Internap Corporation Annual Report 2007

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FY2007 Annual Report · Internap Corporation

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2007 Annual Report

Business Description

Internap is a leading Internet business solutions company that provides The Ultimate Online Experience™

by managing, delivering and monetizing applications and content with unsurpassed performance and

reliability. From increasing the performance of enterprise applications, to faster, more robust websites,

to serving cutting-edge video – and driving revenue from it – Internap helps business and government

organizations take the Internet further than ever imagined.

With a global platform of data centers, managed Internet services, a content delivery network (CDN),

and ad delivery services, Internap frees its customers to innovate by enhancing their business processes and

creating new revenue opportunities. More than 3,700 companies across the globe trust Internap to help them

achieve their business and technology goals.

Internap’s 420 employees are located in our Atlanta headquarters, as well as in ofﬁ ces around the world,

including major U.S. cities, Canada, London and Japan. Founded in 1996, Internap trades on the NASDAQ

Global Market under the ticker symbol INAP.

You’re Online...

Being a Sports Fan

Blogging

Trading Stocks

Shopping

Downloading
Music

Watching Live TV

Listening to
the Radio

INTERNAP | 2007 ANNUAL REPORT 1

2 INTERNAP | 2007 ANNUAL REPORT

And We’re
Making It Happen

Internap is the only company with end-to-end solutions that can handle
an organization’s entire online business from origin to destination.

We Network
Your Business And
Your Customers

We Guarantee 100%
The Best In The Business

We Integrate
To Optimize Performance

We Host
Safe And Reliable IT Systems

We Connect
Better Than Anyone Else

We Store
As Much As You Need

We Convert
Content Into Cash

We Stream
Music, Video, New Media

We Deliver
Content-Rich Media

From enabling Internet applications for millions of end-users around

the world, to creating business opportunities for our more than 3,700

customers; and transforming market potential into ﬁ nancial performance,

Internap is making it happen right now.

INTERNAP | 2007 ANNUAL REPORT 3

Right Now: Our Data Centers
Are Hosting, Storing, Powering
and Securing...

A Strategic Customer Entry Point
Our data centers are a foundation for our bundling strategy rather
than a stand-alone business platform. Businesses can dramatically
speed their time to market and reduce capital spending by renting
a portion of our data centers instead of building their own. Rather
than running applications in-house, our customers can quickly
make their online products and systems “enterprise-ready” by
leveraging Internap’s unmatched integrated infrastructure and
customer service.
We package data center space with IP networking, managed
servers and storage, professional services and content delivery
network (CDN) services to drive higher satisfaction for our customers
and increased margins for Internap.
By using a “just-in-time” build strategy with our data centers, we
can expand capacity in a modular fashion to meet market demand.
This approach enables us to more closely align capital spending with
revenue generation, thus realizing a quicker return on investment.

4 INTERNAP | 2007 ANNUAL REPORT

Data Center Services –
Total Available Market
In North America
($ in billions)

4.6

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4.0

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3.4

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2.9

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With strong demand and
increasing power needs,
the Data Center services
market is expected to
grow more than 16 percent
compounded annually
through 2010.

Source: Gartner North
America Forecast

Direct Network Access

Businesses require off-site data center space to improve
the availability of their applications and control their ongoing
costs of operation. When they choose Internap for these
services, however, they also gain seamless access to
the Internap® route-optimized network, providing the most
reliable IP networking available. Because customers can
purchase data center services and highly reliable IP from
a single enterprise-class provider, they can conﬁ dently
reduce the complexity of their products and concentrate
on what they do best. These are critical benefits for
businesses that want to get their products to market
quickly and within budget.

Global Scale
Our 8 Company-owned data
centers and 34 partner-owned
data centers currently comprise
more than 170,000 square feet
throughout North America
and in London and Asia.

High-Quality Facilities
With Internap, customers can be
assured of a secured, redundant,
scalable and managed data
center solution. Our data center
services also offer managed
servers, managed storage and
remote hands.

Guaranteed Service
As with our other services,
Internap data centers are
supported by 100 percent
Service Level Agreements
that cover both colocation
and connectivity.

The Internap Difference
Utilizing an Internap data center ensures
direct access to Internap’s patented, best-
in-class route-optimized network services,
which reduces online risks.

INTERNAP | 2007 ANNUAL REPORT 5

Right Now: Our IP Services Are
Connecting, Optimizing, Networking,
Designing and Managing...

