Litigation Reform Act of 1995.
As used herein, except as otherwise indicated by the context, references to “we,” “us,” “our,” or the
“Company” refer to Internap Network Solutions Corporation and its subsidiaries.
INAP_Cov.wpc 2
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The future of Internap has never looked better. A disciplined and
highly-focused strategy to strengthen fundamentals has resulted in a
growing and profitable business. With the acquisition of VitalStream,
a world leader in audio and video streaming, we are moving
aggressively to realize our strategic vision – to ignite the confidence
to innovate – by offering the most comprehensive portfolio of Internet
solutions in the industry. The Internet is increasingly the world’s
preferred medium to facilitate communication and commerce.
Internap is becoming the provider of choice for technologies that
enable Internet collaboration, productivity and profitability.
nowclearly, our time is
1
2
we’re
advancing
into hot new markets
Unprecedented levels of broadband penetration in homes and
businesses are supporting an explosion in the delivery of rich media
content and video streaming. From user-generated content such as
a homemade video to a movie trailer produced by a major motion
picture studio, the integration of video into virtually every Web-based
property is growing exponentially. Indeed, for the first time in history,
Internet viewership is surpassing television usage levels. This behavior
is creating a unique opportunity for content providers to monetize their
digital assets. Advertising dollars are following this migration and also
opening the door for Internap to capitalize on an Internet advertising
market that AccuStream ¡Media projects to be $2.3 billion within
four years.
3
consider
our complete suite of solutions
No single competitor can match the breadth and depth of Internap’s
VitalStream has enhanced our portfolio significantly, providing
technology portfolio and service delivery platform. The foundation of
valuable content delivery solutions that ensure a high-quality
this portfolio is our unique network architecture combined with patented
end-user experience. Services also include streaming video and
route control technology, which has been the industry standard for
audio advertising solutions with targeted, real-time ad insertion
the past decade. This intelligent network, which includes our Private
technology, creating an entirely new revenue source for Internap.
Network Access Points (P-NAP®) infrastructure, makes end-to-end
Dynamic applications such as streaming audio and video require
delivery of Web-based traffic faster and more reliable. In fact, our service
reliable and consistent delivery with the type of quality inherent to
level agreement guarantees 100 percent uptime. Our colocation
Internap’s history of providing high-performance Internet services.
services are strategic assets that provide secure, reliable and redundant
The net result is a combined portfolio of complementary services
data center services for our customers. Combined with our high-
that create profound synergies for Internap and its customers.
performance IP connectivity service, this segment of our business is
growing annually as we continue to meet customer demands.
4
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Broadband Subscription
Drives Internet Video Viewing...
... and Increases the Total Number
of Streams Over the Internet
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05 06 07 08 09 10
Worldwide Broadband Subscriber Forecast
Internet Video Viewing
The rapid growth in access to high-speed
Internet is driving video usage online.
The total number of video streams over
the Internet is expanding at a 26 percent
compound annual growth rate.
Source: In-Stat, 3/06
Source: eMarketer, 2006
Total Internet Advertising Dollars
Continue to Grow...
... and Video Ad Spending
is Accelerating
C A G R 15 %
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Total Internet advertising dollars are growing at
a 15 percent compound annual growth rate.
We expect video ad spending to reach nearly
$2.5 billion by 2010.
Source: AccuStream iMedia Research, 2006
Source: eMarketer, 2006
5
Internet Video Advertising Spending
Internet Video Viewing
our advantages are worth a
second look
Internap is changing the way content owners outsource their
in this product suite. This platform is an integrated software
Internet technology needs with a one-stop comprehensive solution
suite and customer portal through which customers can manage
that is unsurpassed by competitors in service, performance
media assets, capture business intelligence and reporting, as well
and quality. Only Internap can offer an integrated product suite
as monetize their media via subscription or advertising. Our
that includes data center services, IP connectivity, content delivery
end-to-end solution creates a compelling value proposition that
services (CDS) and advertising solutions that have global reach.
allows customers to focus on using their online assets and Internet
Internap’s MediaConsole® platform is a key strategic differentiator
applications in ways that drive new and increased revenue.
6
7
As Internet-centric business models evolve, Internap frees
our clients to innovate, become more customer-focused,
expand to new markets, improve overall service quality, and
ultimately increase their profitability.
8
acc elerated
growth is all about volume
Our growth strategy is all about high volume. More
customers. Larger accounts. New products. Increased
revenue. The combination of Internap and VitalStream
creates a broad enterprise customer base of more than
3,000 companies. With a strong sales and service group
of 130 people, we are pursuing disciplined, targeted
sales strategies to offer our new and expanded suite
of solutions to this existing base of customers, as well
as to attract new customers. At the same time, we are
focused intently on innovation, superior service delivery
and new product development. The goal is for Internap
to be the strategic partner of choice for businesses that
want to innovate and leverage the Internet to accelerate
their growth and profitability. Our global platform and
comprehensive portfolio allow Internap to compete for
more of every dollar spent by customers for service and
management of mission-critical applications.
Internap now competes for
more
of every dollar
9
10
to our stockholders
our time is now
Last year, our commitment to you was
in 2005 to 33 percent in 2006 by
2,300 customers, representing many of
to make Internap thrive – to transform
achieving operating efficiencies and
the largest and most respected names
our organization and our business into
increasing productivity.
in the financial services, technology,
one that was healthy, growing and
In the first quarter of 2006, we
retail, media and entertainment fields.
successful. I am pleased to report
recorded the first profitable quarter in
The fact that no single customer
on behalf of the entire Internap team
our 10-year history, and we continued
represents more than two percent of
that we have kept this promise and
to be profitable in each successive
revenue demonstrates the diversity of
significantly strengthened Internap’s
quarter throughout the year. As a result,
our business.
potential to not simply thrive, but to WIN
for the fiscal year 2006, we generated
in the marketplace as never before.
GAAP net income of $3.7 million, or
We began 2006 with a strong
$0.11 per basic share – a significant
foundation – a world-class portfolio
improvement over 2005. Our adjusted
of technology solutions, strategic
EBITDA for 2006 was $25.0 million, an
relevancy to a large and loyal customer
increase of $14.3 million over 2005,
base and a team of outstanding
another record for Internap.
Internet experts renowned for their
We ended the year with a cash
exceptional level of knowledge and
and short-term investment balance of
service. Our challenge was to leverage
$58.9 million, up $18.4 million over 2005.
these assets to improve Internap’s
Cash from operations continues to be
bottom line and to deliver long overdue
an area of strength, and our operational
value to our stockholders. It was time
discipline continues to provide positive
for change, so we developed a plan
financial leverage, generating cash and
and successfully executed it to make
allowing us to fund future growth.
this change a reality.
Throughout the year, we
Our top line revenue grew at an
experienced minimal revenue
unprecedented rate of 18 percent to
churn and gained 186 net
$181.4 million. Expense-to-revenue
new customers. At year-end,
levels decreased from 40 percent
we counted approximately
In the first quarter of 2006, we
recorded the first profitable
quarter in our 10-year history,
and we continued to be profitable
in each successive quarter
throughout the year.
James P. DeBlasio
President and Chief Executive Officer
In order to provide a new level of
to acquire VitalStream Holdings, Inc.,
Pandora trust Internap with their critical
scale and service to our customers,
thereby extending our presence into
Internet business.
we invested in the business by building
the growing CDN and streaming
This potential begins with the
out our high-performance IP network
video market. This transaction closed
integration of VitalStream, which
to 10-Gigabit capacity in 11 of our
in February 2007 and, as you read
provides us with tremendous syner-
largest markets. We also deployed new
earlier, has resulted in one of the most
gistic benefits, including an infusion of
colocation assets in key cities and, in
comprehensive suites of Internet
talent and leadership, complementary
early 2007, announced the build-out of
solutions in the marketplace today.
products and technology platforms,
our eighth owned data center, as well
You will note the extensive use of
economies of scale and increased
as a third facility in the Seattle market,
the word we in our recounting of 2006
market reach. In-Stat estimated,
to meet customer demand.
accomplishments. The challenges
in a 2006 market analysis, that by
This potential begins with the integration
of VitalStream, which provides us
with tremendous synergistic benefits,
including an infusion of talent and
leadership, complementary products
and technology platforms, economies
of scale and increased market reach.
2010 more than $315 billion in stra-
tegic transactions per year will occur
via the Internet. Most of these trans-
actions will involve far more complex
applications than just a few years
ago. We believe business such as
e-commerce, online financial transac-
tions, software downloads, VoIP, IPTV
and gaming can be conducted more
efficiently through a global network.
The integration of VitalStream
solutions uniquely positions Internap
to provide our customers with a
Throughout 2006, management met
met, the changes made, the progress
comprehensive set of products that
regularly with current and potential
realized and the value created are all
exceeds their business needs. Trends
investors to apprise them on how we
a reflection of a team that could not
such as global broadband penetration,
are building a new Internap, steeped
have worked any harder or smarter
the rise in user-generated content and
in a commitment to discipline and to
on your behalf. For their relentless
the increased desire among businesses
achieving our full potential. A 1-for-10
commitment and dedication, I extend
to engage online customers in more
reverse stock split in July removed
my deep personal appreciation. The
targeted and interactive ways support
much of the volatility in our stock, better
Internap that is before us today is truly
the demand for these solutions.
aligning us with our technology peers.
a reflection of their efforts to help build a
One of our enterprise customers,
We also returned to the NASDAQ
company that allows our customers to
Planetvu, which is a global IPTV provider,
Stock Market in September, this time
focus on innovation, while we manage,
is an excellent example of how the new
to the global stage. In turn, the Market
deliver, distribute and monetize their
Internap can win in the marketplace
recognized our achievements.
Internet applications. As a result of our
by benefiting our customers in a mean-
And, in what is potentially a game-
ability to deliver this value proposition,
ingful way. Planetvu is a multi-language
changing transaction for Internap, we
enterprise customers such as ABC
entertainment and TV service focused
announced in October our intention
Radio, FastSearch, FXCM Group and
on delivering television to various
12
national audiences throughout North
America. Live television programming
is now available from 6,000 miles away
in Asia. Our unique bundled offering
enables Planetvu to serve their entire
customer base. The Internap solutions
we provide Planetvu include route opti-
Our solutions are broader and more
easily tailored to meet the demands
of the world’s fastest-growing and
most dynamic companies.
mization technologies that deliver media
acquired streaming and content
and determination that proved
content from India to the United States;
delivery customers onto one of the
successful in 2006. By pursuing our
data center services that manage and
industry’s highest performing and most
strategic vision – to ignite confidence
store these applications; and CDN ser-
reliable networks.
and innovation in our customers – we
vices to distribute live video streams to
These initiatives, combined with
plan to keep Internap firmly focused
Planetvu’s customers residing in North
Internap’s enhanced portfolio of
on the day-to-day operating activities
America. Planetvu’s success story is
solutions, bring new opportunities for
and customer service critical to
just one of many customer examples
our 130-plus direct sales and service
maximizing profitability.
that illustrate the relevance of our end-
professionals to sell a differentiated
Our commitment is to be the leader
to-end suite of Internet solutions.
solution in this fast-growing market.
in this space by enabling new business
We have several projects under way
The opportunity to sell additional
models and empowering our customers
in 2007 to further raise the quality, scale
services to our combined Internap
to keep pace with the rapidly growing
and geographic reach of our service
and VitalStream base of over 3,000
potential of the Internet, its technology
offerings. We will interconnect all of our
customers is substantial. Because
and applications.
CDN points of presence (PoPs) into
our solutions are broader and more
We look forward to updating you
our global P-NAP infrastructure, as
easily tailored to meet the demands of
on our progress and extend our appre-
announced in a press release in April
the world’s fastest-growing and most
ciation to the customers, stockholders
of 2007.
dynamic companies, our sales force
and employees who have and continue
The initiative will occur in scheduled
has the opportunity to pursue previously
to support our efforts.
phases throughout the year and
untapped customer markets.
adhere to our disciplined approach to
Internap’s strong balance sheet
managing capital expenditures, while
and cash flow position enable us to
Sincerely,
strengthening service reliability. With
respond quickly to opportunities in the
this CDN expansion, Internap will be
market and allow flexibility in making
in a position to offer new global and
strategic investments. This financial
regional contracts across Asia, Europe
position also allows us to grow the
and North America for both streaming
business organically. We continue to
and content delivery services.
look strategically at solutions and new
Our network optimization plan also
technologies that can expand and
James P. DeBlasio
includes consolidation of our CDN
leverage our existing business.
President and Chief Executive Officer
PoPs into our data centers. This
While Internap is thriving today, more
consolidation will enable and facilitate
work remains. We will continue moving
the migration of our 800-plus newly
forward with the sense of discipline
13
now more than ever
Q&A with Jim DeBlasio and Gene Eidenberg
Gene, as one of the founders of Internap
in 1996, you have seen the Company
go through a number of stages over
the past decade. How significant of a
milestone is the VitalStream acquisition
in the Company’s history?
Gene: Extremely significant when you
consider Internap’s original value propo-
sition. We always viewed the IP business
as a foundation upon which more services
could be launched. VitalStream’s content
delivery and streaming solutions are
really about fulfilling the original promise
of Internap. Actually, it is more accurate
to say, “beginning to fulfill the promise.”
We are enthusiastic about continuing to
build this Company.
14 14
Does that mean you intend to undertake
additional acquisitions in the near
future?
Jim: We are always looking at new
products and services that complement
our portfolio and add value for our
stockholders. We begin this process
with a well-defined strategy that aligns
with the vision of where Internap is
heading, as well as consideration for
what is going on in the marketplace.
This approach allows us to qualify
opportunities as they arise, so that we
can make informed decisions about
whether acquiring new technologies
makes sense for moving the Company
forward. We will continue to evaluate
any new developments and qualify
opportunities as they come along. In
the meantime, our new Internap has
ample opportunities to pursue as we
continue to integrate our respective
customer bases, sales forces and
operational teams.
The Internet seems to be going through
another evolutionary period with the
popularity of user-generated content,
IPTV and rich media streaming. How
does Internap capitalize on this new era
of Internet usage?
Jim: The statistics about video usage are
phenomenal. According to eMarketer,
half of all online consumers watched
streaming video during the last month.
Video influences the way sites are now
structured and provides businesses
new ways to communicate with end-
users on the Web. Video traffic doubles
every six to eight months on a typical
media site. Consumers are telling
researchers that they will watch a 15-
second advertisement if it is embedded
in the video they want to see as a way
to continue to receive “free” content.
The Internet is the ultimate vehicle
for enterprises that are creating new
business models and for people who
want to try something new. These groups
and their behavior represent the type of
opportunities created by the evolving
Internet landscape. Internap wants
to be their trusted partner of choice
and the go-to for making the end-user
experience fast and reliable.
How will you maintain the same level
of fiscal discipline now that you are a
larger company?
Jim: The key is to first understand what
we did well in 2006 and determine
what drives Internap’s success, then
replicate those strategies in 2007
to help grow the business. One way
we are achieving scale is through an
organizational design that supports
our core products and services, which
are Data Center Services, IP Services
and Content Delivery & Monetization
Services. Each of these three primary
business units is run by a general
manager who is responsible for the
adjusted gross profit and has decision-
making authority for the products and
services within his group. Having each
business unit managed by a subject-
matter expert allows us to increase
our focus on delivering new, innovative
services to our growing customer
base, and takes advantage of cross-
selling and up-selling opportunities to
scale the business. This structure also
improves our ability to respond quickly to
opportunities and to focus intensely on
driving both our margins and profitable
growth. Look for us to continue to be
relentless, accountable and passionate
about winning in the marketplace and
providing world-class solutions to
our customers.
as well as the ability for content owners
to monetize their assets.
What is the status of Internap’s legacy
products such as the Flow Control
Platform™ (FCP), given the current focus
on VitalStream?
Jim: Internap has a unique heritage
of delivering intelligent routing solutions
that overcome the Internet’s inherent
weaknesses, such as latency and
packet loss that can plague performance.
The FCP still plays a key role in our
end-to-end suite of Internet solutions
and is ideal for larger companies that
prefer to manage their networks in-
house. Internap’s technology remains
unsurpassed and provides yet
another solution in our portfolio that
differentiates our ability to enable peak
performance of our customers’ mission-
critical applications.
What does Internap stand for in the
marketplace today?
Gene: Today, Internap stands for confi-
dence and innovation. Through the hard
and dedicated work of all those who
have been a part of Internap over the
last decade, our Company has become
one of the most recognized and trust-
ed for delivering customer service and
high-performance Internet solutions.
Our people are some of the world’s
leading experts on Internet routing and
optimization, which has resulted in a
deep level of customer loyalty. Internap
gives customers the confidence that
we will reliably manage their critical
business applications. In fact, we guar-
antee a 100 percent uptime for our IP
service. The VitalStream brand shares
similar respect in the marketplace, and
we believe our combined knowledge
and dedication to excellence will serve
us well.
Jim: As the Company grows, I believe
Internap’s signature brand traits,
which have resulted in our credibility
as a trusted partner, will continue
to serve us well. Both Internap and
VitalStream are known as pioneers in
their respective fields and both have a
culture of innovation, which positions
us for leadership in the rich media
streaming market. Combined with the
best-in-class talent, commitment and
experience of our people, I certainly agree
that these qualities define what Internap
stands for in the marketplace and help
drive our success.
How does Internap plan to leverage
the combined Internap and VitalStream
customer base?
Jim: Internap has always been a
customer-centric organization with a
reputation that is differentiated by our
best-in-class customer support. Our
combined base of more than 3,000
customers creates new opportunities
for our direct sales team of 130 to up-
sell products and services to our existing
accounts. We have an expanded suite of
services to offer, and no single customer
represents more than 2 percent of our
revenue. Combined with our enhanced
portfolio of solutions, we believe Internap is
better positioned to compete for a greater
percentage of dollars spent by customers
on Internet products and services.
Our sales and service delivery road
map will also create opportunities to
penetrate new enterprise accounts,
regardless of size or location. We plan
to aggressively help customers uncover
new ways to leverage the Internet to
solve their unique business challenges,
improve productivity and ultimately
generate more revenue. In turn, Internap
can become more profitable and return
greater value to our stockholders.
Internap’s customers range from
financial services and retail to media and
entertainment companies. Do you see
any interesting technology trends across
these verticals?
Gene: For the past 10 years, Internap’s
diverse customers have always been
at the forefront of deploying cutting-
edge Internet applications, and we
have seen both business models and
technology needs shift over time.