Intelligent Route-Optimization
Leads The Industry
Since its inception more than a decade ago, our Performance
IP™ service has been in a class of its own. Our patented route-
optimization technology provides customers with speed, reliability
and service guarantees that have remained unmatched in the
industry. Through constant monitoring and management, Internap
alerts customers to network issues across the Internet and
remedies them efﬁ ciently. Internap deﬁ ned our Service Level
Agreements to lead the industry, so customers get reliable
performance supported with excellent service.

6 INTERNAP | 2007 ANNUAL REPORT

IP – Total Available
Market In North America
($ in billions)

8.9

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9.4

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10.4

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9.9

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The market for IP services
is expected to grow at a
compounded annual rate
of 5 percent through
2010. In 2007, Internap
Performance IP™ business
grew at an annual rate of
9 percent, signiﬁ cantly
outpacing the market.

Source: Gartner Dataquest

100% Network Performance

“Time is money.” This expression has never been more true than in

the world of e-commerce, where real time equals real money. Though

Internet reliability has evolved to higher levels of performance, hazards

such as network congestion, disabled carriers, and latency spikes

continue to create business risk. With the advent of hyper-paced

Web 2.0 applications, network demands will become even greater.

As thousands of our Performance IP customers know, however, the

Internap solution goes beyond technology. Our Network Operations

Center (NOC) is nothing less than legendary in the industry for the

problem-solving expertise and customer-centric orientation of our

network engineers. As our customers will tell you, when you have to

know the answer quickly and correctly, this level of attention is priceless.

Network Intelligence
Our redundant P-NAP® (Private Network
Access Point) facilities located around
the world provide us with a unique
competitive advantage. We can intel-
ligently route applications and content
across Internet backbones, a capability
that a single-source Internet service
provider cannot duplicate.

Professional Services
From assessment and design through
implementation, Internap Professional
Services teams speed the deployment
of our customers’ networks. By helping
businesses analyze and assemble the
right IP infrastructure, Internap enhances
performance and saves our customers
time and money.

The Route Matters
Just like vehicle trafﬁ c, Internet
performance can be affected by
trafﬁ c volume and temporary
outages. Our optimized route
technology ensures that customer
trafﬁ c keeps moving at the speed
needed to satisfy business
requirements.

The Internap Difference
Our Performance IP service is so reliable
that we offer a proactive Service Level
Agreement with a 100 percent uptime
and performance guarantee.

INTERNAP | 2007 ANNUAL REPORT 7

Right Now: Our Content Delivery
Network Is Delivering, Streaming,
Analyzing and Monetizing…

CDN Market Worldwide
Revenue Forecast
($ in billions)

2.0

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2.6

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1.4

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1.0

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High-speed broadband
connections are driving
the growth of the Internet
video viewing market and
the need for content
delivery expertise.

*Source: Morgan Stanley/Frost & Sullivan

CDN Provides Growth Opportunities
It is estimated that the worldwide CDN market will grow at an average
compounded rate of 38 percent through 2010*. This makes CDN one
of the largest growth opportunities in the Internet services market today.
Our CDN segment has the highest growth potential among our businesses
and is accompanied by high margins. As CDN customers use our
network for activities such as streaming media, high deﬁ nition video and
ad delivery, Internap also increases its relevance and value to customers
by becoming an integral part of their revenue models.

8 INTERNAP | 2007 ANNUAL REPORT

Ad Delivery
Content owners can monetize
their digital assets through our
advertising delivery services.

Optimal Performance
For Every Play

There’s more to streaming media and other advanced

content delivery than simply clicking “play.” Quality

matters. Delivery challenges include transcoding,

player development, latency, jitter, and packet loss.

Since no single network has the optimal path for all

destinations, the only way to identify problems is to

possess visibility into trafﬁ c ﬂ ows and to control optimal

routing among a variety of network service providers. This

is the essence of the Internap CDN value proposition.

With our intelligent route architecture integrated into our

CDN and monetization services, we elevate quality and

performance to an entirely new level.

Unparalleled Control
Our feature-rich MediaConsole®
integrates all streaming formats.
This customer portal provides
media asset management, digital
rights management (DRM), event
authentication, detailed reporting
and analytical tools and real-time
statistics. A robust dashboard
displays the business intelligence
that customers can use to guide
their operations.

Rich Media Content
From home videos posted on the Web
to studio movie trailers, rich media
content also includes user-generated
content and consumer-oriented
applications such as social networking
and blogging, as well as a variety of
enterprise management applications.

Mobile Entertainment
Music downloads created a new industry.
Gaming has grown from single-user
systems to massive multi-player online
models. Movie downloads are not far
away. Technology will enable a whole
new breed of interactive entertainment
delivered to mobile devices. Internap
content delivery network solutions will
be there.

The Internap Difference
Our patented route-optimization software and CDN
technology are integrated into our global IP network
infrastructure. This creates a unique and unmatched
solution that optimizes content delivery supported by the
only 100 percent performance guarantee in the industry.