In the 90s, the hot application was
e-commerce, then around 2000,
it was VoIP. Today, we see video,
rich media and the emergence
of Web 2.0 applications.
With each new “killer
app” came a richer
user experience, but
each also created more
complex requirements
for performance. We
believe Internap is poised
to take advantage of these
trends by giving busi-
nesses a complete
end-to-end solution
– from managing
Internet infrastruc-
ture, to delivering and
distributing applications,
Gene Eidenberg, Chairman
15
Executive Management Team
James P. DeBlasio
President and
Chief Executive Officer
Vincent J. Molinaro
Chief Operating Officer
David A. Buckel
Vice President and
Chief Financial Officer
Philip N. Kaplan
Chief Strategy Officer
Tim P. Sullivan
Chief Technology Officer
Richard P. Dobb
Vice President, General Counsel
and Secretary
Eric Suddith
Vice President, Human Resources
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
Kevin L. Ober
Managing Partner,
Divergent Venture Partners
Director since: 1997
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
Dr. Daniel C. Stanzione
President Emeritus, Bell Laboratories
and former Chief Operating Officer,
Lucent Technologies
Director since: 2004
* (resigned 3/15/07)
Our Management Team
Left to Right: James DeBlasio, David Buckel,
Vincent Molinaro, Philip Kaplan, Richard Dobb
Tim Sullivan and Eric Suddith
16
Internap Network Services Corporation
2006
Financial Review
18
Selected Financial Data
20
Management’s Discussion and Analysis of
Financial Condition and Results of Operations
33
Consolidated Statements of Operations
34
Consolidated Balance Sheets
35
Consolidated Statements of Stockholders’
Equity and Comprehensive Income (Loss)
36
Consolidated Statements of Cash Flows
37
Notes to Consolidated Financial Statements
54
Report of Independent Registered Public
Accounting Firm
55
Management’s Report on Internal Control
Over Financial Reporting
56
Stock Performance
Internap 2006 Annual Report
17
Selected Financial Data
Financial Review 2006
The consolidated statement of operations data and other fi nancial data presented below were prepared using our consolidated fi nancial statements for the
fi ve years ended December 31, 2006. You should read this selected consolidated fi nancial data together with the consolidated fi nancial statements and
related notes contained in this Annual Report and in our 2005 and 2004 Annual Reports on Form 10-K fi led with the SEC, as well as the section of this
Report and of our 2005 and 2004 Annual Reports on Form 10-K entitled, “Management’s Discussion and Analysis of Financial Condition and Results of
Operations.”
(In thousands, except per share data)
2006(1)
2005
2004
2003
2002
Year Ended December 31,
Consolidated Statement of Operations Data:
Revenue
Costs and expense:
Direct cost of network and sales, exclusive of depreciation
and amortization, shown below (2)
Direct cost of customer support
Product development
Sales and marketing
General and administrative
Depreciation and amortization(2)
Amortization of deferred stock compensation
Asset impairment and restructuring cost (benefit)
(Gain) loss on disposals of property and equipment
Pre-acquisition liability adjustment
Lease termination expense
Total operating costs and expense
Income (loss) from operations
Non-operating (income) expense
Net income (loss) before income taxes
Provision for income taxes
Equity in (earnings) loss of equity-method investment, net of taxes
Less deemed dividend related to beneficial conversion feature (3)
Net income (loss)
Net income (loss) per share:
Basic (4)
Diluted (4)
$ 181,375
$ 153,717
$ 144,546
$ 138,580
$ 132,487
97,854
11,566
4,475
27,173
22,104
15,856
–
323
(113)
–
–
82,535
10,670
4,864
25,864
20,096
14,737
60
44
(19)
–
–
77,569
10,180
6,412
23,411
24,772
15,461
–
3,644
(3)
–
–
78,334
9,483
6,982
21,491
16,711
37,087
390
1,084
(53)
(1,313)
–
85,734
12,913
7,447
21,641
20,907
55,285
260
(2,857)
3,722
–
804
179,238
158,851
161,446
170,196
205,856
2,137
(1,551)
3,688
145
(114)
–
(5,134)
(87)
(5,047)
–
(83)
–
(16,900)
772
(17,672)
–
390
–
(31,616)
2,158
(33,774)
–
827
34,576
(73,369)
1,055
(74,424)
–
1,244
–
$ 3,657
$
(4,964)
$ (18,062)
$ (69,177)
$ (75,668)
$
$
0.11
0.10
$
$
(0.15)
(0.15)
$
$
(0.63)
(0.63)
$
$
(3.96)
(3.96)
$
$
(4.87)
(4.87)
Weighted average shares used in per share calculations
Basic (4)
34,748
33,939
28,732
17,460
15,555
Diluted (4)
35,739
33,939
28,732
17,460
15,555
18
Internap 2006 Annual Report
Selected Financial Data
Financial Review 2006
Consolidated Balance Sheet Data:
Cash, cash equivalents and short-term marketable securities
Non-current marketable investments securities
Total assets
Note payable and capital lease obligations, less current portion
Series A convertible preferred stock (5)
Total stockholders’ equity
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 provided by (used in) financing activities
As of December 31,
2006
2005
2004
2003
2002
$ 58,882
–
173,702
3,364
–
126,525
$ 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)
As of December 31,
2006
2005
2004
2003
2002
$ 13,382
29,599
(10,399)
1,957
$ 10,161
5,493
(9,428)
(5,454)
$ 13,066
(1,150)
(29,659)
45,747
$ 3,799
(11,175)
561
4,280
$ 8,632
(40,331)
9,581
(7,582)
(1) Effective January 1, 2006, we adopted SFAS No. 123 (revised 2004), “Share-Based Payment” (SFAS No. 123R) and related interpretations, using the modified prospective
transition method and therefore have not restated prior periods’ results. Prior to the adoption of SFAS No. 123R on January 1, 2006, we accounted for stock-based
compensation plans under the recognition and measurement provisions of Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees,”
and related interpretations. We also provided disclosures in accordance with SFAS No. 123, “Accounting for Stock-Based Compensation,” as amended by SFAS No. 148,
“Accounting for Stock-Based Compensation – Transition and Disclosures – an Amendment of FASB Statement No. 123.” Accordingly, no expense was recognized for options
to purchase our common stock that were granted with an exercise price equal to fair market value at the date of grant and no expense was recognized in connection with
purchases under employee stock purchase plans for any periods prior to January 1, 2006.
(2) Prior to 2006, direct cost of network and sales did not include amortization of purchased technology and such amounts were included in depreciation and amortization.
In accordance with Question 17 of the Financial Accounting Standards Board (FASB) Implementation Guide to Statement of Financial Accounting Standard (SFAS) No. 86,
“Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed,” we have reclassified these costs from “Depreciation and amortization”
to “Direct cost of network and sales.” These reclassifications had no effect on previously reported operating loss or net loss.
(3) 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 $9.50 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 3.5 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.
(4) Adjusted to reflect the 1-for-10 reverse stock split of our common stock on July 11, 2006.
(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 million,
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.
Internap 2006 Annual Report
19
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Financial Review 2006
The following discussion should be read in conjunction with the
consolidated fi nancial statements and accompanying notes of this
Annual Report.
OVERVIEW
We market products and services that provide managed and premise-
based Internet Protocol (IP) and route optimization technologies that
enable business-critical applications such as e-commerce, Customer
Relationship Management (CRM), video and audio streaming, Voice-over
Internet Protocol (VoIP), Virtual Private Networks (VPNs), and supply chain
management. Our core IP connectivity services and route control technology
product and service offerings are complemented by IP access solutions
such as data center services, Content Delivery Networks (CDNs) and man-
aged security. At December 31, 2006, we delivered services through our
43 network access points across North America, London, and the Asia-
Pacifi c region, including Tokyo, Japan and Sydney, Australia. Our Private
Network Access Points (P-NAP) feature direct high-speed connections to
major Internet backbones such as AT&T, Sprint, Verizon, 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 ineffi cien-
cies of traditional IP connectivity options. Our intelligent routing technology
can facilitate traffi c over multiple carriers, as opposed to just one carrier’s
network, to ensure highly-reliable performance over the Internet.
We believe our unique managed multi-network approach provides better
performance, control and reliability compared to conventional Internet
connectivity alternatives. 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 guar-
antee performance on their own network. We serve customers in a variety
of industries, including fi nancial services, entertainment and media, travel,
e-commerce, retail and technology. As of December 31, 2006, we provided
our services to more than 2,250 customers in the United States and abroad,
including several Fortune 1000 and mid-tier enterprises.
we added more than 180 net new customers, bringing our total to more
than 2,250 enterprise customers as of December 31, 2006. Revenue for
the year ended December 31, 2006 increased 18% to $181.4 million,
compared to revenue of $153.7 million for the year ended Decem-
ber 31, 2005.
• Solidifi ed management team is focused on achieving profi tability and
revenue by leveraging operating effi ciencies. In November 2005,
James P. DeBlasio, a 20-year technology veteran and former Lucent
executive, was appointed CEO. Throughout 2006, our management team
implemented a renewed emphasis on aggressive cost containment with
a focus on reducing net losses and driving gross profi t to achieve cost
savings to benefi t gross profi t to improve stockholder 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.
The company experienced a net increase in customers from 2005 to 2006.
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-effi ciently employed. These factors
have a direct bearing on our fi nancial position and results of operations.
• Approximately two-thirds of our new monthly recurring revenue is from new
customers. Selling new monthly recurring revenue to new customers allows
us to expand our customer base, as well as guard against customer loss.
• While we have limited 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 qualifi ed leads, generate interest and promote business benefi ts
among key audiences. We will also conduct public relations efforts
focused on securing third party recognition of our products and services
from 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.
HIGHLIGHTS AND OUTLOOK
RECENT DEVELOPMENTS
• 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 custom-
ers 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 continue to pay a premium
for our high-performance managed Internet connectivity services.
Reverse stock split. On July 10, 2006, we implemented a 1-for-10 reverse
stock split of our common stock. Our stockholders authorized the reverse
stock split on June 21, 2006, at our annual stockholders’ meeting. Our com-
mon stock began trading on a split-adjusted basis on July 11, 2006. All share
and per share information herein (including shares outstanding, earnings
per share and warrant and stock option exercise prices) have been retroac-
tively restated for all periods presented to refl ect the reverse stock split.
• Our success in executing our premium pricing strategy depends, to a
signifi cant degree, on our ability to differentiate our connectivity solutions
from lower-cost alternatives. The key measures of our success in achiev-
ing this differentiation are revenue and customer growth. During 2006,
VitalStream acquisition. On October 12, 2006, we entered into a defi nitive
agreement to acquire VitalStream Holdings, Inc., or VitalStream, in an all-
stock transaction to be accounted for using the purchase method of account-
ing for business combinations. The transaction closed on February 20, 2007.
20
Internap 2006 Annual Report
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Financial Review 2006
Under the terms of the agreement, VitalStream stockholders received, at a
fi xed exchange ratio, 0.5132 shares of our common stock for every share
of VitalStream common stock in a tax-free exchange. As a result, we
issued approximately 12.2 million shares of common stock to VitalStream
stockholders, which represented approximately 25% of our outstanding
shares. We also assumed outstanding options for the purchase of shares
of VitalStream common stock, converted into options to purchase approxi-
mately 1.5 million shares of Internap common stock. The purchase price
for the acquisition includes the estimated fair value of our common stock
issued, stock options assumed, and estimated direct transaction costs. We
derived the values using an average market price per share of our common
stock of $16.40, which was based on an average of the closing prices for
a range of trading days from October 6, 2006 through October 16, 2006,
which range spans October 12, 2006, the announcement date of the
proposed transaction. The preliminary purchase price of $222.0 million
was determined based upon the number of VitalStream shares and options
outstanding at the closing date of February 20, 2007 and taking into
consideration estimated direct transaction costs.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The discussion and analysis of our fi nancial condition and results of
operations are based upon our consolidated fi nancial statements, which
have been prepared in accordance with accounting principles generally
accepted in the United States. The preparation of these fi nancial statements
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 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 under different
assumptions or conditions.
Management believes the following critical accounting policies affect the
judgments and estimates used in the preparation of our consolidated
fi nancial statements.
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 fi xed 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 back-up, and remote storage and restoration services. We also offer
T-1 and fractional DS-3 connections at fi xed rates.
We recognize revenue when persuasive evidence of an arrangement exists,
the product, service or software license has been provided, the fees are
fi xed 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 services, products or software licenses.
We assess whether the fee is fi xed 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, or PCS, associated with sales of our
FCP solution and similar products are amortized ratably over the contract
period, which is generally one year.
Customer credit risk. We routinely review the creditworthiness of our
customers. If we determine 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 allow-
ance for doubtful accounts is based upon specifi c and general customer
information, which also includes estimates based on management’s best
understanding of the customer’s ability to pay. Customer’s ability to pay
takes into consideration payment history, legal status (e.g., 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 specifi c and general customer information,
including outstanding promotional credits, customer disputes, credit adjust-
ments not yet processed through the billing system and historical activity.
If the fi nancial condition of our customers were to deteriorate, or manage-
ment become 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,
specifi c 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 on our
consolidated balance sheets.
Investments. We account for investments without readily determinable
fair values at historical cost, as determined by our initial investment. The
Internap 2006 Annual Report
21
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Financial Review 2006
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, 2006 in Aventail
Corporation, or Aventail, a 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
on our consolidated balance sheets.
We account for investments that provide us with the ability to exercise
signifi cant infl uence, but not control, over an investee, using the equity
method of accounting. Signifi cant infl uence, 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, 2006,
Internap Japan Co., Ltd., or Internap Japan, our joint venture with NTT-ME
Corporation of Japan and another NTT affi liate, qualifi es 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
our consolidated statements of operations.
Investments in marketable securities primarily include high-credit quality
corporate debt securities and U.S. Government Agency debt securities.
These investments are classifi ed as available-for-sale and are recorded at fair
value with changes in fair value refl ected in other comprehensive income.
Goodwill. 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 fi rst 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 fi rst
step of the SFAS No. 142 analysis, we engaged a professional business
valuation and appraisal fi rm that utilized discounted cash fl ow valuation
methods and the guideline company method for reasonableness. The
forecasts of future cash fl ows 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 deter-
mining fair value depend on our stock price, since market capitalization
will impact the discount rate to be applied as well as market multiple
analyses. Changes in the forecast could cause us to either pass or fail
the fi rst step test and could result in the impairment of goodwill.
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 dupli-
cate 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 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 modifi ed in
light of new information or developments, if any. Conversely, any resolved
disputes that will result in a credit over the disputed amounts are recog-
nized in the month when we determine the resolution. 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 fl ows.
Accrued liabilities. Similar to accruals for disputed telecommunications
costs above, we must estimate other signifi cant costs such as utilities and
sales, use, telecommunications and other taxes. These estimates are
often necessary, either because invoices for services 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, historical trends, related usage, forecasts and
quotes. Management periodically reviews and modifi es estimates in light
of new information or developments, if any. Because estimates regarding
accrued liabilities include assessments of uncertain outcomes, such
estimates are inherently vulnerable to changes due to unforeseen circum-
stances that could materially and adversely affect our results of operations
and cash fl ows.
Restructuring liability. When circumstances warrant, we may elect to exit
certain business activities or change the manner in which we conduct
ongoing operations. When we make such a change, 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
22
Internap 2006 Annual Report
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Financial Review 2006
information, if any, of which it becomes aware. Should circumstances
warrant, management will adjust its previous estimates to refl ect 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 restructur-
ing estimates in a future period, compared to the $4.8 million restructuring
liability at December 31, 2006 would result in an $0.5 million expense or
benefi t 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.
Stock-based compensation. We account for stock-based instruments
issued to employees in exchange for their services under the fair value
recognition provisions of SFAS No. 123 (revised 2004), “Share-Based
Payment” (SFAS No. 123R) and related interpretations. We adopted this
statement using the modifi ed prospective transition method and therefore
have not restated prior period’s results. Under SFAS No. 123R, share-based
compensation cost is measured at the grant date based on the calculated
fair value of the award. The expense is recognized over the employees’
requisite service period, generally the vesting period of the award. Prior
to the adoption of SFAS No. 123R on January 1, 2006, we utilized the
disclosure only provisions of SFAS No. 123, “Accounting for Stock-Based
Compensation” and accounted for stock-based compensation plans under
the recognition and measurement provisions of APB Opinion No. 25,
“Accounting for Stock Issued to Employees,” and related interpretations.
Accordingly, no expense was recognized for options to purchase our
common stock that were granted with an exercise price equal to fair market
value at the date of grant, and no expense was recognized in connection
with purchases under our employee stock purchase plans for any periods
prior to January 1, 2006.
The fair value of equity instruments granted to employees is estimated
using the Black-Scholes option-pricing model. To determine the fair value,
this model requires that we make certain assumptions regarding the volatility
of our stock, the expected term of each option and the risk-free interest rate.
Further, we also make assumptions regarding employee termination and
stock option forfeiture rates that impact the timing of aggregate compensa-
tion expense recognized. These assumptions are subjective and generally
require signifi cant analysis and judgment to develop.
Because our options are not publicly traded, assumed volatility is based
on the historical volatility of our stock. We have also used historical data
to estimate option exercises, employee termination and stock option
forfeiture rates. The risk-free interest rate for periods within the expected
life of the option is based on the U.S. Treasury yield curve in effect at the
time of grant. Changes in any of these assumptions could materially
impact our results of operations in the period the change is made.
RECENT ACCOUNTING PRONOUNCEMENTS
In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain
Hybrid Financial Instruments – an amendment of FASB Statements No. 133
and 140.” SFAS No. 155 eliminates the exemption from applying SFAS
No. 133, “Accounting for Derivative Instruments and Hedging Activities,”
to interests in securitized fi nancial assets so that similar instruments are
accounted for similarly, regardless of the form of the instruments. SFAS
No. 155 also allows issuers of fi nancial statements to elect fair value
measurement at acquisition, at issuance, or when a previously recognized
fi nancial instrument is subject to a remeasurement (new basis) event, on
an instrument-by-instrument basis, in cases in which a derivative would
otherwise have to be bifurcated. SFAS No. 155 is effective for all fi nancial
instruments acquired or issued after the fi rst fi scal year beginning after
September 15, 2006. We believe that SFAS No. 155 will not have a
material impact on our consolidated fi nancial statements.
In March 2006, the FASB issued SFAS No. 156, “Accounting for Servic-
ing of Financial Assets – an amendment of FASB Statement No. 140.”
SFAS No. 156 requires that all separately recognized servicing assets and
servicing liabilities be initially measured at fair value, if practicable. It also
permits, but does not require, the subsequent measurement of servicing
assets and servicing liabilities at fair value. An entity that uses derivative
instruments to mitigate the risks inherent in servicing assets and servic-
ing liabilities is required to account for those derivative instruments at
fair value. Under SFAS No. 156, an entity can elect subsequent fair value
measurement of its servicing assets and servicing liabilities by class, thus
simplifying its accounting and providing for income statement recognition
of the potential offsetting changes in fair value of the servicing assets,
servicing liabilities, and related derivative instruments. An entity that elects
to subsequently measure servicing assets and servicing liabilities at fair
value is expected to recognize declines in fair value of the servicing
assets and servicing liabilities more consistently than by reporting other-
than-temporary impairments. SFAS No. 156 is effective for fi scal years
beginning after September 15, 2006. We believe that SFAS No. 156 will
not have a material impact on our consolidated fi nancial statements.
In June 2006, Emerging Issues Task Force Issue No. 06-3, “How Sales
Taxes Collected from Customers and Remitted to Governmental Authorities
Should Be Presented in the Income Statement (That Is, Gross Versus Net
Presentation),” or EITF 06-3, was issued. EITF 06-3 requires disclosure
of the presentation of taxes on either a gross (included in revenues and
costs) or a net (excluded from revenues) basis as an accounting policy
decision. The provisions of this standard are effective for interim and
Internap 2006 Annual Report
23
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Financial Review 2006
annual reporting periods beginning after December 15, 2006. We do
not expect the adoption of EITF 06-3 to have a material impact on our
consolidated fi nancial statements.
In June 2006, the FASB issued FASB Interpretation No. 48, or FIN 48,
“Accounting for Uncertainty in Income Taxes – an interpretation of FASB
Statement No. 109, Accounting for Income Taxes,” which clarifi es the
accounting for uncertainty in income taxes. FIN 48 prescribes a recognition
threshold and measurement attribute for the fi nancial statement recogni-
tion and measurement of a tax position taken or expected to be taken in
a tax return. The Interpretation requires that we recognize in the fi nancial
statements the impact of a tax position, if that position is more-likely-than-
not of being sustained on audit, based on the technical merits of the
position. FIN 48 also provides guidance on derecognition, classifi cation,
interest and penalties, accounting in interim periods and disclosure. The
provisions of FIN 48 are effective beginning January 1, 2007 with the
cumulative effect of the change in accounting principle recorded as an
adjustment to opening retained earnings. We are continuing to evaluate
the possible impact of FIN 48, on our consolidated fi nancial statements.
In September 2006, the Securities and Exchange Commission, or SEC,
released Staff Accounting Bulletin No. 108, “Considering the Effects of
Prior Year Misstatements When Quantifying Misstatements in Current Year
Financial Statements” (SAB 108). SAB 108 provides guidance on how the
effects of the carryover or reversal of prior year fi nancial statement misstate-
ments should be considered in quantifying a current year misstatement.
Prior practice allowed the evaluation of materiality on the basis of the error
quantifi ed as the amount by which the current year income statement
was misstated (rollover method) or the cumulative error quantifi ed as the
cumulative amount by which the current year balance sheet was misstated
(iron curtain method). The guidance provided in SAB 108 requires both
methods to be used in evaluating materiality. Immaterial prior year errors
may be corrected with the fi rst fi ling of prior year fi nancial statements after
adoption. The cumulative effect of the correction would be refl ected in the
opening balance sheet with appropriate disclosure of the nature and
amount of each individual error corrected in the cumulative adjustment,
as well as a disclosure of the cause of the error and that the error had
been deemed to be immaterial in the past. The adoption of SAB 108 did
not have a material impact on our consolidated fi nancial statements.
In September 2006, the FASB issued Statement of Financial Accounting
Standards No. 157, “Fair Value Measurements,” or SFAS No. 157. This
Statement defi nes fair value as used in numerous accounting pronounce-
ments, establishes a framework for measuring fair value in generally
accepted accounting principles, or GAAP, and expands disclosure related
to the use of fair value measures in fi nancial statements. SFAS No. 157
does not expand the use of fair value measures in fi nancial statements,
but standardizes its defi nition and guidance in GAAP. The Standard
emphasizes that fair value is a market-based measurement and not an
entity-specifi c measurement based on an exchange transaction in which
the entity sells an asset or transfers a liability (exit price). SFAS No. 157
establishes a fair value hierarchy from observable market data as the
highest level to fair value based on an entity’s own fair value assumptions
as the lowest level. The Statement is to be effective for our fi nancial
statements issued in 2008; however, earlier application is encouraged.
We believe that SFAS No. 157 will not have a material impact on our
consolidated fi nancial statements.
In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting
for Defi ned Benefi t Pension and Other Postretirement Plans – an amendment
of FASB Statements No. 87, 88, 106, and 132R,” which requires the
recognition of the over-funded or under-funded status of a defi ned benefi t
postretirement plan in a company’s balance sheet. This portion of the new
guidance is effective on December 31, 2006. Additionally, the pronounce-
ment eliminates the option for companies to use a measurement date prior
to their fi scal year-end effective December 31, 2008. SFAS No. 158 provides
two approaches to transition to a fi scal year-end measurement date, both
of which are to be applied prospectively. Under the fi rst approach, plan
assets are measured on September 30, 2007 and then remeasured on
January 1, 2008. Under the alternative approach, a 15-month measure-
ment will be determined on September 30, 2007 that will cover the period
until the fi scal year-end measurement is required on December 31, 2008.
We do not have any defi ned benefi t pension or postretirement plans that
are subject to SFAS No. 158. As such, we do not expect the pronounce-
ment to have a material impact on our consolidated fi nancial statements.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option
for Financial Assets and Financial Liabilities Including an Amendment of
FASB Statement No. 115,” which permits companies to measure many
fi nancial instruments and certain other assets and liabilities at fair value
on an instrument-by-instrument basis (the fair value option). Adoption of
the standard is optional and may be adpoted beginning in the fi rst quarter
of 2007. We are currently evaluating the possible impact of adopting
SFAS No. 159 on our consolidated fi nancial statements.
RESULTS OF OPERATIONS
Revenue is generated primarily from the sale of Internet connectivity
services at fi xed 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 back-up, remote
storage and restoration services.
Direct cost of network and sales is comprised primarily of:
• costs for connecting to and accessing Internet network service providers
and competitive local exchange providers;
• costs incurred for providing additional third party services to our customers;
• costs incurred for providing additional third party services to our customers;
• costs of Flow Control Platform solution and similar products sold; and
• amortization of technology-based intangible assets.
24
Internap 2006 Annual Report
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Financial Review 2006
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 depending
on customer demands and pricing variables while network access point
facility costs are generally fi xed in nature. Direct cost of network and
sales does not include compensation, depreciation or amortization other
than the amortization of technology-based intangible assets.
Direct cost of customer support consists primarily of employee compensa-
tion 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 direct cost of customer support.
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 associ-
ated with internal use software are capitalized when the software enters
the application development stage until implementation of the software
has been completed. All other product development costs are expensed
as incurred.
Sales and marketing costs consist of compensation, commissions and
other costs for personnel engaged in marketing, sales and fi eld service
support functions, as well as advertising, trade shows, 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 expenses for executive, fi nance, human resources and administra-
tive personnel, professional fees and other general corporate costs.
Liquidity. Although we have been in existence since 1996, we have
experienced signifi cant operational restructurings in recent years,
which include substantial changes in our senior management team,
streamlining our cost structure, consolidating network access points
and terminating certain non-strategic real estate leases and license
arrangements. We have a history of quarterly and annual period net
losses through the year ended December 31, 2005. For the year ended
December 31, 2006, we recognized net income in each quarter with
year to date net income of $3.7 million. As of December 31, 2006, our
accumulated defi cit was $856.5 million. We continue to analyze our
business to control our costs, principally through making process
enhancements and renegotiating network contracts for more favorable
pricing and terms.
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 network and sales,
exclusive of depreciation and amortization
shown below
Direct cost of customer support
Product development
Sales and marketing
General and administrative
Depreciation and amortization
Other operating costs and expense
Total operating costs and expense
Income (loss) from operations
Total other (income) expense, net
Year Ended December 31,
2006
2005
2004
100%
100%
100%
54
6
3
15
12
9
–
99
1
(1)
54
7
3
17
13
9
–
103
(3)
–
54
7
4
16
17
11
3
112
(12)
–
Net income (loss)
2%
(3)%
(12)%
Years Ended December 31, 2006 and 2005
Revenue. Revenue for 2006 increased $27.7 million, or 18%, from
$153.7 million for the year ended December 31, 2005 to $181.4 million
summarized as follows (in thousands):
Revenue:
Internet protocol (IP) services
Data center services
Other/reseller services
Year Ended December 31,
2006
2005
$104,393 $ 99,848
36,226
17,643
53,996
22,986
$181,375 $153,717
The revenue increase is primarily attributable to growth in new and
existing data center customers, resulting in an increase in data center
services revenue of $17.8 million, or 49%, to $54.0 million. Revenue
growth is facilitated in part by the continued expansion of our available
data center space and our continued efforts to bundle our IP and data
center services. The demand for data center services has outpaced
industry-wide supply, which has allowed us to increase the overall
pricing for the data center component of our pricing models.
Demand for IP traffi c also continues to increase but with declining prices.
During the year ended December 31, 2006, IP traffi c over our networks
increased approximately 83% from the year ended December 31, 2005.
The increase in IP traffi c has come as both existing and new customers
require greater overall capacity due to growth in the usage of their
applications as well as in the nature of applications consuming greater
amounts of bandwidth. In particular, we added a number of high-traffi c
customers through competitive IP pricing and minimum commitments
Internap 2006 Annual Report
25
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Financial Review 2006
during the year ended December 31, 2006. Overall, revenue from IP
connectivity services increased $4.5 million, or 5%, to $104.4 million for
the year ended December 31, 2006.
Similar to past years, revenue for the three months ending December 31,
2006 was also modestly enhanced by our customers’ increased holiday
traffi c. Other/reseller services are specifi cally infl uenced by “bursting
rates” for exceeding rate caps or usage limits in the fourth quarter of the
year. Other/reseller services also include a recovery of revenue previously
reserved as uncollectible, which also contributed to the increase in IP
revenue for 2006.
As of December 31, 2006, our customer base totaled more than 2,250
customers across our 22 metropolitan markets.
Direct cost of network and sales. Direct cost of network and sales increased
from $82.5 million for the year ended December 31, 2005 to $97.9 million
for the year ended December 31, 2006, representing an increase of 19%.
The increase of $15.4 million in direct cost of network and sales was largely
related to variable cost components associated with revenue growth. We,
however, have also had signifi cant increases in fi xed cost components as
we have upgraded our P-NAP facilities and expanded data centers for
customer growth. The primary components of the increase in direct costs
include $11.2 million for data centers, $2.5 million for content delivery, or
CDN, services, and $1.4 million related to IP services. Costs for IP services
are especially subject to ongoing negotiations for pricing and minimum
commitments. As our IP traffi c continues to grow, we have greater bargain-
ing power for lower bandwidth rates and more opportunities to proactively
manage network costs, such as utilization and traffi c optimization among
network service providers.
Connectivity costs vary based upon customer traffi c and other demand-
based pricing variables. Data center costs have substantial fi xed cost
components, primarily for rent, but also signifi cant demand-based pricing
variables, such as utilities. CDN, Edge Appliance and other costs associated
with reseller arrangements are generally variable in nature. We expect all
of these costs to continue to increase during 2007 with any revenue
increases. In addition, data center services give us access to new customers
for whom we can bundle hosting and connectivity services together,
potentially generating greater profi tability. At December 31, 2006, we had
approximately 149,000 square feet of data center space with a utilization
rate of approximately 79%, as compared to approximately 124,000 square
feet of data center space with a utilization rate of approximately 76% at
December 31, 2005.
Other operating expenses. Compensation and facilities-related costs have
a pervasive impact on operating expenses other than direct cost of network
and sales. After direct cost of network and sales, compensation and benefi ts
are our most signifi cant expense. Cash-basis compensation and benefi ts
were $42.9 million for both the years ended December 31, 2006 and
2005, which refl ects a net increase in commissions of $1.6 million, offset
by a $1.0 million decrease in salaries and wages and a $0.6 million
decrease in employee benefi ts. The increase in commissions is revenue-
driven while the decreases in compensation and benefi ts refl ect a consis-
tent headcount of approximately 330 full-time employees compared to
December 31, 2005 and favorable experience on self-insured medical
claims. Compensation for the year ended December 31, 2006 also
includes a substantial increase in employee bonuses over the year ended
December 31, 2005.
As discussed in note 2 of the consolidated fi nancial statements, we adopted
SFAS No. 123R on January 1, 2006. Accordingly, total operating costs
and expense and net income for 2006 includes stock-based compensa-
tion expense in the following amounts:
Direct cost of customer support
Product development
Sales and marketing
General and administrative
Total stock-based compensation
$1,102
628
2,145
2,067
$5,942
Prior to the adoption of SFAS No. 123R on January 1, 2006, we utilized
the disclosure only provisions of SFAS No. 123 and accounted for stock-
based compensation plans under the recognition and measurement
provisions of APB Opinion No. 25 and related interpretations. Accordingly,
no expense was recognized for options to purchase our common stock
that were granted with an exercise price equal to fair market value at the
date of grant for any periods prior to January 1, 2006.
Pro forma stock-based compensation expense as previously reported for
2005 was $9.7 million. The decrease of $3.8 million in recorded stock-
based compensation expense for the year ended December 31, 2006
compared to the pro forma stock-based compensation expense for the
year ended December 31, 2005 is due primarily to cancellations of
outstanding stock options and the difference between estimated and
actual forfeitures. SFAS No. 123R requires compensation expense to be
recorded net of estimated forfeitures with a subsequent adjustment to
refl ect actual forfeitures as they occur. Previously, forfeitures of unvested
stock options were accounted for on a pro forma basis as they were
incurred, generally resulting in higher pro forma stock compensation than
under the current provisions of SFAS No. 123R. In addition, a signifi cant
number of unvested stock options were forfeited upon the resignation of
Mr. Gregory Peters, our former Chief Executive Offi cer, thus reducing the
number of outstanding stock options for determining comparative stock-
based compensation expense for the year ended December 31, 2006.
Overall, facility and related costs, including repairs and maintenance,
communications and offi ce supplies but excluding direct cost of network
and sales, decreased $0.9 million, or 13%, to $6.0 million for the year
ended December 31, 2006 compared $6.9 million for the year ended
December 31, 2005. Facility costs decreased $0.7 million in sales and
marketing and $0.9 million in general and administrative, primarily
through consolidation and cost containment efforts.
26
Internap 2006 Annual Report
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Financial Review 2006
Other signifi cant operating costs are discussed with the fi nancial statement
captions below:
Direct cost of customer support. Direct cost of customer support increased
8% from $10.7 million for the year ended December 31, 2005 to
$11.6 million for the year ended December 31, 2006. The increase of
$0.9 million was primarily due to increases in costs related to stock-based
compensation of $1.1 million, offset by decreased compensation and
employee benefi ts of $0.7 million, as discussed above. In addition, facilities
and related expenses increased $0.7 million, based on more accurate
data for allocation of costs, primarily from sales and marketing.
Product development. Product development costs for the year ended
December 31, 2006 decreased 8% to $4.5 million from $4.9 million for
the year ended December 31, 2005. The decrease of $0.4 million is
attributable to decreases in costs related to compensation and employee
benefi ts of $0.5 million, outside professional services of $0.5 million and
training expenses of $0.1 million. The decreases were offset by an
increase in stock-based compensation expense of $0.6 million for the
year ended December 31, 2006, as discussed above. The decrease in
compensation and employee benefi ts partially refl ects the redeployment
of technical resources from product support to internal network support,
which is accounted for in general and administrative expense. The
decrease in outside professional services is primarily due to a specifi c
project in 2005.
Sales and marketing. Sales and marketing costs for the year ended
December 31, 2006 increased 5% to $27.2 million from $25.9 million
for the year ended December 31, 2005. The net increase of $1.3 million
was primarily due to increases in stock-based compensation expense of
$2.1 million and commissions of $1.6 million, offset by decreases in
compensation and employee benefi ts expenses of $1.4 million, all of
which were discussed above. Also, as discussed with direct cost of
customer support above, facilities and related expenses decreased
$0.7 million, largely due to more accurate data allocations of expenses
to direct cost of customer support.
Outside professional services decreased $0.3 million, and travel, entertain-
ment and training expenses decreased $0.2 million. The decreases in
outside professional services and training are the result of better utilization
of internal resources while the decrease in travel and entertainment resulted
from an effort to reduce less essential travel. All of these reductions were
partially offset by an increase of $0.3 million in marketing and advertising
efforts during the year ended December 31, 2006.
General and administrative. General and administrative costs for the
year ended December 31, 2006 increased 10% to $22.1 million from
$20.1 million for the year ended December 31, 2005. The increase of
$2.0 million refl ects a $2.4 million increase in taxes (non-income based),
licenses, and fees, a $2.1 million increase in stock-based compensation
expense and a $1.1 million increase in compensation and employee
benefi ts. These increases were offset by decreases in outside professional
services of $0.9 million, bad debt expense of $0.9 million, facility
and related expense of $0.9 million, a reduction of insurance and
administrative expense of $0.3 million and a reduction of training expense
of $0.2 million. Part of the increase in cash-basis compensation and
benefi ts is the redeployment of technical resources from product support
as noted under the caption product development above.
The increase in taxes, licenses and fees is principally related to a March
2005 reduction in an accrual for an assessment of $1.4 million, including
interest and penalties, received in July 2004 from the New York State
Department of Taxation and Finance. The New York assessment resulted
from an audit of our state franchise tax returns for the years 2000–2002.
In March 2005, New York State Department of Taxation and Finance reduced
the assessment to $0.1 million, including interest, and waived penalties.
The increases in compensation and benefi ts, including stock-based
compensation, and the decrease in facility-related costs are discussed
above. In addition, the decrease in outside professional services can be
attributed to a number of factors, including focused cost control and
better utilization of internal resources. Professional services for the year
ended December 31, 2006 also includes $0.6 million related to an
abandoned corporate development project.