INTERNAP | 2007 ANNUAL REPORT 9

Right Now: Only Internap
Does So Much, So Well

Data Centers

IP Network

Content
Content
Delivery Network
Delivery Network

The Internap Difference: A Bundled Solution
We enable our customers to better serve their customers through an integrated solution suite based on our global networked

infrastructure and core route-optimization technology. No other service provider delivers such a value-added mix of products:

data center space, IP networking and content delivery network services. This entire suite is supported by industry-

leading SLAs (service level agreements) with 100 percent performance guarantees, comprehensive visibility and

control, and world-class, round-the-clock engineering expertise. Not only do we help our customers determine the

optimal mix of services today, we’re there to help them scale their businesses for tomorrow.

10 INTERNAP | 2007 ANNUAL REPORT

President and Chief Executive Ofﬁcer

ﬁ

To Our Stockholders
Right Now The Future Is Right In Front Of Us.

More than 12 years ago, when the Internet was beginning to make

its mark on popular culture and mainstream commerce, Internap

recognized the need to ensure swift and reliable connectivity.

We introduced a proprietary route-optimization technology that

met this need and quickly set an industry performance standard.

Today, we continue to anticipate needs and introduce solutions

that ensure optimal functionality and performance so that our

customers can do what they do best – capitalize on the potential

of the Internet to innovate and create some of the most exciting

services and applications in the world. No other service provider

does this better than Internap, and this expertise is translating

directly into proﬁ table growth. Continued on page 12

INTERNAP | 2007 ANNUAL REPORT 11

Letter To Stockholders

The past 12 months have been a transformational period for Internap. We completed

the acquisition of VitalStream to broaden our product offerings to include a content

delivery network (CDN) and related technologies. We scaled our business by expanding

our global footprint and capacity in order to continue to provide the highest levels of

support for our customers worldwide. We signed the largest customer contracts in the

Company’s history and continued to grow our diverse customer base. We began to

build positive traction in the market for our end-to-end, bundled service offering.

All of this was accomplished while generating record revenue, adjusted EBITDA and

adjusted gross margins.

ﬁ

Record Results
During 2007, Internap grew revenue
29 percent, the highest annual growth
rate in six years, to $234 million.
Adjusted gross margins expanded
310 basis points to 49 percent, a
signiﬁcant achievement given the
operating losses that we had to work
through from the former VitalStream
business. Our commitment to ﬁnan-
cial discipline remained strong. We
held our expense-to-revenue ratio
to approximately 33.5 percent in
2007, very close to the same ratio in
2006, despite growth throughout
the organization. As a result, we were
able to continue our profitable
growth. Adjusted EBITDA increased
49 percent to $37 million. Normal-
ized net income, which excludes
the impact of stock compensation
expense and items that we consider
nonrecurring, totaled $16.1 million
in 2007, an increase of 62.3 percent
over 2006.

ﬁ

CDN Integration
Beyond the ﬁnancial achievements
of 2007, Internap made signiﬁcant
progress against numerous strategic
priorities. We also dealt with some

ﬁ

12 INTERNAP | 2007 ANNUAL REPORT

challenges, namely a more lengthy
integration process of VitalStream’s
CDN services than we had antici-
pated initially. As a result, CDN
performance in 2007 was lower than
we expected. With the integration of
CDN into our patented IP network
completed by year-end, we began
2008 in a much stronger position
to realize the full potential of
this business.

ﬁ

During the year we made
signiﬁcant investments to increase
the scale of our CDN technology to
support our enterprise customers.
We added ﬁ ve new CDN Points of
Presence (POPs) to expand our
network infrastructure in Asia and
Europe. We also fully integrated
CDN with our proprietary route-
optimization technology to ensure
optimal performance. Finally, we
extended our 100 percent Service
Level Agreements that have been
a hallmark of our Performance IP™
service to Internap’s CDN services.
The end result is a CDN offering
that is in a considerably stronger
competitive position and one that
should be an effective growth vehicle
for the Company going forward.

Building Scale
Our core IP network and data
center businesses performed well
in 2007. Data center operations,
which often serve as the initial entry
point for our customers, increased
revenue 47.9 percent, thanks to high
market demand and an expanded
footprint. During the year, we added
more than 20,000 square feet of
built-out data center space, and
plans call for an additional build-
out of more than 30,000 square feet
in 2008. Our strategy of modular,
“just-in-time” build-outs is serving
us well, enabling the Company to
capture market demand in a risk-
averse manner.