Depreciation and amortization. Depreciation and amortization, including
other intangible assets, for the year ended December 31, 2006 increased
8% to $15.9 million compared to $14.7 million for the year ended
December 31, 2005. The increase of $1.2 million was primarily attributed
to an increased depreciable base of assets as we upgraded our P-NAP
facilities and continue to expand our data center facilities.
Income taxes. The provision for income taxes refl ects alternative minimum
taxes as we have become profi table during the year ended December 31,
2006. We continue to maintain a full valuation allowance against our
deferred tax assets of approximately $172.9 million, consisting primarily
of net operating loss carryforwards. We may recognize deferred tax
assets in future periods when they are determined to be realizable. To
the extent we may owe income taxes in future periods, we intend to use
our net operating loss carryforwards to the extent available to reduce
cash outfl ows for income taxes.
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
Other/reseller services
Year Ended December 31,
2005
2004
$ 99,848 $101,103
25,737
17,706
36,226
17,643
$153,717 $144,546
Internap 2006 Annual Report
27
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Financial Review 2006
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 customers
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 traffi c, much of
which was subject to “bursting rates” for exceeding rate caps. Revenue
from our Edge Appliance products, included in other/reseller services,
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 Decem-
ber 31, 2005, revenue from IP connectivity services continues to decrease
as a result of repricing of our customer base. Other/reseller services also
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 approximately
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.
Direct cost of network and sales. Direct cost of network and sales increased
from $77.6 million for the year ended December 31, 2004 to $82.5 million
for the year ended December 31, 2005, representing an increase of 6%.
The increase of $4.9 million in direct cost of network and sales 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 traffi c and other demand-
based pricing variables. Data center costs have substantial fi xed cost
components, primarily for rent, but also signifi cant 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 provide us access to new customers for whom we can bundle
hosting and connectivity services, 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%.
Direct cost of customer support. Direct cost of customer support 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 benefi ts of $0.3 million for higher staffi ng 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 benefi ts, along with a $0.2 million decrease in offi ce equip-
ment maintenance costs. The decrease in compensation and employee
benefi t costs were related to organizational changes that allowed us to
reprioritize projects and more effi ciently 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 market-
ing Edge Appliances and technology and expansion in the Asia-Pacifi c
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 refl ects 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 offi ce 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 benefi ts.
The reduction in taxes, licenses and fees related to the combination of
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 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 substantial decrease from
the original assessment was a result of including the weighted averages of
investment capital and subsidiary capital, along with business capital,
28
Internap 2006 Annual Report
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Financial Review 2006
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 signifi cantly
lower apportionment percentages in 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 implementation of the Sarbanes-Oxley Act of 2002 and
related initiatives in 2004. The improvement in facility and related costs
is 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 a more
favorable collections experience in 2005.
Depreciation and amortization. Depreciation and amortization, including
non-technology-based other intangible assets, for the year ended
December 31, 2005 decreased 5% to $14.7 million compared to
$15.5 million for the year ended December 31, 2004. The decrease of
$0.8 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 quar-
ter ended September 30, 2004, all remaining contractual obligations for
network infrastructure and other costs included in the restructuring were
satisfi ed, and we reduced the remaining recorded liability for the obliga-
tions from $1.7 million to zero.
LIQUIDITY AND CAPITAL RESOURCES
Cash Flow for the Years Ended December 31, 2006, 2005,
and 2004
Net cash from operating activities. Net cash provided by operating activities
was $29.6 million for the year ended December 31, 2006, and was
primarily due to net income of $3.7 million adjusted for non-cash items
of $25.4 million, offset by changes in working capital items of $0.5 million.
The changes in working capital items include net use of cash for accounts
receivable of $1.7 million, inventory, prepaid expense and other assets
of $1.8 million, and accrued restructuring of $1.5 million. These were
offset by net sources of cash in accounts payable of $3.0 million,
accrued liabilities of $1.4 million and deferred revenue of $1.1 million.
The increase in receivables at December 31, 2006 compared to Decem-
ber 31, 2005 was related to the 18% increase in revenue. Quarterly days
sales outstanding at December 31, 2006 decreased to 38 days from 43
days as of December 31, 2005. The increase in payables is primarily
related to the timing of payments with the 2006 balance being consistent
with our normal operating expenses and payment terms.
Net cash provided by operating activities was $5.5 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 $19.7 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
items were offset by net sources of cash in accrued liabilities of $0.8 mil-
lion 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 mil-
lion 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
items 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 days sales
outstanding increased to 41 days from 39 days as of December 31, 2004
and 2003, respectively. The increase in payables is primarily related to
more stringent cash controls in 2004 compared to 2003.
Net cash from investing activities. Net cash used in investing activities for
the year ended December 31, 2006 was $10.4 million, primarily due to
capital expenditures of $13.4 million. Our capital expenditures were
principally for upgrading our P-NAP facilities and the expansion of our
data center facilities.
Net cash used in investing activities for the year ended December 31, 2005
was $9.4 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
Internap 2006 Annual Report
29
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Financial Review 2006
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 offi ce space in the latter half of the year.
Net cash from fi nancing activities. Net cash provided by fi nancing activities
for the year ended December 31, 2006 was $2.0 million. Cash provided
by fi nancing activities was primarily due to proceeds from stock options,
employee stock purchase plan and exercise of warrants of $6.8 million,
offset by principal payments on a note payable of $4.4 million and pay-
ments on capital lease obligations of $0.5 million. As a result of these
activities, we had $7.7 million in a note payable and $0.4 million in capital
lease obligations as of December 31, 2006 with $4.7 million in the note
payable and capital leases scheduled as due within the next 12 months.
Net cash used in fi nancing activities for the year ended December 31, 2005
was $5.5 million. Cash used in fi nancing activities included principal pay-
ments 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 activities, we had $12.0 million in notes payable and $0.8 million
in capital lease obligations as of December 31.
Net cash provided by fi nancing 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 pro-
ceeds 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 repay-
ment 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 fi nancing activities included $24.3 million toward reducing our notes
payable and aforementioned capital lease obligations and $8.4 million to
repay the outstanding balance on our revolving credit facility.
Liquidity. We recorded net income of $3.7 million and a net loss of $5.0
million for the years ended December 31, 2006 and 2005, respectively.
As of December 31, 2006, our accumulated defi cit was $856.5 million.
We cannot guarantee that we will remain profi table, given the competitive
and evolving nature of the industry in which we operate. We may not be
able to sustain or increase profi tability on a quarterly basis, and our failure
to do so would adversely affect our business, including our ability to raise
additional funds.
Although we experienced positive operating cash fl ow for the year ended
December 31, 2006, we have a history of negative operating cash fl ow
and have primarily depended upon equity and debt fi nancings, as well as
borrowings under our credit facilities, to meet our cash requirements for
most quarters since we began our operations. Furthermore, we cannot
guarantee that we will continue to generate positive cash fl ow as we
integrate VitalStream. However, we expect to meet our cash requirements
in 2007 through a combination of cash from operating cash fl ows, 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 a number of factors,
including the continued market acceptance of our services and products,
the ability to expand and retain our customer base, and other factors. If our
cash requirements vary materially from those currently planned, if our cost
reduction initiatives have unanticipated adverse effects on our business, or
if we fail to generate suffi cient cash fl ow from the sales of our services and
products, we may require additional fi nancing sooner than anticipated. We
can offer no assurance that we will be able to obtain additional fi nancing on
commercially favorable terms, or at all, and provisions in our existing credit
facility limit our ability to incur additional indebtedness. Our $5.0 million
credit facility will expire on December 27, 2007. We cannot assure you
that this credit facility will be renewed upon expiration on commercially
favorable terms, or at all. We believe we have suffi cient cash to operate
our business for the foreseeable future.
Revolving credit facility. At December 31, 2006, we had a $5.0 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, 2006, to modify the amount available for
borrowing under the revolving credit agreement from $10.0 million to
$5.0 million with an additional $5.0 million available as needed, decrease
the letter of credit sub-limit from $6.0 million to $4.7 million, extend the
expiration date of the revolving credit facility from December 28, 2006 to
December 27, 2007 and update the loan covenants.
Availability under the revolving credit facility is based on 85% of eligible
accounts receivable. As of December 31, 2006, $3.9 million in letters
of credit were issued, and we had available $1.1 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. As of December 31,
2006, we were in compliance with the various loan covenants.
30
Internap 2006 Annual Report
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Financial Review 2006
Note payable to fi nancial institutions. The $17.5 million term loan discussed
with the revolving credit facility above has a fi xed interest rate of 7.5%
and is due in 48 equal monthly installments of $0.4 million for principal
plus interest through September 1, 2008. The balance outstanding at
December 31, 2006 was $7.7 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.
Capital leases. Our future minimum lease payments on remaining capital
lease obligations at December 31, 2006 totaled $0.5 million.
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 modifi cations 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 commitments with corresponding
revenue growth.
The following table summarizes our credit obligations and future contractual commitments as of December 31, 2006 but does not include credit obligations
or future contractual commitments assumed in the VitalStream acquisition consummated on February 20, 2007 (in thousands):
Note payable (1)
Capital lease obligations (2)
Operating lease commitments
Service commitments
Less than
1 year
$ 4,375
367
20,083
12,490
$37,315
Payments Due by Period
1– 3
Years
$ 3,281
89
37,062
13,672
$54,104
3 – 5
Years
$ –
–
34,399
3,496
$37,895
More than
5 years
$ –
–
95,433
3,709
$99,142
Total
$ 7,656
456
186,977
33,367
$228,456
(1) Note payable does not include interest expense of $0.4 million and $0.1 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.
Common and preferred stock. Our Certifi cate of Incorporation includes
authorization for 200 million shares of preferred stock, of which 3.5 mil-
lion shares were designated as Series A. As of December 31, 2006, no
shares of preferred stock were issued or outstanding.
• The exercise price per share of each replacement option granted in the
exchange offer was $14.46, the average of the closing prices of the
common stock as reported by the American Stock Exchange and the
NASDAQ Global Market, as applicable, for the 15 consecutive trading days
ending immediately prior to the grant date of the replacement options;
We issued approximately 12.2 million shares of our common stock to the
former stockholders of VitalStream in connection with the acquisition,
which closed on February 20, 2007.
• For all eligible options with an exercise price per share greater than or
equal to $20.00, the exchange ratio was 1-for-2; and
On July 10, 2006, we implemented a 1-for-10 reverse stock split and
amended our Certifi cate of Incorporation to reduce our authorized shares
from 600 million to 60 million. The Company began trading on a post-reverse
split basis on July 11, 2006. All share and per share information herein
(including shares outstanding, earnings per share and warrant and stock
option data) have been retroactively adjusted for all periods presented to
refl ect this reverse split.
In June 2006, our stockholders approved a measure to reprice certain
outstanding options under our existing equity incentive plans. Options
with an exercise price per share greater than or equal to $13.00 were
eligible for the repricing. The repricing was implemented through an
exchange program under which eligible participants were offered the
opportunity to exchange their eligible options for new options to purchase
shares. Each new option had substantially the same terms and conditions
as the eligible options cancelled except as follows:
• Each new option has a three-year vesting period, vesting in equal monthly
installments over three years, so long as the grantee continues to be a
full-time employee of the Company and has a ten-year term.
Employees of the Company eligible to participate in the exchange offer
tendered, and the Company accepted for cancellation, eligible options to
purchase an aggregate of 344,987 shares of common stock, representing
49.4% of the total shares of common stock underlying options eligible for
exchange in the exchange offer. The Company issued replacement options
to purchase an aggregate of 179,043 shares of common stock in exchange
for the cancellation of the tendered eligible options.
On March 4, 2004, we sold 4.03 million shares of our common stock in
a public offering at a purchase price of $15.00 per share which resulted
in net proceeds to us of $55.9 million, after deducting underwriting
Internap 2006 Annual Report
31
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Financial Review 2006
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.
ASSET IMPAIRMENT AND RESTRUCTURING COSTS
As described in note 3 to the fi nancial statements, we recognized an
impairment charge of $0.3 million during the year ended December 31,
2006 for certain costs incurred on a new fi nancial accounting system.
Additionally, we implemented signifi cant restructuring plans in 2001 and
2002 that resulted in substantial charges for real estate and network
infrastructure obligations, personnel and other charges. Additional
charges have subsequently been incurred as we continued to evaluate
our restructuring reserve. Nominal charges were recorded in the years
ended December 31, 2006 and 2005, and net restructuring charges of
$3.6 million were recorded during the year ended December 31, 2004.
We may incur additional changes in future periods.
OFF-BALANCE SHEET ARRANGEMENTS
As discussed in note 4 to the consolidated fi nancial statements, we
maintain a 51% ownership interest in Internap Japan, a joint venture
with NTT-ME Corporation of Japan and another NTT affi liate. Due to
certain minority interest protections afforded to our joint venture partners,
we are unable to assert control over the joint venture’s operational and
fi nancial policies and practices required to account for the joint venture
as a subsidiary whose assets, liabilities, revenue and expense would
be consolidated.
As discussed in note 13 to the consolidated fi nancial statements, warrants
to purchase approximately 34,000 shares of our common stock at a
weighted exercise price of $9.50 per share were outstanding as of
December 31, 2006.
QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
Cash and cash equivalents. We maintain cash and short-term deposits at
our fi nancial institutions. Due to the short-term nature of our deposits, we
record them on the balance sheet at fair value.
Other investments. We have a $1.2 million equity investment in Aventail,
a, privately-held company, after reducing 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 investment in Aventail.
We have also invested $4.1 million in Internap Japan, our joint venture
with NTT-ME Corporation and another NTT affi liate. This investment is
accounted for using the equity-method and to date we have recognized
$3.5 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.
The market for services being offered by Internap Japan has not been
proven and may never materialize.
Note payable. As of December 31, 2006, we had a note payable recorded
at its present value of $7.7 million bearing a rate of interest which we
believe is commensurate with its associated market risk.
Capital leases. As of December 31, 2006, we had capital leases recorded
at $0.4 million, refl ecting 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, 2006, we had $1.1 million available
under our revolving credit facility with a bank, and the balance outstanding
under the $17.5 million term loan was $7.7 million. The interest rate for
the loan was fi xed at 7.5%. The interest rate under the revolving credit
facility is variable and was 8.75% at December 31, 2006. 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 fi xed rate or a balance of fi xed 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 fl ows
by expected maturity dates for our debt obligations that extend beyond one
year as of December 31, 2006 (dollars in thousands):
Long-term debt:
Term loan
Interest rate
2007
2008
Fair
Value
$4,375
$3,281
$7,656
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. We do
not believe, therefore, that we currently have any signifi cant direct foreign
currency exchange rate risk.
Infl ation. The effect of infl ation and changing prices on net sales and
revenues and income from continuing operations has not been material
to the Company.
32
Internap 2006 Annual Report
Consolidated Statements of Operations
Financial Review 2006
(In thousands, except per share amounts)
Revenue
Costs and expense:
Direct cost of network and sales, exclusive of depreciation and amortization, shown below
Direct cost of customer support
Product development
Sales and marketing
General and administrative
Depreciation and amortization
Asset impairment and restructuring
Amortization of deferred stock compensation
Gain on disposals of property and equipment
Total operating costs and expense
Income (loss) from operations
Non-operating (income) expense:
Interest expense
Interest income
Other, net
Total non-operating (income) expense
Net income (loss) before income taxes and equity in earnings of unconsolidated subsidiary
Provision for income taxes
Equity in (earnings) loss of equity-method investment, net of taxes
Net income (loss)
Net income (loss) per share:
Basic
Diluted
Weighted average shares used in per share calculations
Basic
Diluted
The accompanying notes are an integral part of these consolidated financial statements.
Year Ended December 31,
2006
2005
2004
$ 181,375
$ 153,717
$ 144,546
97,854
11,566
4,475
27,173
22,104
15,856
323
–
(113)
179,238
2,137
883
(2,305)
(129)
(1,551)
3,688
145
(114)
82,535
10,670
4,864
25,864
20,096
14,737
44
60
(19)
158,851
(5,134)
1,373
(1,284)
(176)
(87)
(5,047)
–
(83)
$ 3,657
$ (4,964)
$
$
0.11
0.10
34,748
35,739
$
$
(0.15)
(0.15)
33,939
33,939
77,569
10,180
6,412
23,411
24,772
15,461
3,644
–
(3)
161,446
(16,900)
1,981
(665)
(544)
772
(17,672)
–
390
$ (18,062)
$
$
(0.63)
(0.63)
28,732
28,732
Internap 2006 Annual Report
33
Consolidated Balance Sheets
Financial Review 2006
(In thousands, except per share amounts)
ASSETS
Current assets:
Cash and cash equivalents
Short-term investments in marketable securities
Accounts receivable, net of allowance of $888 and $963, respectively
Inventory
Prepaid expenses and other assets
Total current assets
Property and equipment, net
Investments
Intangible assets, net
Goodwill
Deposits and other assets
Total assets
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Note payable, current portion
Accounts payable
Accrued liabilities
Deferred revenue, current portion
Capital lease obligations, current portion
Restructuring liability, current portion
Other current liabilities
Total current liabilities
Note 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, 60,000 shares authorized, 35,873 and 34,168 shares
issued and outstanding, respectively
Additional paid-in capital
Deferred stock compensation
Accumulated deficit
Accumulated items of other comprehensive income
Total stockholders’ equity
Total liabilities and stockholders’ equity
The accompanying notes are an integral part of these consolidated financial statements.
Year Ended December 31,
2006
2005
$ 45,591
13,291
20,282
474
3,818
83,456
47,493
2,135
1,785
36,314
2,519
$ 173,702
$
4,375
8,776
8,689
3,260
347
1,400
84
$ 24,434
16,060
19,128
779
2,741
63,142
50,072
1,999
2,329
36,314
1,513
$ 155,369
$
4,375
5,766
7,267
2,737
559
1,202
–
26,931
21,906
3,281
1,080
83
3,384
11,432
986
7,656
533
247
5,075
9,185
1,039
$ 47,177
$ 45,641
–
–
36
982,624
–
(856,455)
320
126,525
$ 173,702
34
970,221
(420)
(860,112)
5
109,728
$ 155,369
34
Internap 2006 Annual Report
Consolidated Statements of Stockholders’ Equity and Comprehensive Income (Loss)
Financial Review 2006
Additional
Paid-In
Capital
Treasury
Deferred
Stock
Stock Compensation
Items of
Accumulated Comprehensive
Income (Loss)
Defi cit
Total
Stockholders’
Equity
$855,446
$ –
$ –
$(837,086)
$300
$ 70,524
Accumulated
(In thousands)
Balance, December 31, 2003
Net loss
Change in unrealized gains and losses on investments
Foreign currency translation adjustment
Total comprehensive loss
Series A
Convertible
Preferred Stock
Shares
Par
Value
1,751 $ 51,841
–
–
–
–
–
–
Conversion of Series A convertible preferred stock
(1,751)
(51,841)
Issuance of common stock, net of issuance cost
Stock compensation plans activity
Exercise of warrants
Balance, December 31, 2004
Net loss
Change in unrealized gains and losses on investments
Foreign currency translation adjustment
Total comprehensive loss
Deferred stock compensation grant
Amortization of deferred stock compensation
Stock compensation plans activity
Balance, December 31, 2005
Net income
Change in unrealized gains and losses on investments
Foreign currency translation adjustment
Total comprehensive income
Reclassifi cation of deferred stock compensation
resulting from implementation of SFAS No. 123R
Stock-based compensation
Stock compensation plans activity
Exercise of warrants
Balance, December 31, 2006
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
Common Stock
Shares
22,875
–
–
–
5,900
4,025
897
118
Par
Value
$23
–
–
–
6
4
1
–
–
–
–
51,835
55,928
4,972
74
33,815
34
968,255
–
–
–
–
–
353
–
–
–
–
–
–
–
–
–
480
–
1,486
34,168
34
970,221
–
–
–
–
–
–
–
578
576
551
–
–
–
–
1
1
–
(420)
5,985
3,030
3,808
–
(395)
395
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
(480)
60
–
(18,062)
–
–
–
–
–
–
(855,148)
(4,964)
–
–
–
–
–
(420)
(860,112)
–
–
–
420
–
–
–
3,657
–
–
–
–
–
–
–
68
229
–
–
–
–
(18,062)
68
229
(17,765)
–
55,932
4,973
74
597
113,738
–
(118)
(474)
–
–
–
5
–
80
235
–
–
–
–
(4,964)
(118)
(474)
(5,556)
–
60
1,486
109,728
3,657
80
235
3,972
–
5,591
3,426
3,808
35,873
$36
$982,624
$ –
$ –
$(856,455)
$320
$126,525
The accompanying notes are an integral part of these consolidated financial statements.
Internap 2006 Annual Report
35
Consolidated Statements of Cash Flows
Financial Review 2006
(In thousands)
Cash flows from operating activities:
Net income (loss)
Adjustments to reconcile net income (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
Equity in (earnings) loss of equity-method investment
Non-cash changes in deferred rent
Stock-based compensation expense
Asset impairment
Lease incentives
Non-cash interest expense on capital lease obligations
Other, net
Changes in operating assets and liabilities:
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 investments in marketable securities
Maturities of marketable securities
Purchases of property and equipment
Proceeds from disposal of property and equipment
Reduction of restricted cash
Other, net
Net cash flows (used in) provided by investing activities
Cash flows from financing activities:
Change in revolving credit facility
Proceeds from note payable
Principal payments on notes payable
Payments on capital lease obligations
Proceeds from issuance of common stock, net of issuance costs
Proceeds from exercise of warrants
Proceeds from exercise of stock options and employee stock purchase plan
Other, net
Net cash flows provided by (used in) financing activities
Net increase (decrease) 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
Cash paid for taxes
Non-cash acquisition of property and equipment
Capitalized stock-based compensation
Conversion of preferred stock to common stock
Year Ended December 31,
2006
2005
2004
$ 3,657
$ (4,964)
$ (18,062)
16,372
(113)
548
(114)
2,247
5,942
319
–
–
212
(1,702)
(1,778)
3,010
1,422
1,070
(1,493)
29,599
(17,427)
20,277
(13,382)
133
–
–
(10,399)
–
–
(4,375)
(538)
–
3,808
3,031
31
1,957
21,157
24,434
$ 45,591
$
793
149
162
43
–
15,314
(19)
1,431
(83)
2,690
75
–
713
–
(397)
(3,616)
(170)
(5,433)
805
1,023
(1,876)
5,493
(18,710)
19,350
(10,161)
17
76
–
(9,428)
–
–
(6,483)
(512)
–
–
1,471
70
(5,454)
(9,389)
33,823
$ 24,434
$ 1,223
–
971
–
–
16,040
(3)
2,415
390
879
–
–
–
904
176
(3,771)
1,633
851
(1,316)
(1,743)
457
(1,150)
(16,753)
–
(13,066)
51
49
60
(29,659)
(8,392)
17,500
(4,051)
(20,289)
55,932
74
4,973
–
45,747
14,938
18,885
$ 33,823
$ 1,767
–
1,597
–
51,841
The accompanying notes are an integral part of these consolidated financial statements.
36
Internap 2006 Annual Report
Notes to Consolidated Financial Statements
Financial Review 2006
1. DESCRIPTION OF THE COMPANY AND
NATURE OF OPERATIONS
Internap Network Services Corporation (“Internap,” “we,” “us,” “our” or
the “Company”) markets products and services that provide managed and
premise-based Internet Protocol, or IP, and route optimization technologies
that enable business-critical applications such as e-commerce, customer
relationship management, or CRM, video and audio streaming, Voice-over-IP,
or VoIP, virtual private networks, or VPNs, and supply chain management.
Our product and service offerings are complemented by IP access solutions
such as data center services, content delivery networks, or CDN, and man-
aged security. We deliver services through our 43 network access points
across North America, London, and the Asia-Pacifi c region, including Tokyo.
Our Private Network Access Points, or P-NAPs, feature multiple direct
high-speed connections to major Internet networks, including AT&T, Sprint,
Verizon, (formerly MCI), Savvis, Global Crossing Telecommunications, and
Level 3 Communications.
The nature of our business subjects us to certain risks and uncertainties
frequently encountered by rapidly evolving markets. These risks include the
failure to develop or supply technology or services, the ability to obtain ade-
quate fi nancing, competition within the industry, and technology trends.
Although we have been in existence since 1996, we have incurred signif-
icant operational restructurings in recent years, which have included
substantial changes in our senior management team, streamlining our
cost structure, consolidating network access points, terminating certain
non-strategic real estate leases and license arrangements. We have a
history of quarterly and annual period net losses through the year ended
December 31, 2005. For the year ended December 31, 2006, we recognized
net income in each quarter with year to date net income of $3.7 million.
At December 31, 2006, our accumulated defi cit was $856.5 million. We
continue to analyze our business to control our costs, principally through
making process enhancements and renegotiating network contracts for
more favorable pricing and terms.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Accounting principles
The consolidated fi nancial statements and accompanying notes are pre-
pared in accordance with accounting principles generally accepted in the
United States of America. The consolidated fi nancial statements include the
accounts of Internap and all majority owned subsidiaries. Signifi cant inter-
company transactions have been eliminated in consolidation.
Estimates and assumptions
Our consolidated fi nancial statements have been prepared in accordance
with accounting principles generally accepted in the United States of America.
The preparation of these fi nancial statements 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 related to revenue recognition, doubtful accounts, cost-basis investments,
intangible assets, stock-based compensation, 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 equivalents
with major fi nancial 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.
Investments in marketable securities
Marketable securities primarily include high credit quality corporate debt
securities and U.S. Government Agency debt securities. Management
determines the appropriate classifi cation of marketable securities at the
time of purchase. At December 31, 2006 and 2005, all marketable securities
are classifi ed as available-for-sale. Available-for-sale securities are carried
at fair value, with the unrealized gains and losses reported in other compre-
hensive income. Our marketable securities are reviewed each reporting
period for declines in value that are considered 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 specifi c identifi cation method. Interest and dividends
on securities classifi ed as available-for-sale are included in interest income
in the consolidated statements of operations.
Other 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, 2006 in Aventail
Corporation, or Aventail, a 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 invest-
ments in the accompanying consolidated balance sheets.
We account for investments that provide us with the ability to exercise
signifi cant infl uence, but not control, over an investee using the equity
method of accounting. Signifi cant infl uence, but not control, is generally
deemed to exist if we have an ownership interest in the voting stock of
Internap 2006 Annual Report
37
Notes to Consolidated Financial Statements
Financial Review 2006
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, 2006,
Internap Japan Co. Ltd., or Internap Japan, our joint venture with NTT-ME
Corporation of Japan and another NTT affi liate, qualifi es 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
income and losses, net of taxes, as separate caption in our consolidated
statements of operations.
Fair value of fi nancial instruments
Our short-term fi nancial instruments, including cash and cash equivalents,
accounts receivable, accounts payable, note payable, and capital lease
obligations are carried at cost. The cost of our short-term fi nancial instru-
ments approximate fair value due to their relatively short maturities. Our
marketable securities are designated as available-for-sale and are recorded
at fair value with changes in fair value refl ected in other comprehensive
income. The carrying value of our long-term fi nancial instruments, including
note 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 for collectibility
each period. This evaluation involves assessing the aging of the amounts
due to the Company and reviewing the creditworthiness of customers.
Based on this evaluation, we record an allowance for accounts receivable
that are estimated to not be collectible.
Financial instrument credit risk
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 fi nancial 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 fi nancial institutions. We have not experienced any
credit losses on our cash, cash equivalents or marketable securities.
Inventory
Inventory is carried at the lower of cost or market using the fi rst-in, fi rst-out
method. Cost includes materials related to the production of our Flow Control
Platform, or FCP, and our Flow Control Xcelerator, or FCX, solutions.
years or over the lease term, depending on the nature of the improvement,
but in no event beyond the lease term. The duration of lease obligations
and commitments range from 24 months for certain networking equip-
ment to 240 months for certain facility leases. Additions 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 Financial
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, specifi c
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.
Costs of computer software development
In accordance with the American Institute of Certifi ed Public Accountants’
Statement of Position 98-1, “Accounting for the Costs of Computer Soft-
ware Developed or Obtained for Internal Use,” we capitalize certain direct
costs incurred developing internal use software. We capitalized $0.9 mil-
lion and $1.9 million in internal software development costs for the years
ended December 31, 2006 and 2004, respectively. We did not capitalize
any costs during the year ended December 31, 2005.
As of December 31, 2006 and 2005, the balance of unamortized software
costs was $2.5 million and $1.9 million, respectively. The software has
not been placed in service as of December 31, 2006, so no amortization
expense has been recorded.
For the year ended December 31, 2005 we capitalized $0.5 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 years ended
December 31, 2006 or 2004. As of December 31, 2006 and 2005, the
balance of unamortized software costs was $0.2 million and $0.1 million,
respectively, and for the years ended December 31, 2006 and 2005,
amortization expense was $0.2 million and $0.4 million, respectively.
Property and equipment
Goodwill and other intangible assets
Property and equipment is 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
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, goodwill is not impaired and no further
38
Internap 2006 Annual Report
Notes to Consolidated Financial Statements
Financial Review 2006
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 compared 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 com-
pleted our annual goodwill impairment test as of August 1, 2006 and
determined that the carrying amount of goodwill was not impaired.
Other acquired intangible assets, including developed technologies and
patents, have fi nite 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 fi fteen 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 fl ow from such
asset is separately identifi able 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 fl ows 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 disposal. Losses due to impairment
of long-lived assets are charged to operations during the period in which
the impairment is identifi ed.
Income taxes
We account for income taxes under the liability method. Deferred tax assets
and liabilities are determined based on differences between fi nancial
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.
Stock-based compensation
Effective January 1, 2006, we adopted SFAS No. 123 (revised 2004),
“Share-Based Payment” (SFAS No. 123R) and related interpretations, using
the modifi ed prospective transition method and therefore have not restated
prior periods’ results. SFAS No. 123R establishes the accounting for equity
instruments exchanged for employee services. Under SFAS No. 123R,
share-based compensation cost is measured at the grant date based on
the calculated fair value of the award. The expense is recognized over the
employees’ requisite service period, generally the vesting period of the award.
Prior to the adoption of SFAS No. 123R on January 1, 2006, we accounted
for stock-based compensation plans under the recognition and measure-
ment provisions of Accounting Principles Board (APB) Opinion No. 25,
“Accounting for Stock Issued to Employees,” and related interpretations.
We also provided disclosures in accordance with SFAS No. 123,
“Accounting for Stock-Based Compensation,” as amended by SFAS No. 148,
“Accounting for Stock-Based Compensation – Transition and Disclosures –
an Amendment of FASB Statement No. 123.” Accordingly, no expense was
recognized for options to purchase our common stock that were granted
with an exercise price equal to fair market value at the date of grant and
no expense was recognized in connection with purchases under our
employee stock purchase plans for any periods prior to January 1, 2006.
On November 10, 2005, the FASB issued FASB Staff Position No. FAS
123R-3, “Transition Election Related to Accounting for Tax Effects of
Share-Based Payment Awards,” that allows for a simplifi ed method to
establish the beginning balance of the APIC pool related to the tax effects
of employee stock-based compensation, and to determine the subsequent
impact on the APIC pool and consolidated statements of cash fl ows of
the tax effects of employee stock-based compensation awards that are
outstanding upon adoption of SFAS 123R. In 2006, the Company adopted
the alternative transition method provided in the FASB Staff Position for
calculating the tax effects of stock-based compensation pursuant to
SFAS 123R. The adoption did not have a material impact on our results
of operations and fi nancial condition.
SFAS No. 123R does not allow the recognition of a deferred tax asset for
unrealized tax benefi ts associated with the tax deductions in excess of the
compensation recorded (excess tax benefi t). The Company will recognize
a benefi t from stock-based compensation in equity if the excess tax bene-
fi t is realized by following the tax law ordering approach.
Treasury stock
As permitted by our stock-based compensation plans, we may, from time
to time, acquire shares of treasury stock as payment of taxes due from
employees for stock-based compensation. During 2006, shares of treasury
stock were acquired as payment of taxes and subsequently reissued as
part of our stock-based compensation plans. When shares are reissued,
we use the weighted average cost method for determining cost. The
difference between the cost of the shares and the issuance price is
added or deducted from additional contributed capital.
Reverse stock split
On July 10, 2006, we implemented a 1-for-10 reverse stock split on our
common stock and amended our Certifi cate of Incorporation to reduce
our authorized shares from 600 million to 60 million. We began trading
on a post reverse split basis on July 11, 2006. All share and per share
information herein (including shares outstanding, earnings per share and
warrant and stock option data) have been retroactively adjusted for all
periods presented to refl ect this reverse split.
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 revenue is generated
primarily from the sale of Internet connectivity services at fi xed rates or
Internap 2006 Annual Report
39
Notes to Consolidated Financial Statements
Financial Review 2006
usage-based pricing to our customers that desire a DS-3 or faster connec-
tion and other ancillary services. Ancillary services include data center
services, content delivery network, or CDN, services, server management
and installation services, virtual private networking services, managed
security services, data back-up, remote storage and restoration services.
We also offer T-1 and fractional DS-3 connections at fi xed rates.
We recognize revenue when persuasive evidence of an arrangement exists,
the product, service or software license has been delivered, the fees are
fi xed 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 fi xed 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 is deferred and amortized over the estimated
life of the customer relationship, which is generally two years, as the instal-
lation 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, which is generally one year.
We routinely review the creditworthiness and payment status of our
customers. If we determine 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 specifi c and general
customer information, which also includes estimates based on manage-
ment’s best understanding of our customers’ ability to pay and their
payment status. Customers’ ability to pay takes into consideration payment
history, legal status (e.g., bankruptcy), and the status of services we are
providing. We assess the payment status of customers by reference to
the terms under which services or goods are provided with any payments
not made on or before their due date considered past-due. 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 specifi c and general
customer information, including outstanding promotional credits, customer
disputes, credit adjustments not yet processed through the billing system
and historical activity. If the fi nancial condition of our customers were to
deteriorate, or management become aware of new information impacting
a customer’s credit risk, additional allowances may be required.
Research and product development costs
Product development costs are primarily related to network engineering
costs associated with changes to the functionality of our proprietary services
and network architecture. Such costs that do not qualify for capitalization 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 accelera-
tion technologies. Research and development costs were $2.4 million,
$2.9 million and $2.4 million for the years ended December 31, 2006,
2005, and 2004, respectively.
Advertising costs
We expense all advertising costs as they are incurred. Advertising costs for
2006, 2005 and 2004 were $1.3 million, $0.2 million and $1.3 million,
respectively.
Net income (loss) per share
Basic and diluted net income (loss) per share has been computed using
the weighted average number of shares of common stock outstanding
during the period. Diluted net income (loss) per share is computed using
the weighted average number of common and potentially dilutive shares
outstanding during the period. Potentially dilutive shares consist of the
incremental common shares issuable upon the exercise of outstanding
stock options and warrants and unvested restricted stock using the trea-
sury stock method. The treasury stock method calculates the dilutive
effect for only those stock options and warrants for which the sum of
proceeds, including unrecognized compensation and windfall tax bene-
fi ts, if any, is less than the average stock price during the period pre-
sented. Potentially dilutive shares are excluded from the computation of
net income (loss) per share if their effect is antidilutive.
Basic and diluted net income (loss) per share for the years ended
December 31, 2006, 2005 and 2004 are calculated as follows
(in thousands, except per share amounts):
Year Ended December 31,
2006
2005
2004
Net income (loss)
$ 3,657 $ (4,964) $ (18,062)
Weighted average shares used
in per share calculations:
Basic
34,748
33,939
28,732
Diluted
35,739
33,939
28,732
Net income (loss) per share:
Basic
$ 0.11
$
(0.15) $
(0.63)
Diluted
$ 0.10
$
(0.15) $
(0.63)
Antidilutive securities not included
in diluted net income (loss)
per share calculation:
Options to purchase common stock
Restricted stock
Warrants to purchase common stock
1,408
–
–
35,562
1,000
14,998
43,949
–
14,998
1,408
51,560
58,947
40
Internap 2006 Annual Report
Notes to Consolidated Financial Statements
Financial Review 2006
Reclassifi cations
In 2005 and 2004, direct cost of network and sales did not include
amortization of purchased technology and such amounts were included
in depreciation and amortization. In accordance with Question 17 of the
Financial Accounting Standards Board (FASB) Implementation Guide to
Statement of Financial Accounting Standard (SFAS) No. 86, “Accounting for
the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed,”
we have reclassifi ed these costs from “Depreciation and amortization”
to “Direct cost of network and sales” in the accompanying consolidated
statements of operations with the following effect (in thousands):
Direct cost of network and sales, exclusive
of depreciation and amortization shown below:
Previously reported
Reclassifi cation
As reclassifi ed
Depreciation and amortization:
Previously reported
Reclassifi cation
As reclassifi ed
Year Ended December 31,
2005
2004
$ 81,958
577
$ 76,990
579
$ 82,535
$ 77,569
$ 15,314
(577)
$ 16,040
(579)
$ 14,737
$ 15,461
These reclassifi cations had no effect on previously reported operating loss
or net loss.