IP services was again our
largest segment in 2007 and
represents the foundation of our
business. Fundamentals in IP
network services were strong
during the year, with a 35 percent
increase in trafﬁc. Strong demand,
combined with some easing of
pricing pressure in this business,
helped to maintain year-over-year
margins. As trafﬁ c continues to
grow in this business segment, we
expect that operating leverage,

ﬁ

The Right Team

Our leadership team brings years of high-tech and communications experience, as well as a proven track

record for operational expertise, financial discipline and customer service commitment. Most importantly,

this team is united by its focus to expand existing customer relationships and grow into new markets in order

to create value for Internap stockholders.

Letter To Stockholders (continued)

ﬁ

scale and proﬁ tability will continue
to expand. No other Internet service
provider can route mission-critical
trafﬁ c and applications as effec-
tively and with the guarantees that
Internap offers. With this patented
technology now integrated into our
CDN, Internap can deliver more
compelling value to customers than
ever before.

Competitive Differentiation
It is this value proposition that
continues to fuel our enthusiasm
about the opportunities that drove
the VitalStream acquisition and
our bundled services strategy. The
explosive growth of user-generated
content, streaming video, social
networking, multi-player gaming and
other applications, represents an
enormous opportunity for Internap.
Virtually every type of business
today leverages the Internet in
some manner. The technology to
support these applications requires
more than simply a CDN company,
an IP service provider, or a data
center facility. It requires a company
that encompasses all of these

ﬁ

services with guaranteed speed and
reliability, as well as an innovative
and customer-centric approach
to business.
This proﬁle is at the core of our
bundled, end-to-end service offer-
ing; a strategy that provides a high
degree of differentiation in the
marketplace for us today. There is
simply no peer that can match the
combination of our product offering
and performance guarantee. This
strategy provides customers with
unique “one-stop shopping” and
provides us with numerous com-
petitive advantages.
First, we expand our market
opportunity through the ability to
cross-sell among the customer
bases of each business. Among our
CDN customers, for example, only
a small percentage opt for a service
bundle today, creating a signiﬁcant
base of potential into which we can
sell our other services. Second,
our sales proposition to bundled
customers ultimately becomes a
quality-driven rather than a price-
driven decision. This moves our
relationship with the customer to a

ﬁ

higher-value level, which translates
directly into increased margins.
Finally, a “bundled” customer is
more likely to remain an Internap
customer. Among customers who
subscribe to two or more of our
service offerings, churn is signiﬁ-ﬁ
cantly lower than for those who
subscribe to only one offering.

Customer Wins
Marketplace enthusiasm for our
bundled offerings gained momentum
throughout 2007 and was under-
scored by the signing of the two
largest contracts in the Company’s
history. Quality Technology Services
(QTS), one of the nation’s largest
privately-held providers of data center
facilities and managed services,
selected Internap to be the preferred
provider of CDN services and
exclusive provider of IP connectivity
services to all of their accounts. This
three-year agreement represents
revenues of approximately $15 million
for Internap.

Similarly, hosting provider
SoftLayer Technologies initially
signed a five-year, $16 million

Revenue
($ in millions)

154

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145

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139

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234

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181

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The addition of CDN services
and strong demand in data
center and core managed
IP services contributed to a
29.1 percent year-over-year
increase in revenue.

Customers

3,789

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2,278

1,929

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2,092

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1,683

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The Company’s diverse customer
base, which approached 4,000
at year-end 2007, spans multiple
sectors including transportation,
technology, entertainment and
ﬁ
ﬁnancial services.

14 INTERNAP | 2007 ANNUAL REPORT

ﬁ

contract with Internap for data
center and network services. Once
on board, Internap’s execution and
performance impressed SoftLayer
enough that the agreement was
expanded to include CDN services.
We believe that our team’s hard work
will pay off handsomely over the
next ﬁve years, with an estimated
$56 million in total revenue expected.
The conﬁ dence that QTS and
SoftLayer have placed in Internap
is echoed across our growing
customer base. Overall, we added
more than 600 new accounts in
2007 to end the year with 3,789
customers. Customers such as
Register.com, Scottrade and Red Hat
have joined our highly diversiﬁedﬁ
customer base, which serves multiple
market sectors.

ﬁ

World-Class Organization
An expanded product portfolio and
an ever-expanding customer base
bring more opportunity. In order to
fully capitalize on these opportuni-
ties, it is critical that the appropriate
business structure and talent be in
place. To this end, we have success-

ﬁ

fully recruited a number of new
executives to our ranks in the areas
of ﬁnance, marketing and informa-
tion technology. Our management
team today has the experience and
industry knowledge necessary to
take Internap to its next level of
performance. Our ability to recruit
respected technology executives also
speaks to their level of conﬁdence
in Internap’s future.