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. Since the sale of products and the related assets
comprise less than 10% of our total revenue and total assets, respectively,
management does not disaggregate its business for internal reporting and
therefore presents a single business segment. Through December 31,
2006, neither revenue generated nor long-lived assets located outside
the United States were signifi cant, as all were less than 10%.
Recent accounting pronouncements
In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain
Hybrid Financial Instruments – an amendment of FASB Statements No. 133
and 140.” SFAS No. 155 eliminates the exemption from applying SFAS No.
133, “Accounting for Derivative Instruments and Hedging Activities,” to
interests in securitized fi nancial assets so that similar instruments are
accounted for similarly, regardless of the form of the instruments. SFAS
No. 155 also allows issuers of fi nancial statements to elect fair value
measurement at acquisition, at issuance, or when a previously recognized
fi nancial instrument is subject to a remeasurement (new basis) event, on
an instrument-by-instrument basis, in cases in which a derivative would
otherwise have to be bifurcated. SFAS No. 155 is effective for all fi nancial
instruments acquired or issued after the fi rst fi scal year beginning after
September 15, 2006. We believe that SFAS No. 155 will not have a
material impact on our consolidated fi nancial statements.
In March 2006, the FASB issued SFAS No. 156, “Accounting for Servicing
of Financial Assets – an amendment of FASB Statement No. 140.” SFAS
No. 156 requires that all separately recognized servicing assets and ser-
vicing liabilities be initially measured at fair value, if practicable. It also
permits, but does not require, the subsequent measurement of servicing
assets and servicing liabilities at fair value. An entity that uses derivative
instruments to mitigate the risks inherent in servicing assets and servicing
liabilities is required to account for those derivative instruments at fair
value. Under SFAS No. 156, an entity can elect subsequent fair value
measurement of its servicing assets and servicing liabilities by class, thus
simplifying its accounting and providing for income statement recognition
of the potential offsetting changes in fair value of the servicing assets,
servicing liabilities, and related derivative instruments. An entity that elects
to subsequently measure servicing assets and servicing liabilities at fair
value is expected to recognize declines in fair value of the servicing assets
and servicing liabilities more consistently than by reporting other-than-
temporary impairments. SFAS No. 156 is effective for fi scal years beginning
after September 15, 2006. We believe that SFAS No. 156 will not have a
material impact on our consolidated fi nancial statements.
In June 2006, Emerging Issues Task Force Issue No. 06-3, “How Sales
Taxes Collected from Customers and Remitted to Governmental Authori-
ties Should Be Presented in the Income Statement (That Is, Gross Versus
Net Presentation)” (EITF 06-3), was issued. EITF 06-3 requires disclosure
of the presentation of taxes on either a gross (included in revenues and
costs) or a net (excluded from revenues) basis as an accounting policy
decision. The provisions of this standard are effective for interim and
annual reporting periods beginning after December 15, 2006. We do
not expect the adoption of EITF 06-3 to have a material impact on our
consolidated fi nancial statements.
In June 2006, the FASB issued FASB Interpretation No. 48 (FIN 48),
“Accounting for Uncertainty in Income Taxes – an interpretation of FASB
Statement No. 109, Accounting for Income Taxes,” which clarifi es the
accounting for uncertainty in income taxes. FIN 48 prescribes a recognition
threshold and measurement attribute for the fi nancial statement recogni-
tion and measurement of a tax position taken or expected to be taken in
a tax return. The Interpretation requires that we recognize in the fi nancial
statements the impact of a tax position, if that position is more-likely-than-
not of being sustained on audit, based on the technical merits of the
position. FIN 48 also provides guidance on derecognition, classifi cation,
interest and penalties, accounting in interim periods, and disclosure. The
provisions of FIN 48 are effective beginning January 1, 2007 with the
cumulative effect of the change in accounting principle recorded as an
adjustment to opening retained earnings. We are continuing to evaluate
the possible impact of FIN 48 on our consolidated fi nancial statements.
Internap 2006 Annual Report
41
Notes to Consolidated Financial Statements
Financial Review 2006
In September 2006, the Securities and Exchange Commission, or SEC,
released Staff Accounting Bulletin No. 108, “Considering the Effects of
Prior Year Misstatements When Quantifying Misstatements in Current
Year Financial Statements” (SAB 108). SAB 108 provides guidance on
how the effects of the carryover or reversal of prior year fi nancial state-
ment misstatements should be considered in quantifying a current year
misstatement. Prior practice allowed the evaluation of materiality on the
basis of the error quantifi ed as the amount by which the current year income
statement was misstated (rollover method) or the cumulative error quanti-
fi ed as the cumulative amount by which the current year balance sheet
was misstated (iron curtain method). The guidance provided in SAB 108
requires both methods to be used in evaluating materiality. Immaterial prior
year errors may be corrected with the fi rst fi ling of prior year fi nancial
statements after adoption. The cumulative effect of the correction would
be refl ected in the opening balance sheet with appropriate disclosure of
the nature and amount of each individual error corrected in the cumulative
adjustment, as well as a disclosure of the cause of the error and that the
error had been deemed to be immaterial in the past. The adoption of SAB
108 did not have a material impact on our consolidated fi nancial statements.
In September 2006, the FASB issued Statement of Financial Accounting
Standards No. 157, “Fair Value Measurements” (SFAS No. 157). SFAS
No. 157 defi nes fair value as used in numerous accounting pronounce-
ments, establishes a framework for measuring fair value in generally
accepted accounting principles, or GAAP, and expands disclosure related
to the use of fair value measures in fi nancial statements. SFAS No. 157
does not expand the use of fair value measures in fi nancial statements,
but standardizes its defi nition and guidance in GAAP. SFAS No. 157
emphasizes that fair value is a market-based measurement and not an
entity-specifi c measurement based on an exchange transaction in which
the entity sells an asset or transfers a liability (exit price). SFAS No. 157
establishes a fair value hierarchy from observable market data as the
highest level to fair value based on an entity’s own fair value assumptions
as the lowest level. SFAS No. 157 is to be effective for our fi nancial state-
ments issued in 2008; however, earlier application is encouraged. We believe
that SFAS No. 157 will not have a material impact on our consolidated
fi nancial statements.
In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting
for Defi ned Benefi t Pension and Other Postretirement Plans – an amendment
of FASB Statements No. 87, 88, 106, and 132R,” which requires the
recognition of the over-funded or under-funded status of a defi ned benefi t
postretirement plan in a company’s balance sheet. This portion of the new
guidance is effective on December 31, 2006. Additionally, the pronouncement
eliminates the option for companies to use a measurement date prior to
their fi scal year-end effective December 31, 2008. SFAS No. 158 provides
two approaches to transition to a fi scal year-end measurement date, both
of which are to be applied prospectively. Under the fi rst approach, plan
assets are measured on September 30, 2007 and then remeasured on
January 1, 2008. Under the alternative approach, a 15-month measure-
ment will be determined on September 30, 2007 that will cover the period
until the fi scal year-end measurement is required on December 31, 2008.
We do not have any defi ned benefi t pension or postretirement plans that
are subject to SFAS No. 158. As such, we do not expect the pronouncement
to have a material impact on our consolidated fi nancial statements.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option
for Financial Assets and Financial Liabilities Including an Amendment of
FASB Statement No. 115,” which permits companies to measure many
fi nancial instruments and certain other assets and liabilities at fair value
on an instrument-by-instrument basis (the fair value option). Adoption of
the standard is optional and may be adpoted beginning in the fi rst quarter
of 2007. We are currently evaluating the possible impact of adopting
SFAS No. 159 on our consolidated fi nancial statements.
3. ASSET IMPAIRMENT AND RESTRUCTURING COSTS
In 2004, we began the implementation of a new fi nancial system. In
accordance with the American Institute of Certifi ed Public Accountants
(AICPA) Statement of Position (SOP) 98-1, “Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use,” certain costs
related to the system implementation were capitalized. Implementation of
the fi nancial system was suspended at the end of 2004, and resumed
during 2006 with a new vendor to assist in the initial phase of the imple-
mentation. During the 2006 implementation process and as part of our
periodic evaluation of the carrying value of long-lived assets, management
evaluated the carrying value of the costs capitalized during the 2004
implementation in accordance with the guidance provided by SFAS No.
144, “Accounting for the Impairment and Disposal of Long-Lived Assets.”
We determined that due to the selection of a new implementation vendor,
process changes resulting from internal reorganizations and new proce-
dures established to comply with the Sarbanes-Oxley Act of 2002, some
of the work completed during the 2004 implementation would no longer
be used and that the related carrying value of the capitalized costs was
not recoverable. As such, management recognized an impairment charge
of $0.3 million during the year ended December 31, 2006.
In 2001 and 2002, we implemented signifi cant restructuring plans that
resulted in substantial charges for real estate and network infrastructure
obligations, personnel and other charges. Additional related charges
have subsequently been incurred as we continue to evaluate our
restructuring reserve.
In 2006, we recorded a nominal charge for net changes in estimated
expenses related to real estate obligations. The following table displays
the activity and balances for restructuring activity for 2006 (in thousands):
December 31,
2005
Restructuring Restructuring
Liability
Charges Reductions
December 31,
2006
Cash Restructuring
Liability
Restructuring costs
activity for 2001
restructuring charge:
Real estate obligations
$6,277
$4
$(1,497)
$4,784
42
Internap 2006 Annual Report
Notes to Consolidated Financial Statements
Financial Review 2006
In 2005, we recorded net charges totaling less than $0.1 million primarily
for changes in estimated expenses related to real estate obligations. The
following table displays the activity and balances for restructuring and
asset impairment activity for 2005 (in thousands):
income. All proceeds were from the maturity of the securities, not from
sales. Accordingly, we have not recognized any realized gains or losses.
Summaries of our investments in marketable securities are as follows
(in thousands):
December 31,
2004
Restructuring Restructuring
Liability
Charges Reductions
December 31,
2005
Cash Restructuring
Liability
Restructuring costs
activity for 2001
restructuring charge:
Real estate obligations
$8,153
$44
$(1,920)
$6,277
In 2004, we incurred net additional restructuring costs of $3.6 million as
a result of a comprehensive analysis of the remaining accrued restructuring
liability. After reviewing the analysis, management concluded that sub-
leasing the facilities remaining in the restructuring accrual took 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 infrastructure and other costs included in the restructuring
were satisfi ed, and we reduced the remaining 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
2004 (in thousands):
December 31,
2003 Restructuring
Charges
(Benefi t) Reductions
Restructuring
Liability
December 31,
2004
Cash Restructuring
Liability
Short-term investments in
marketable securities
Short-term investments in
marketable securities
December 31, 2006
Cost Unrealized Recorded
Value
Gain
Basis
$13,264
$27
$13,291
December 31, 2005
Cost Unrealized Recorded
Value
Gain
Basis
$16,113
$(53) $16,060
We maintain a 51% ownership interest in Internap Japan, a joint venture
with NTT-ME Corporation of Japan and another NTT affi liate. We are
unable to assert control over the joint venture’s operational and fi nancial
policies and practices required to account for the joint venture as a sub-
sidiary 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 signifi cant infl uence 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.”
Restructuring costs
activity for 2001
restructuring charge:
Real estate obligations
Network infrastructure
obligations
Other
Net asset write-downs for
2002 restructuring charge
$5,843
$5,323
$(3,013)
$8,153
Our investment activity in the joint venture is as follows (in thousands):
1,125
867
7,835
(951)
(867)
(174)
–
–
–
3,505
(3,187)
8,153
(139)
139
–
–
$7,696
$3,644
$(3,187)
$8,153
Investment balance, January 1,
Proportional share of net income (loss)
Unrealized foreign currency translation
gain (loss), net
Year Ended December 31,
2006
$823
114
2005
2004
$ 861
83
$1,195
(390)
21
(121)
56
Investment balance, December 31,
$958
$ 823
$ 861
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.
4. INVESTMENTS
Investments in marketable securities primarily include high-credit-quality
corporate debt securities and U.S. Government Agency debt securities.
These investments are classifi ed as available-for-sale and are recorded
at fair value with changes in fair value refl ected in other comprehensive
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 fi nancing, we concluded that our investment in Aventail had
experienced a decline in value that was other-than-temporary. As a result,
Internap 2006 Annual Report
43
Notes to Consolidated Financial Statements
Financial Review 2006
during 2001 we recognized a $4.8 million loss on investment when we
reduced its recorded basis to $1.2 million, which remains its basis as of
December 31, 2006.
5. PROPERTY AND EQUIPMENT
Property and equipment consists of the following (in thousands):
Network equipment
Network equipment under capital lease
Furniture, equipment and software
Leasehold improvements
Property and equipment, gross
Less: Accumulated depreciation and amortization
($1,375 and $843 related to capital leases at
December 31, 2006 and 2005, respectively)
Year Ended December 31,
2006
2005
$ 65,430 $ 67,186
1,596
30,393
94,583
1,596
31,712
100,024
198,762 193,758
(151,269) (143,686)
$ 47,493 $ 50,072
During 2006 and 2005, $8.6 million and $8.4 million, respectively, of fully
depreciated assets were retired. In conjunction with the ongoing analysis
of our property and equipment, we identifi ed certain assets, initially classi-
fi ed predominantly as network equipment, that are more characteristic of
infrastructure. As of December 31, 2005, $20.3 million and $1.2 million,
representing the cost basis initially recorded in network equipment and
furniture, equipment and software, respectively, were reclassifi ed to lease-
hold improvements. These reclassifi cations had no effect on previously
reported balance sheets, depreciable lives or operations.
Depreciation and amortization of property and equipment associated
with direct cost of network and sales and other depreciation expense is
summarized as follows (in thousands):
Year Ended December 31,
2006
2005
2004
Direct cost of network and sales
Other depreciation and amortization
$13,250
2,606
$11,804
2,933
$10,898
4,563
Subtotal
Amortization of purchased technology,
included in direct cost of network and sales
15,856
14,737
15,461
516
577
579
Total depreciation and amortization
$16,372
$15,314
$16,040
The assumptions, inputs and judgments used in performing the valuation
analysis are inherently subjective and refl ect 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 circum-
stances, 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, 2006 and 2005, 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, 2006
Gross
December 31, 2005
Gross
Carrying Accumulated
Amount Amortization
Carrying Accumulated
Amount Amortization
Contract-based
Technology-based
$14,518
5,911
$(14,291)
(4,353)
$14,518
5,911
$(14,263)
(3,837)
$20,429
$(18,644)
$20,429
$(18,100)
Amortization expense for identifi able intangible assets during 2006, 2005
and 2004 was $0.5 million, $0.6 million and $0.6 million, respectively.
Estimated amortization expense for the next fi ve years is as follows as of
December 31, 2006 (in thousands):
2007
2008
2009
2010
2011
Thereafter
$ 443
443
443
339
28
89
$1,785
7. ACCRUED LIABILITIES
Accrued liabilities consist of the following (in thousands):
6. GOODWILL AND OTHER INTANGIBLE ASSETS
We perform our annual goodwill impairment test as of August 1 of each
calendar year and estimated the fair value of our reporting units utilizing
a discounted cash fl ow method. Based on the results of these analyses
our goodwill was not impaired as of August 1, 2006.
Taxes
Compensation payable
Network commitments
Insurance payable
Other
Year Ended December 31,
2006
2005
$ 2,005
4,075
520
38
2,051
$ 1,753
2,463
305
639
2,107
$ 8,689
$ 7,267
44
Internap 2006 Annual Report
Notes to Consolidated Financial Statements
Financial Review 2006
8. REVOLVING CREDIT FACILITY AND NOTE PAYABLE
At December 31, 2006, we had a $5.0 million revolving credit facility
and a $17.5 million term loan (note payable) under a loan and security
agreement with a bank. The agreement was amended as of December 27,
2006, to modify the amount available for borrowing under the revolving
credit agreement from $10.0 million to $5.0 million with an additional
$5.0 million available as needed, decrease the letter of credit sub-limit from
$6.0 million to $4.7 million, extend the expiration date of the revolving
credit facility from December 28, 2006 to December 27, 2007 and update
the loan covenants. The interest rate on the revolving credit was set to the
bank’s prime rate.
Availability under the revolving credit facility is based on 85% of eligible
accounts receivable. As of December 31, 2006, $3.9 million of letters
of credit were issued, and we had available $1.1 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 note payable under the security agreement described above has a fi xed
interest rate of 7.5% and is due in 48 equal monthly installments of principal
plus interest through September 1, 2008. The loan was used to purchase
assets previously recorded as capital leases under a master agreement
with a primary supplier of networking equipment. The loan is collateralized
by all of our assets, except patents. The balance outstanding under the
note payable was $7.7 million and $12.0 million at December 31, 2006
and 2005, respectively.
The maturity of the note payable at December 31, 2006 is as follows
(in thousands):
Future minimum capital lease payments together with the present value
of the minimum lease payments as of December 31, 2006, are as follows
(in thousands):
2007
2008
2009
Remaining capital lease payments
Less: Amounts representing imputed interest
Present value of minimum lease payments
Less: Current portion
$ 367
63
26
456
(26)
430
(347)
$ 83
10. INCOME TAXES
The current and deferred income tax provisions were as follows for the
years ended December 31, 2005 and 2006 (in thousands):
Current
Federal
State
Total current
Deferred
Federal
State
Total deferred
Income tax provision
Year Ended
December 31,
2006
2005
$145
–
145
–
–
–
$ –
–
–
–
–
–
$145
$ –
2007
2008
Total maturities and principal payments
Less: current portion
$4,375
3,281
7,656
(4,375)
$3,281
We account for income taxes under the liability method. Deferred tax assets
and liabilities are determined based on differences between fi nancial
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.
The carrying value of our note payable as of December 31, 2006,
approximates fair value as the interest rates approximate current market
rates of similar debt obligations.
Reconciliations of the provision (benefi t) for income taxes to the amount
compiled by applying the statutory federal income tax rate to income (loss)
before income taxes is as follows:
9. 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. As of December 31,
2006, our capital leases have expiration dates ranging from June 2007
to May 2009.