ﬁ

Our management team is
fortunate to lead one of the most
respected employee teams in the
industry. Our staff “in the field
and on the floor” enjoys a well-
deserved reputation for providing
superior technological solutions and
customer service par excellence.
You can be sure that every customer
win is an endorsement of Internap’s
technology and its people. This team
continues to have my personal
gratitude for their talent and their
commitment.

As we enter 2008, we feel very
conﬁ dent about Internap’s competi-
ﬁ
tive position in the marketplace and
its strategy to generate proﬁtable
growth for our stockholders.

ﬁ

Operating Cash Flow
($ in millions)

ı
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(1)

ı
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(11)

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ı

For the second consecutive
year, strong sales and
operational discipline
helped generate strong
operating cash ﬂow.

ﬂ

Challenges are an inherent part
of growing in a rapidly evolving,
dynamic marketplace, and we will
continue to demonstrate our
commitment to solve them in an
effective manner. Our focus remains
on growing existing customer
relationships through our bundled
product offering and expanding
our presence to win increased
market share. Financial discipline
and operational diligence will be
improved and maintained as we
execute these strategic priorities
in order to maximize proﬁ tability.
We appreciate the conﬁdence that
our customers and stockholders
continue to place in Internap and
intend to reward your conﬁdence
with performance.

ﬁ

Sincerely,

James P. DeBlasio

President and Chief Executive Ofﬁcer

ﬁ

May 15, 2008

INTERNAP | 2007 ANNUAL REPORT 15

Right Time, Right Place
A Conversation With Jim DeBlasio
About Internap’s Competitive Position

Q. Internap acquired VitalStream in order to

add CDN to its product and service portfolio. Have
you been satisﬁ ed with the performance of your
CDN offering in its ﬁ rst year as part of Internap?

A. Our purchase of VitalStream enabled us to

enter the fast-growing CDN market and to provide a
differentiated end-to-end solution for our customers,
both of which were important, long-term strategic
goals for Internap. Our expectation was that we would
be able to bring CDN to enterprise scale more quickly,
and the delay did slow our CDN revenue growth in the
second half of 2007. However, we made a great deal
of progress in scaling CDN to increase reliability, reach
and range of product. This progress is beginning to pay
off with an increasing deal size and pace. Our efforts
to upsell existing customers have been well received,
with 38 percent of new CDN bookings being sold into
our existing customer base.

Q. There have been several new entrants into

the CDN market since you acquired VitalStream.
How does this affect the competitive landscape?

A. It doesn’t surprise us to see more competitors in

a space that is growing as fast as CDN. It really has had
no effect on our bundling strategy or on our premium
CDN service. Our premium CDN service is armed with an
unmatched SLA, patented route-optimization technology,
NOC support, delivery diversity, and service customiz-
ability. It’s a very unique service that should perform well,
regardless of the competitive environment.

Q. The marketplace for Internet service providers

has long been an exceptionally competitive one.
What type of pricing trends do you see going forward?

A. Pricing declines are a reality of the telecom

services market. Internap typically achieves premium
pricing relative to the market because of the proprietary
nature of our service and the value that it delivers to
customers in the form of reliability and speed. We also

The Right
Direction

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(cid:44)(cid:70)(cid:61)(cid:75)(cid:78)(cid:56)(cid:73)(cid:60)(cid:0)(cid:29)(cid:70)(cid:78)(cid:69)(cid:67)(cid:70)(cid:56)(cid:59)(cid:74)

(cid:30)(cid:10)(cid:28)(cid:70)(cid:68)(cid:68)(cid:60)(cid:73)(cid:58)(cid:60)

(cid:38)(cid:76)(cid:74)(cid:64)(cid:58)(cid:0)(cid:29)(cid:70)(cid:78)(cid:69)(cid:67)(cid:70)(cid:56)(cid:59)(cid:74)

(cid:40)(cid:69)(cid:67)(cid:64)(cid:69)(cid:60)(cid:0)(cid:32)(cid:56)(cid:68)(cid:64)(cid:69)(cid:62)

(cid:44)(cid:75)(cid:73)(cid:60)(cid:56)(cid:68)(cid:64)(cid:69)(cid:62)(cid:0)(cid:47)(cid:64)(cid:59)(cid:60)(cid:70)
(cid:47)(cid:70)(cid:34)(cid:41)

(cid:44)(cid:75)(cid:70)(cid:58)(cid:66)(cid:0)(cid:45)(cid:73)(cid:56)(cid:59)(cid:64)(cid:69)(cid:62)
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The Next-Generation IP
Company (2004)
It’s hard to believe that only three-to-four years ago

VoIP, music downloads and online gaming were

just beginning to become mainstream. Well aware

of the market opportunity, Internap’s superior

route-optimization technology was well-positioned

to meet the demands of a new generation of

Internet use.

CDN customers experienced network outages that led
to a number of disputes and credit requests. We
have addressed this issue on two levels. At the service
level, we have improved the reliability and reach of our
CDN platform, as well as extended our 100 percent
uptime Service Level Agreement to our CDN products.
On an administrative level, we have implemented a
number of new processes that better identify, track
and monitor customer usage and credit requests. All of
these measures should signiﬁcantly improve customer
satisfaction and service, which have long been a core
business strength at Internap

ﬁ

Q. The expectation is that the U.S. economy will

continue to weaken in 2008. What is your strategy
for managing through a strong economic downturn?

A. Through the ﬁ rst quarter of 2008, we have not

ﬁ

seen any signs of weakness in our business due to
macroeconomic forces. Should this change, I believe
we are in solid shape to weather any downturn. The
diversity of our customer base and the vertical markets
that we serve should help mitigate the effect of an over-
all downturn. We also have demonstrated our ability to
control costs and run the business in a prudent and
disciplined manner. Finally, our balance sheet is very
strong, as are the overall fundamentals of the Company.
Combined, all of these factors put us in a relatively
favorable position to weather a possible downturn.

have the advantage of bundling Performance IP with other
services, which leads to increased operating leverage
and expanding margins. It’s important to note that on a
per-megabit basis, while we did see pricing pressure in
2007, it was at a slower rate than several years ago.

Q. Internap shares were under a great deal of

pressure during the second half of 2007. From your
perspective, what caused this pressure?

A. The stock market has been hit hard across the

ﬁ

board in recent quarters, and our shares have certainly
traded in line with this trend. We cannot speculate on
the relatively short-term ups and downs of the market,
nor can we manage our business around it. Our focus is
to continue to manage the business for proﬁtable growth,
which we believe the market will reward in time. It is
worth noting and a bit ironic that the bundled service
offering that serves our customers so well makes us a
bit of an anomaly for investors. Internap has no pure
investment peers. We are neither a pure Internet service
play nor a pure CDN play. When there is a headwind in
either of these markets, we tend to get caught up in it.
It’s an interesting dynamic, but in the long run, we believe
the end-to-end solution will beneﬁt the Company and
its stockholders from a strategic perspective.

ﬁ

Q. Why did the Company extend the ﬁ ling of

its 2007 10-K?

A. Our filing was extended due to the need to

examine the adequacy of our sales and billing allowance
primarily associated with customer credits for CDN
service. In the second and third quarter of 2007, some

(cid:55)(cid:69)(cid:0)(cid:67)(cid:65)(cid:78)(cid:0)(cid:77)(cid:65)(cid:75)(cid:69)(cid:0)(cid:84)(cid:72)(cid:73)(cid:83)(cid:0)(cid:67)(cid:79)(cid:77)(cid:80)(cid:65)(cid:78)(cid:89)

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(cid:18) (cid:16) (cid:16) (cid:21) (cid:0)(cid:33) (cid:46) (cid:46) (cid:53) (cid:33) (cid:44) (cid:0) (cid:50) (cid:37) (cid:48) (cid:47) (cid:50)(cid:52)

We Can Make This
Company Thrive (2005)
As Internap approached its 10-year

anniversary, the Company made a

renewed commitment to achieving

proﬁ tability through a fortiﬁ ed core

business, excellent execution and

a winning workforce. Accountability,

discipline and focus were the operative

words for a new management team

dedicated to rewarding stockholders.

Play To Win (2006)
Making good on commitments from

the previous year, Internap achieved

proﬁ tability in a record performance

2006 Annual Report

year. To sustain proﬁ table growth well

to win

into the future, the Company acquired

our time is now

VitalStream in order to capitalize on the

fast-growing CDN market and to expand

Internap’s bundled service offering.

A Message From Gene Eidenberg

Internap is a growing and profitable company with healthy
margins. As an investor and director of Internap since 1997,
I have been fortunate to be part of the building of an increasingly
important company.