Federal income tax (benefi t)
at statutory rates
State income tax (benefi t)
Nondeductible stock compensation
Other
Change in valuation allowance
Effective tax rate
Year Ended December 31,
2006
2005
2004
34%
4%
8%
1%
(43%)
4%
(34%)
(4%)
–
1%
37%
–
(34%)
(4%)
–
1%
37%
–
Internap 2006 Annual Report
45
Notes to Consolidated Financial Statements
Financial Review 2006
Temporary differences between the fi nancial statement carrying amounts
and tax bases of assets and liabilities that give rise to 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:
U.S. net operating loss carryforwards
Foreign operating loss carryforwards
Tax credit carryforwards
Property and equipment
Investments
Stock compensation
Deferred revenue, less current portion
Restructuring costs, less current portion
Deferred rent
Non-current deferred income tax assets
Less: Valuation allowance
Year Ended
December 31,
2006
2005
$ 115 $ 329
860
433
457
5,383
854
1,225
132
532
–
390
2,394
(2,379)
8,316
(8,263)
15
53
128,527
14,574
165
20,315
1,824
216
386
1,286
4,344
133,917
14,582
–
22,738
1,824
–
367
1,438
3,413
171,637
(170,568)
178,279
(177,249)
1,069
1,030
Non-current deferred income tax liabilities:
Purchased intangibles
(1,084)
(1,083)
Non-current deferred income tax assets (liabilities), net
(15)
(53)
Net deferred tax assets (liabilities)
$ – $ –
As of December 31, 2006 we have net operating loss carryforwards of
approximately $553.9 million that will expire from 2012 through 2025.
Capital loss carryforwards of $5.4 million expired in 2006. In addition,
alternative minimum tax credit carryforwards were created during 2006
of approximately $165,000, which have an indefi nite carryforward period.
We also have foreign net operating loss carryforwards of approximately
$41.9 million as of December 31, 2006 that will begin to expire in 2008.
During 2005, the Company did not present foreign net operating losses
as a deferred tax asset. Such losses would have required a full valuation
allowance, in the opinion of management. The foreign net operating losses
are presented in the table above as deferred tax assets that require a full
valuation allowance as of December 31, 2006 and 2005, respectively.
Utilization of net operating losses is subject to the limitations imposed by
Section 382 of the Internal Revenue Code. Under this provision, we will be
precluded from utilizing approximately $215.7 million of our $553.9 million
in net operating 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 valuation 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 recov-
erability 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.
It is company policy to reinvest foreign earnings indefi nitely within each
country when foreign operations become profi table. As a result, no provi-
sion or benefi t is made for income taxes that would be payable upon the
distribution of such earnings, and it is not practicable to determine the
amount of the related unrecognized deferred income tax liability.
11. EMPLOYEE RETIREMENT PLAN
We sponsor a defi ned contribution retirement savings plan that qualifi es
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 $0.7 million,
$0.6 million and $0.2 million for 2006, 2005 and 2004, respectively.
12. COMMITMENTS, CONTINGENCIES, CONCENTRATIONS
OF RISK AND LITIGATION
Operating leases
We, as a lessee, have entered into leasing arrangements relating to offi ce
and service point rental space and offi ce equipment that are classifi ed
as operating leases. Lease terms range from 2 to 30 years and contain
various periods of free rent and renewal options. However, rent expense
is recorded on a straight-line basis over the initial lease term and renewal
periods that are reasonably assured. Future minimum lease payments on
non-cancelable operating leases are as follows at December 31, 2006
(in thousands):
2007
2008
2009
2010
2011
Thereafter
$ 20,083
19,740
17,322
16,924
17,475
95,433
$186,977
Rent expense was $18.8 million, $13.6 million and $12.9 million for the
years ended December 31, 2006, 2005 and 2004, respectively. Sub-
lease income, recorded as a reduction of rent expense, was $0.6 million,
$0.2 million and $0.3 million during the years ended December 31,
2006, 2005 and 2004, respectively.
46
Internap 2006 Annual Report
Notes to Consolidated Financial Statements
Financial Review 2006
Service commitments
We have entered into service commitment contracts with Internet network
service providers to provide interconnection services and data center pro-
viders to provide space for our customers. Future minimum payments under
these service commitments having terms in excess of one year are as
follows at December 31, 2006 (in thousands):
2007
2008
2009
2010
2011
Thereafter
Vendor disputes
$12,491
8,532
5,140
1,722
1,773
3,709
$33,367
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 dis-
putes 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 modifi ed in light of new informa-
tion 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 mate-
rially and adversely affect our results of operations and cash fl ows.
As part of our acquisition of CO Space on June 20, 2000, we assumed
a pre-acquisition accounts payable liability of $1.3 million. As disclosed
in our 2003 fi nancial statements, we wrote off the $1.3 liability amount
as we believed the obligation no longer existed. In the fourth quarter of
2006, the Company received an inquiry from the vendor regarding the
status of the former $1.3 million payable. We have reviewed the inquiry
and continue to believe that we have no obligation to make the $1.3 mil-
lion payment. However, the vendor may continue to assert it has rights to
a claim and has made a request for payment. As of December 31, 2006,
we have not accrued any amounts associated with this claim as we
believe a loss is neither probable or estimable. Any associated legal costs
will be expensed as incurred.
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 addi-
tion, the routers and switches used in our network infrastructure are currently
supplied by a limited number of vendors. Furthermore, we do not carry
signifi cant inventories of the products we purchase, and we have no guar-
anteed supply arrangements with our vendors. A loss of a signifi cant 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 fi nancial 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 fi nancial
condition, results of operations or cash fl ows.
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 profes-
sional service provider to initiate an appeal. In April 2005, New York
State Department of Taxation and Finance reduced the assessment to
$0.1 million, including interest and waived penalties. 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 signifi cantly lower apportionment percentages in 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 refl ected
in accrued liabilities and general and administrative expense in the
accompanying fi nancial statements.
Internap 2006 Annual Report
47
Notes to Consolidated Financial Statements
Financial Review 2006
13. 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 Certifi cate of Incorporation. An aggre-
gate 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.
Common stock
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 an acquisition in 2003, we granted warrants to purchase
an aggregate of 0.2 million shares of our common stock to stockholders of
the acquired company. These warrants were exercisable if the stockholders
of the acquired company participated in a private placement of shares of
our common or preferred stock and their participation was in an amount
equal to or greater than $4.4 million. Each warrant was exercisable for one
share of our common stock at an exercise price of $9.50 per share and
expired on October 1, 2006. There was no value allocated to these warrants.
Outstanding warrants to purchase shares of common stock at
December 31, 2006, are as follows (shares in thousands):
On September 18, 2006, our common stock began trading on the NASDAQ
Global Market, under the symbol “INAP.” We voluntarily delisted our
common stock from the American Stock Exchange (AMEX), effective
September 17, 2006.
Year of Expiration
2008
Weighted
Average
Exercise Price
Shares
$9.50
34,080
On July 10, 2006, we implemented a 1-for-10 reverse stock split of our
common stock. Authorization to implement the reverse stock split was
approved on June 21, 2006, by our stockholders at our annual stock-
holders’ meeting. Our common stock began trading on a split-adjusted
basis on July 11, 2006. All share and per share information herein
(including shares outstanding, earnings per share and warrant and stock
option exercise prices) have been retroactively restated for all periods
presented to refl ect the reverse stock split.
On March 4, 2004, we sold 4.03 million shares of our common stock in a
public offering at a purchase price of $15.00 per share which resulted in
net proceeds to us of $55.9 million after deducting underwriting discounts
and commissions and offering expense.
Treasury stock
During 2006, shares of treasury stock were acquired as payment of taxes
on stock-based compensation from employees and subsequently reissued
as part of our stock-based compensation plans.
Warrants to purchase common stock
As of December 31, 2006, there were warrants outstanding to purchase
approximately 34,000 shares of our common stock at an exercise price
of $9.50 per share.
On September 14, 2001, in conjunction with our series A preferred stock
fi nancing, we issued warrants to purchase up to 17.1 million shares of
common stock at $1.48256 per share for a period of fi ve 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.
14. STOCK-BASED COMPENSATION PLANS
General
We have adopted SFAS No. 123 (revised 2004), “Share-Based Payment”
(SFAS No. 123R) and related interpretations, using the modifi ed prospective
transition method and therefore have not restated prior periods’ results.
SFAS No. 123R establishes the accounting for equity instruments exchanged
for employee services. Under SFAS No. 123R, share-based compensation
cost is measured at the grant date based on the calculated fair value of
the award. The expense is recognized over the employee’s requisite service
period, generally the vesting period of the award. Prior to the adoption of
SFAS No. 123R on January 1, 2006, we accounted for stock-based
compensation plans under the recognition and measurement provisions
of Accounting Principles Board (APB) Opinion No. 25, “Accounting for
Stock Issued to Employees,” and related interpretations. We also provided
disclosures in accordance with SFAS No. 123, “Accounting for Stock-Based
Compensation,” as amended by SFAS No. 148, “Accounting for Stock-
Based Compensation – Transition and Disclosures – an Amendment of
FASB Statement No. 123.” Accordingly, no expense was recognized for
options to purchase our common stock that were granted with an exercise
price equal to fair market value at the date of grant, and no expense was
recognized in connection with purchases under our employee stock pur-
chase plans for any periods prior to January 1, 2006. As a result of
adopting SFAS No. 123R on January 1, 2006, our income before taxes
and net income for the year ended December 31, 2006 was $5.1 million,
or $0.15 per basic and $0.14 per diluted share, lower than if we had con-
tinued to account for stock-based compensation under APB Opinion No. 25.
48
Internap 2006 Annual Report
Notes to Consolidated Financial Statements
Financial Review 2006
Deferred compensation related to 100,000 shares of restricted stock was
granted in connection with the September 30, 2005 employment agree-
ment between the Company and its new President and Chief Executive
Offi cer. This deferred compensation was refl ected in stockholders’ equity
as of December 31, 2005, and is being recognized ratably in accordance
with the terms of vesting. Upon the adoption of SFAS No. 123R, the
unamortized balance of the deferred compensation was reclassifi ed to
additional paid-in capital.
In June 2006, our stockholders approved a measure to reprice certain
outstanding options under our existing equity incentive plans. Options
with an exercise price per share greater than or equal to $13.00 were
eligible for the repricing. The repricing was implemented through an
exchange program under which eligible participants were offered the
opportunity to exchange their eligible options for new options to purchase
shares. Each new option had substantially the same terms and conditions
as the eligible options cancelled, except as follows:
• The exercise price per share of each replacement option granted in the
exchange offer was $14.46, the average of the closing prices of the
common stock as reported by the American Stock Exchange and the
NASDAQ Global Market, as applicable, for the 15 consecutive trading days
ending immediately prior to the grant date of the replacement options;
• For all eligible options with an exercise price per share greater than or
equal to $20.00, the exchange ratio was 1-for-2; and
• Each new option has a three-year vesting period, vesting in equal monthly
installments over three years, so long as the grantee continues to be a
full-time employee of the Company and has a ten-year term.
A total of 50 employees eligible to participate in the exchange offer tendered,
and we accepted for cancellation, eligible options to purchase an aggregate
of 344,987 shares of common stock, representing 49.4% of the total shares
of common stock underlying options eligible for exchange in the exchange
offer. We issued replacement options to purchase an aggregate of 179,043
shares of common stock in exchange for the cancellation of the tendered
eligible options.
In accordance with SFAS No. 123R, we will recognize $0.1 million of
incremental compensation cost over the three-year vesting period as a
result of the option exchange. The incremental expense was measured
as the excess of the fair value of the repriced options over the fair value
of the original options immediately before the terms of the original options
were modifi ed. The measurement was based on the share price and other
pertinent factors at that date of modifi cation.
Stock-based compensation expense
The following table summarizes the amount of stock-based compensation
expense, net of estimated forfeitures in accordance with SFAS No. 123R,
included in the accompanying consolidated statements of operations for
the year ended December 31, 2006 (in thousands):
Direct cost of customer support
Product development
Sales and marketing
General and administrative
Total stock-based compensation expense
included in net income
Year Ended
December 31,
2006
$1,102
628
2,145
2,067
$5,942
Less than $0.1 million of stock-based compensation was capitalized during
the twelve months ended December 31, 2006.
The following table illustrates the effect on net loss and net loss per share
as if we had applied the fair value recognition provisions of SFAS No. 123
to stock-based employee compensation for years ended December 31,
2005 and 2004 (in thousands except per share amounts):
Net loss, as reported
Add: Stock-based employee compensation
expense included in reported net loss
Adjust: Total stock-based employee compensation
expense determined under fair-value-based
method for all awards
Pro forma net loss
Loss per share:
Basic and diluted – as reported
Basic and diluted – pro forma
Year Ended
December 31,
2005
2004
$ (4,964) $(18,062)
75
–
(9,678)
(15,364)
$(14,567) $(33,426)
$ (0.15) $ (0.63)
(1.16)
(0.43)
Note that the above pro forma disclosure was not presented for the twelve
months ended December 31, 2006 because stock-based compensation
has been accounted for in the statement of operations using the fair value
recognition method under SFAS No. 123R for those periods.
The decrease in recorded stock-based compensation expense for the
twelve months ended December 31, 2006, compared to the pro forma
stock-based compensation expense for the twelve months ended
December 31, 2005 is due primarily to cancellations of outstanding stock
options and the difference between estimated and actual forfeitures.
Internap 2006 Annual Report
49
Notes to Consolidated Financial Statements
Financial Review 2006
SFAS No. 123R requires compensation expense to be recorded net of
estimated forfeitures with a subsequent adjustment to reflect actual
forfeitures as they occur. Previously, forfeitures of unvested stock options
were accounted for on a pro forma basis as they were incurred, generally
resulting in higher pro forma stock compensation than under the current
provisions of SFAS No. 123R. In addition, a signifi cant number of unvested
stock options were forfeited upon the resignation on November 18, 2005
of Mr. Gregory Peters, our former Chief Executive Offi cer, thus reducing the
number of outstanding stock options for determining comparative stock-
based compensation expense for the twelve months ended December 31,
2006. These unvested options were included in the calculation of our pro
forma stock expense previously reported for the twelve months ended
December 31, 2005.
The weighted average fair values of outstanding stock options has been
estimated at the date of grant using a Black-Scholes option pricing model.
The signifi cant weighted average assumptions used for estimating the
fair value of the activity under our stock option plans for the years ended
December 31, 2006, 2005 and 2004, were expected terms of 5.7, 4.0
and 4.0 years, respectively; historical volatilities of 123%, 118% and
142%, respectively; risk free interest rates of 4.63%, 4.22% and 4.27%,
respectively and no dividend yield. The weighted average estimated fair
value per share of our employee stock options at grant date was $7.75,
$3.50 and $11.83 for the years ended December 31, 2006, 2005 and
2004, respectively.
Stock compensation and option plans
On June 23, 2005, we adopted the Internap Network Services Corporation
2005 Incentive Stock Plan, which was amended and restated on March 15,
2006, or the 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 administered by the compensation
committee of the Board of Directors. A total of 6.8 million shares of stock
is reserved for issuance under the 2005 Plan, comprised of 2.0 million
shares designated in the 2005 Plan, plus 1.0 million shares that remain
available for issuance of options and awards and 3.8 million shares of
unexercised options under certain pre-existing plans. We will not make
any future grants under the specifi ed pre-existing plans, but each of the
specifi ed pre-existing 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, 2006,
2.6 million options were outstanding, 0.4 million shares of non-vested
restricted stock awards were outstanding and 2.9 million shares of stock
were available for issuance under the 2005 plan.
The 2005 Plan also provides that in any calendar year, no eligible employee
or director shall be granted an option to purchase more than 1.4 million
shares of stock or a stock appreciation right based on the appreciation with
respect to more than 1.4 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 $3.0 million. Furthermore, no more than
0.7 million non-forfeitable shares of stock shall be issued pursuant to
stock grants.
During July 1999, we adopted the 1999 Non-Employee Directors’ Stock
Option Plan, or the Director Plan. The Director Plan provides for the grant of
non-qualifi ed stock options to non-employee directors. A total of 0.4 million
shares of our common stock have been reserved for issuance under the
Director Plan. Under the terms of the Director Plan, non-employee directors
receive fully-vested and exercisable initial grants of 8,000 shares of our
common stock on the date such person is fi rst elected or appointed as a
non-employee director. The Director Plan provides that on the day after
each of our annual stockholder meetings, starting with the annual meeting
in 2000, each non-employee director receives a fully vested and exercisable
option for 2,000 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 affi liates. As of December 31, 2006,
0.1 million options were outstanding and 0.3 million options were available
for grant pursuant to the Director Plan.
The option price for each share of stock subject to an option shall generally
be no less than the fair market value of a share of stock on the date the
option is granted. Stock options generally have a maximum term of ten
years from the date of grant. Incentive stock options, or ISOs, may be
granted only to eligible employees and if granted to a 10% stockholder,
the terms of the grant will be more restrictive than for other 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.
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 Board of
Directors or the compensation committee of the Board of Directors, as
applicable. Stock options generally vest 25% after one year and monthly
over the following three years, except for non-employee directors who
usually receive immediately 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 condition 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. Common stock has been reserved under
each of the stock compensation plans to satisfy option exercises with
newly issued stock.
50
Internap 2006 Annual Report
Notes to Consolidated Financial Statements
Financial Review 2006
During 2006, we completed an internal review of our prior stock option
granting practices. As a result of the review, however, we determined that
approximately $0.2 million of net expense should have been recognized
in prior periods in accordance with APB Opinion No. 25, “Accounting for
Stock Issued to Employees.” The expense was due to a small number of
grants made in 2002 and 2003 that had exercise prices that were lower
than our stock price at the date of grant and one grant that should have
been accounted for as a variable stock option, in accordance with FASB
Interpretation No. 28, “Accounting for Stock Appreciation Rights and
Other Variable Stock Option or Award Plans, an interpretation of APB
Opinions No. 15 and 25.” Substantially all of the net expense should have
been recorded between April 1, 2003 and December 31, 2004. We have
considered the impact of the error, including the assessment of any
potential impact on prior period loan covenants and concluded that the
error was not material to our fi nancial statements for any prior period.
Based on this evaluation, we recorded the expense in the current period
and it is included in general and administrative expense in the accompa-
nying statements of operations.