INTERNAP NETWORK SERVICES CORPORATION
2007 FINANCIAL REVIEW

20
Selected Financial Data

22
Management’s Discussion and Analysis of
Financial Condition and Results of Operations

41
Consolidated Statements of Operations

42
Consolidated Balance Sheets

43
Consolidated Statements of Stockholders’ Equity
and Comprehensive (Loss) Income

44
Consolidated Statements of Cash Flows

45
Notes to Consolidated Financial Statements

71
Report of Independent
Registered Public Accounting Firm

72
Stock Performance

INTERNAP | 2007 ANNUAL REPORT 19

SELECTED FINANCIAL DATA
Financial Review 2007

The consolidated statement of operations data and other financial data presented below were prepared using our consolidated financial statements
for the five years ended December 31, 2007. You should read this selected consolidated financial data together with the consolidated financial
statements and related notes contained in this annual report and in our 2006 and 2005 annual reports on Form 10-K/A and Form 10-K, respectively,
filed with the SEC, as well as the section of this annual report and of our 2006 and 2005 annual reports on Form 10-K/A and Form 10-K,
respectively, entitled, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

(In thousands, except per share data)

Consolidated Statement of Operations Data:
Revenue

Operating costs and expenses:
Direct costs of network, sales and services, exclusive of

depreciation and amortization, shown below (3)
Direct costs of amortization of acquired technologies (3)
Direct costs of customer support
Product development
Sales and marketing
General and administrative
Depreciation and amortization
Gain on disposals of property and equipment
Restructuring and asset impairment
Acquired in-process research and development
Amortization of deferred stock compensation
Pre-acquisition liability adjustment

Total operating costs and expense

(Loss) income from operations
Non-operating (income) expense

Year Ended December 31,

2007(1)

2006(2)

2005

2004

2003

$234,090

$181,375

$153,717

$144,546

$138,580

118,394
4,165
16,547
6,564
31,533
32,512
22,242
(5)
11,349
450
–
50

243,801

(9,711)
(937)

97,338
516
11,566
4,475
27,173
22,104
15,856
(113)
323
–
–
–

81,958
577
10,670
4,864
25,864
20,096
14,737
(19)
44
–
60
–

179,238

158,851

2,137
(1,551)

(5,134)
(87)

76,990
579
10,180
6,412
23,411
24,772
15,461
(3)
3,644
–
–
–

161,446

(16,900)
772

78,200
134
9,483
6,982
21,491
16,711
37,087
(53)
1,084
–
390
(1,313)

170,196

(31,616)
2,158

(Loss) income before income taxes and equity
in earnings of equity method investment

(Benefit) provision for income taxes
Equity in (earnings) loss of equity-method investment, net of taxes
Less deemed dividend related to beneficial conversion feature (4)
Net (loss) income

(8,774)
(3,080)
(139)
–
$ (5,555)

3,688
145
(114)
–
$ 3,657

(5,047)
–
(83)
–
$ (4,964)

(17,672)
–
390
–
$ (18,062)

(33,774)
–
827
34,576
$ (69,177)

Net (loss) income per share:
Basic

Diluted

Weighted average shares used in per share calculations
Basic

Diluted

$ (0.12)

$ 0.11

$ (0.15)

$ (0.63)

$ (3.96)

$ (0.12)

$ 0.10

$ (0.15)

$ (0.63)

$ (3.96)

46,942

34,748

35,739

33,939

28,732

17,460

20 INTERNAP | 2007 ANNUAL REPORT

SELECTED FINANCIAL DATA
Financial Review 2007

Consolidated Balance Sheet Data:
Cash, cash equivalents and short-term

marketable securities

Non-current marketable securities
Total assets
Note payable and capital lease obligations, less current portion
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

Year Ended December 31,

2007(1)

2006

2005

2004

2003

$ 71,599
–
427,010
17,806
346,633

$ 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

2007(1)

Year Ended December 31,
2005

2006

2004

2003

$ 30,271
27,592
(36,393)
15,240

$ 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

(1) On February 20, 2007 we completed our acquisition of VitalStream, whereby VitalStream became a wholly-owned subsidiary of Internap. Prior to our acquisition of VitalStream, we did not
offer proprietary CDN services, but instead, we were a reseller of third party CDN services. Under the purchase method of accounting, we allocated the total estimated purchase price
to VitalStream’s net tangible and intangible assets based on their estimated fair values as of February 20, 2007. We recorded the excess purchase price over the value of the net tangible
and identifiable intangible assets as goodwill. Also, as a result of the acquisition we issued approximately 12.2 million shares of Internap common stock.

(2) 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 we 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.

(3) Prior to 2007, direct costs of amortization of acquired technologies were included in the caption direct costs of network, sales and services, exclusive of depreciation and amortization.

In 2007, we reclassified these costs to a separate caption. These reclassifications had no effect on previously reported operating loss (income) or net loss (income).

(4) In August 2003, we completed a private placement of our common stock, which resulted in a decrease of the conversion price of our series A preferred stock to $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 was issuable upon conversion
of our series A preferred stock.