Option activity for each of the three years ended December 31, 2006 under
all of our stock option plans is as follows (shares in thousands):
Balance, December 31, 2003
Granted
Exercised
Cancelled
Balance, December 31, 2004
Granted
Exercised
Cancelled
Balance, December 31, 2005
Granted
Exercised
Cancelled
Weighted
Average
Exercise Price
$15.20
17.39
5.70
22.44
16.96
4.92
4.51
19.15
13.49
9.30
5.84
19.94
Shares
3,916
1,638
(750)
(409)
4,395
948
(202)
(1,585)
3,556
752
(497)
(1,112)
Balance, December 31, 2006
2,699
$11.07
The total intrinsic value of options exercised was $2.6 million, $0.2 million
and $6.0 million for the years ended December 31, 2006, 2005 and 2004,
respectively.
The following table summarizes information about options outstanding at December 31, 2006 (shares in thousands):
Options Outstanding
Weighted Average
Remaining
Contractual Life
(In Years)
Number of
Shares
282
746
482
281
331
321
256
2,699
5.8
8.4
8.9
6.0
6.3
7.9
6.2
7.4
Weighted
Average
Exercise
Price
$ 2.80
4.81
6.44
9.99
13.02
16.02
39.67
$11.07
Options Exercisable
Weighted Average
Remaining
Contractual Life
(In Years)
Number of
Shares
269
342
42
229
231
142
198
1,453
5.7
8.0
7.1
5.6
5.4
5.6
5.8
6.2
Weighted
Average
Exercise
Price
$ 2.73
4.81
6.13
10.07
13.11
17.72
45.04
$13.36
Exercise Prices
$ 0.30 – $ 4.60
$ 4.80 – $ 5.20
$ 5.30 – $ 7.40
$ 7.70 – $ 11.30
$11.60 – $ 14.30
$14.46 – $ 18.70
$18.80 – $345.00
$ 0.30 – $345.00
Internap 2006 Annual Report
51
Notes to Consolidated Financial Statements
Financial Review 2006
None of our stock options or the underlying shares is subject to any right
to repurchase by the Company.
The total intrinsic value at December 31, 2006 of all options outstanding
and expected to vest was $28.8 million. The total intrinsic value at
December 31, 2006 of all options exercisable was $14.5 million.
Restricted stock activity for each two years ended December 31, 2006 is
as follows (shares in thousands):
Weighted Average
Grant-Date
Fair Value
Shares
Non-vested balance, December 31, 2004
Granted
Vested
Non-vested balance, December 31, 2005
Granted
Vested
Forfeited
Non-vested balance, December 31, 2006
–
104
(4)
100
568
(158)
(90)
420
$ –
4.78
4.30
4.80
6.18
5.68
5.61
$6.17
The total fair value of restricted stock awards vested during the years
ended December 31, 2006 and 2005 was $2.1 million and $16,000,
respectively. The cumulative effect of the change in the forfeiture rate for
non-vested restricted stock was immaterial and recorded as part of oper-
ating expense. There were no restricted stock awards during the year
ended December 31, 2004.
Total unrecognized compensation costs related to non-vested stock-based
compensation as of December 31, 2006, is summarized as follows
(dollars in thousands):
Initially, the price for shares of common stock purchased under the 2004
ESPP was the lesser of 85% of the closing sale price per share of common
stock on the fi rst day of the purchase period or 85% of such closing price
on the last day of the purchase period. Approximately 0.1 million shares
were granted under the 2004 ESPP during each of the years ended
December 31, 2006 and 2005. The 2004 ESPP was intended to be a
non-compensatory plan for both tax and fi nancial reporting purposes.
Upon our adoption of SFAS No. 123R in the fi rst quarter of 2006, however,
we recognized compensation expense of $0.1 million during the year ended
December 31, 2006, representing the estimated fair value of the benefi t
to participants as of the beginning of the purchase period. In January 2006,
the 2004 ESPP 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 fi rst day
of the offering period as a basis for determining the purchase price. This
amendment restores the plan to being non-compensatory for fi nancial
reporting purposes and is effective for the purchase period July 1 through
December 31, 2006. As such, no additional compensation expense for the
2004 ESPP was recognized after June 30, 2006. Cash received from partici-
pation in the 2004 ESPP was $0.5 million and $0.3 million for the years
ended December 31, 2006 and 2005, respectively. At December 31, 2006,
0.3 million shares were reserved for future issuance under the 2004 ESPP.
At December 31, 2006, total shares reserved for future awards under all
plans was 6.1 million.
Cash received from all stock-based compensation arrangements was
$3.0 million, $1.5 million and $5.0 million for the years ended Decem-
ber 31, 2006, 2005 and 2004, respectively.
15. RELATED PARTY TRANSACTIONS
Stock Restricted
Stock
Options
Total
$9,309
$3,088
$12,397
2.7
3.0
2.8
As discussed in note 4, 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 2004 through 2006. As of December 31,
2006 and 2005, our outstanding receivable balances with Aventail were
less than $0.1 million.
We have entered into indemnifi cation agreements with our directors and
executive offi cers for the indemnifi cation 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 offi cers.
Unrecognized compensation
Weighted average remaining
recognition period (in years)
Employee stock purchase plans
Effective June 15, 2004, we adopted the 2004 Internap Network Services
Corporation Employee Stock Purchase Plan, or the 2004 ESPP. The pur-
pose of the 2004 ESPP 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 2004 ESPP 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.
52
Internap 2006 Annual Report
Notes to Consolidated Financial Statements
Financial Review 2006
16. SUBSEQUENT EVENT – VITALSTREAM ACQUISITION
17. UNAUDITED QUARTERLY RESULTS
On October 12, 2006, we entered into a defi nitive agreement to acquire
VitalStream Holdings, Inc., or VitalStream, in an all-stock transaction to
be accounted for using the purchase method of accounting for business
combinations. The transaction closed on February 20, 2007. Under the
terms of the agreement, VitalStream stockholders received, at a fi xed
exchange ratio, 0.5132 shares of Internap common stock for every share
of VitalStream common stock in a tax-free exchange. As a result, we
issued approximately 12.2 million shares of common stock in respect of
outstanding VitalStream common shares, which represented approximately
25% of our outstanding shares. The purchase price for the acquisition
includes the estimated fair value of Internap common stock issued, stock
options assumed, and estimated direct transaction costs. The values are
derived using an average market price per share of Internap common
stock of $16.40, which was based on an average of the closing prices for
a range of trading days, from October 6, 2006 through October 16, 2006,
around the announcement date, which was October 12, 2006. The pre-
liminary purchase price of $222.0 million was determined based upon
the number of VitalStream shares and options outstanding at the closing
date of February 20, 2007 and taking into consideration estimated
direct transaction costs.
The total purchase price and purchase price allocation have not been
fi nalized. Using VitalStream’s balance sheet as of December 31, 2006,
total assets acquired are $224.1 million and total liabilities assumed are
$15.0 million. Included in total assets will be intangible assets for devel-
oped technologies, customer relationships, trade names and goodwill.
The following table sets forth selected unaudited quarterly data for the
years ended December 31, 2006 and 2005. In the opinion of manage-
ment, this information has been prepared on the same basis as the
audited fi nancial statements and all necessary adjustments, consisting
of only normal recurring adjustments, have been included in the amounts
stated below to state fairly, in all material respects, the quarterly informa-
tion when read in conjunction with the audited fi nancial 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
2006
March 31
June 30 September 30 December 31
Revenue
Net income
Basic net income
per share
Diluted net income
per share
$42,625
541
$43,905
713
$45,874
195
$48,971
2,208
$ 0.02
$ 0.02
$ 0.01
$ 0.06
0.01
0.02
0.01
0.06
Quarter Ended
2005
March 31
June 30 September 30 December 31
Revenue
Net loss
Basic and diluted
net loss per share
$37,855
(570)
$37,571
(1,046)
$37,999
(3,171)
$40,292
(177)
$ (0.02) $ (0.03)
$ (0.09)
$ (0.01)
Effective January 1, 2006, we adopted SFAS No. 123R and related interpre-
tations, using the modifi ed prospective transition method. Therefore, results
for 2005 do not include stock-based compensation expense for options
to purchase our common stock that were granted with an exercise price
equal to fair market value at the date of grant and do not include expense
for purchases under employee stock purchase plans.
Internap 2006 Annual Report
53
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 consolidated fi nancial statements and of its internal control
over fi nancial reporting as of December 31, 2006, in accordance with the
standards of the Public Company Accounting Oversight Board (United
States). Our opinions, based on our audits, are presented below.
Consolidated fi nancial statements
In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of operations, of stockholders’ equity
and comprehensive income (loss) and of cash fl ows present fairly, in all
material respects, the fi nancial position of Internap Network Services
Corporation and its subsidiaries at December 31, 2006 and 2005, and the
results of their operations and their cash fl ows for each of the three years
in the period ended December 31, 2006 in conformity with accounting
principles generally accepted in the United States of America. These
fi nancial statements are the responsibility of the Company’s management.
Our responsibility is to express an opinion on these fi nancial 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 fi nancial state-
ments are free of material misstatement. An audit of fi nancial statements
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the fi nancial statements, assessing the accounting principles
used and signifi cant estimates made by management, and evaluating the
overall fi nancial statement presentation. We believe that our audits provide
a reasonable basis for our opinion.
As discussed in note 2 to the financial statements, the Company
changed the manner in which it accounts for share-based compen-
sation in fiscal 2006.
Internal control over fi nancial 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
fi nancial reporting as of December 31, 2006 based on criteria estab-
lished in Internal Control – Integrated Framework issued by the Commit-
tee 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 fi nancial reporting as of December 31, 2006, 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 fi nancial reporting and for its
assessment of the effectiveness of internal control over fi nancial reporting.
Our responsibility is to express opinions on management’s assessment and
on the effectiveness of the Company’s internal control over fi nancial
reporting based on our audit. We conducted our audit of internal control over
fi nancial 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 fi nancial reporting was maintained
in all material respects. An audit of internal control over fi nancial report-
ing includes obtaining an understanding of internal control over fi nan-
cial reporting, evaluating management’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 fi nancial reporting is a process designed
to provide reasonable assurance regarding the reliability of fi nancial report-
ing and the preparation of fi nancial statements for external purposes in
accordance with generally accepted accounting principles. A company’s
internal control over fi nancial reporting includes those policies and procedures
that: (i) pertain to the maintenance of records that, in reasonable detail,
accurately and fairly refl ect the transactions and dispositions of the assets
of the company; (ii) provide reasonable assurance that transactions are
recorded as necessary to permit preparation of fi nancial 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 detec-
tion of unauthorized acquisition, use, or disposition of the company’s
assets that could have a material effect on the fi nancial statements.
Because of its inherent limitations, internal control over fi nancial reporting
may not prevent or detect misstatements. Also, projections of any evalua-
tion 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.
Atlanta, GA
March 9, 2007
54
Internap 2006 Annual Report
Management’s Report on Internal Control Over Financial Reporting
Financial Review 2006
Our management is responsible for establishing and maintaining adequate
internal control over fi nancial reporting, as such term is defi ned in Exchange
Act Rule 13a-15(f). Under the supervision and with the participation of
our management, including our Chief Executive Offi cer and Chief Financial
Offi cer, we conducted an evaluation of the effectiveness of our internal
control over fi nancial reporting based on the framework in Internal Control –
Integrated Framework issued by the Committee of Sponsoring Organizations
of the Treadway Commission, or 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, 2006. Our management’s assessment of the effectiveness
of our internal control over fi nancial reporting as of December 31, 2006 has
been audited by PricewaterhouseCoopers LLP, an independent registered
public accounting fi rm, as stated in their report which is included herein.
Internap 2006 Annual Report
55
Stock Performance Graph
Financial Review 2006
The graph set forth below compares cumulative total return to our stockholders from an investment in our common stock with the cumulative total return of
the NASDAQ Market Index, the Hemscott Industry Group 852 Index and companies that comprise the Goldman Sachs Internet Index, resulting from an initial
assumed investment of $100 in each on December 31, 2001, assuming the reinvestment of any dividends, ending at December 31, of each year, 2002–
2006, respectively.
Comparison of 5-Year Cumulative Total Return Among Internap Network Services Corporation,
NASDAQ Market Index, the Companies that Comprise the Goldman Sachs Internet Index, and
Hemscott Industry Group 852 Index
$250
$200
$150
$100
$50
0
2001
2002
2003
2004
2005
2006
Internap Network Services Corporation
Companies that Comprise the Goldman Sachs Internet Index
NASDAQ Market Index
Hemscott Industry Group 852 Index
Assumes $100 Invested on December 31, 2001.
Assumes Dividends Reinvested.
Fiscal Year Ending December 31, 2006.
56
Internap 2006 Annual Report
We ignite customer innovation. Internap is a leading Internet solutions provider that manages,
delivers and distributes applications and content with unsurpassed performance and reliability. With a global
platform of data centers, managed Internet Protocol (IP) services, content delivery networks (CDNs) and content
monetization services, Internap frees its customers to drive innovation inside their businesses and create new
revenue opportunities. Today, more than 3,000 companies across the globe trust Internap to help them achieve
their Internet business goals. Internap’s 450 employees are located in our Atlanta headquarters, as well as in
offices around the world, including major U.S. cities, Canada, London and Asia. Founded in 1996, Internap
trades on the NASDAQ Global Market under the ticker symbol INAP.
Our Value Proposition
Internap’s colocation and data center solutions manage the
complex applications and vital content that form the foundation
of our customers’ businesses. Our industry-leading IP services
ensure the reliable delivery of these Web-based assets, offering
levels of performance essential for growth and innovation in
their business. Internap’s leading-edge content delivery and
advertising solutions distribute our customers’ valued content
reliably and cost-effectively, so they can recognize new revenue
streams, connect with and engage their customers, partners,
employees and consumers across the globe.
a n a g e
M
D eliv e r
Distrib ute
o n etiz e
M
Stockholder Information
Financial Review 2006
Corporate Headquarters
Internap Network Services Corporation
250 Williams Street
Atlanta, GA 30303
404-302-9700
www.internap.com
Investor Relations
Andrew Albrecht
Vice President, Investor Relations
404-302-9841
Stock Trading Information
Internap’s common stock trades on the
NASDAQ under the ticker symbol: INAP.
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 2006 Annual Report on Form 10-K/A for the year ended
December 31, 2006, as fi led 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 NASDAQ Global Market under
the symbol “INAP” and has traded on the NASDAQ Global Market since
September 19, 2006. Our common stock traded on the American Stock
Exchange under the symbol “IIP” from February 18, 2004 through
September 18, 2006. Our common stock traded on the NASDAQ SmallCap
Market from October 4, 2002 through 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.
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On July 11, 2006, we implemented a 1-for-10 reverse stock split of our
common stock. The information in the following table has been adjusted to
refl ect these stock splits. Our fi scal year ends on December 31.
Year Ended December 31, 2006
Fourth Quarter
Third Quarter
Second Quarter
First Quarter
Year Ended December 31, 2005
Fourth Quarter
Third Quarter
Second Quarter
First Quarter
High
Low
$21.25
16.80
15.50
10.60
$ 5.20
5.90
6.30
11.00
$14.10
9.30
9.00
4.20
$ 3.60
4.20
4.10
5.10
As of April 20, 2007, the total number of benefi cial holders of our
common stock was 37,219.
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 fi nancial 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
Special Note Regarding Forward-Looking Statements:
Some of the statements contained in this Annual Report contain forward-looking statements that refl ect
our plans, beliefs and current views with respect to, among other things, future events and fi nancial
performance. We often identify these forward-looking statements by the use of words such as “believe,”
“expect,” “potential,” “continue,” “may,” “will,” “should,” “could,” “would,” “seek,” “predict,” “intend,” “plan,”
“estimate,” “anticipate,” or other comparable words.
Specifi cally, this Annual Report contains, among others, forward-looking statements regarding: our
ability to successfully integrate the operations of Internap and VitalStream; our ability to compete against
existing and future competitors; our ability to respond successfully to the evolution of the high performance
Internet connectivity, content delivery, streaming and related services industries; our ability to respond
successfully to technological change; the availability on favorable terms or at all of services from various
Internet network and other third parties on whom we rely to provide our services, and the failure of such
third party suppliers to deliver their products and services; failures in our network operations centers,
network access points or computer systems; our ability to complete successfully the integration of acquired
companies, including VitalStream; our ability to protect ourselves and our customers from security
breaches; our ability to protect our intellectual property; claims relating to intellectual property rights;
government regulation of the Internet; and the effects of natural disasters or terrorist activity.
Any forward-looking statements contained in this Annual Report are based upon our historical
performance and on our current plans, estimates and expectations. You should not regard the inclusion of
this forward-looking information as a representation by us or any other person that we will achieve the
future plans, estimates or expectations contained in this Annual Report. Such forward-looking statements
are subject to various risks and uncertainties. In addition, there are or will be important factors that could
cause our actual results to differ materially from those in the forward-looking statements. We believe these
factors include, but are not limited to, those described in Part I, Item IA. Risk Factors of our Annual Report
on Form 10-K/A.
You should not construe these cautionary statements as exhaustive and should read such statements
in conjunction with the other cautionary statements that are included in this Annual Report. Moreover, we
operate in a continually changing business environment, and new risks and uncertainties emerge from time
to time. We cannot predict these new risks or uncertainties, nor can we assess the impact, if any, that any
such risks or uncertainties may have on our business or the extent to which any factor, or combination of
factors, may cause actual results to differ from those projected in any forward-looking statement.
Accordingly, the risks and uncertainties to which we are subject can be expected to change over time, and
we undertake no obligation to update publicly or review the risks or uncertainties described in this Annual
Report. We also undertake no obligation to update publicly or review any of the forward-looking statements
made in this Annual Report, whether as a result of new information, future developments or otherwise. If
one or more of the risks or uncertainties referred to in this Annual Report materialize, or if our underlying
assumptions prove to be incorrect, actual results may vary materially from what we have projected. Any
forward-looking statements contained in this Annual Report refl ect our current views with respect to future
events and are subject to these and other risks, uncertainties and assumptions relating to our operations,
fi nancial condition, growth strategy, and liquidity. You should specifi cally consider the factors identifi ed in
this Annual Report that could cause actual results to differ. We qualify all of our forward-looking statements
by these cautionary statements. In addition, with respect to all of our forward-looking statements, we claim
the protection of the safe harbor for forward-looking statements contained in the Private Securities
Litigation Reform Act of 1995.
As used herein, except as otherwise indicated by the context, references to “we,” “us,” “our,” or the
“Company” refer to Internap Network Solutions Corporation and its subsidiaries.
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2006 Annual Report
to win
our time is now
C o r p o r a t e H e a d q u a r t e r s
25 0 Williams Street
At lanta, GA 30303
40 4.302.9 700
w w w. i n t e r n a p . c o m
NA SDA Q: INAP