INTERNAP | 2007 ANNUAL REPORT 21

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Financial Review 2007

The following discussion should be read in conjunction with the consolidated
financial statements and accompanying notes of this annual report.

OVERVIEW

We deliver high performance and reliable Internet solutions through a
suite of network optimization and delivery of products and services. These
solutions, combined with progressive and proactive technical support,
enable companies to confidently migrate business-critical applications,
including audio and video streaming and monetization services, to
the Internet. Our suite of products and services support a broad range of
Internet applications. We currently have approximately 3,800 customers,
serving financial services, healthcare, technology, retail, travel, and
media/entertainment markets. Our customers are located in the United
States and abroad and include several Fortune 1000 and mid-tier
enterprises. Our product and service offerings are complemented by
Internet protocol, or IP, access solutions such as data center services,
content delivery networks, or CDN, and managed security. We deliver
services through our 50 service points across North America, Europe
and the Asia-Pacific region. Our Private Network Access Points, or P-NAPs,
feature multiple direct high-speed connections to major Internet networks
including AT&T Inc., Sprint Nextel Corporation, Verizon Communications
Inc., Savvis, Inc., Global Crossing Limited, and Level 3 Communications, Inc.

The key characteristic that differentiates us from our competition is our
portfolio of patented and patent-pending route-optimization solutions
that address the inherent weaknesses of the Internet and overcome the
inefficiencies of traditional IP connectivity options. Our intelligent routing
technology can facilitate traffic over multiple carriers, as opposed to
just one carrier’s network, to ensure highly reliable performance over
the Internet.

We believe our unique managed multi-network approach provides better
performance, control and reliability compared to conventional Internet
connectivity alternatives. Our Service Level Agreements guarantee per-
formance across the entire Internet in the United States, excluding local
connections, whereas providers of conventional Internet connectivity
typically only guarantee performance on their own network.

On October 12, 2006, we entered into a definitive agreement to acquire
VitalStream Holdings, Inc., or VitalStream, in an all-stock transaction
accounted for using the purchase method of accounting for business
combinations. The transaction closed on February 20, 2007. Our results
of operations include the activities of VitalStream from February 21,
2007 through December 31, 2007.

As discussed in note 18 to our consolidated financial statements, we
revised our quarterly statement of operations for the quarter ended
September 30, 2007 to appropriately record (1) $0.5 million for sales

adjustments, which reduced net accounts receivable and revenue, and
(2) $0.1 million for accretion of interest income that we initially included
as unrealized gain in accumulated other comprehensive income within
stockholders’ equity. The effect of these revisions had no impact on our
consolidated statement of cash flows. We have determined that these
adjustments are not material to our consolidated financial statements
for any of the affected quarterly periods. Accordingly, we have not revised
the 2007 quarterly financial statements included in our previously filed
Forms 10-Q for the quarterly periods ended March 31, June 30 and
September 30, 2007, for these adjustments.

We operate in three business segments: IP services, data center services
and CDN services. For additional information about these segments,
see note 5 to the consolidated financial statements.

The following is a brief description of each of our reportable
business segments.

IP Services
Our patented and patent-pending network performance optimization
technologies address the inherent weaknesses of the Internet, allowing
enterprises to take advantage of the convenience, flexibility and reach
of the Internet to connect to customers, suppliers and partners. Our solutions
take into account the unique performance requirements of each business
application to ensure performance as designed, without unnecessary cost.
Prior to recommending appropriate network solutions for our customers’
applications, we consider key performance objectives including
(1) performance and cost optimization, (2) application control and speed
and (3) delivery and reach. Our charges for IP services are based on a
fixed-fee, usage or a combination of both fixed fee and usage.

Our IP services segment also includes our Flow Control Platform™, or FCP.
The FCP provides network performance management and monitoring
for companies with multi-homed networks and redundant Internet
connections. The FCP proactively reviews customer networks for the best
performing route or the most cost-effective and routes according to our
customers’ requirements. We offer FCP as either a one-time hardware
purchase or as a monthly subscription service. Sales of FCP also generate
annual maintenance fees and professional service fees for installation and
ongoing network configuration. Since the FCP emulates our Performance IP
service in many ways, this product affords us the opportunity to serve
customers outside of our P-NAP market footprint. This product represents
approximately 4% of our IP services revenue and approximately 2% of
our consolidated revenue for the year ended December 31, 2007.

Data Center Services
Our data center services provide a single source for network infrastructure,
IP and security, all of which are designed to maximize solution performance
while providing a more stable, dependable infrastructure, and are backed

22 INTERNAP | 2007 ANNUAL REPORT

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Financial Review 2007

by guaranteed service levels and our team of dedicated support profes-
sionals. We offer a comprehensive solution at 42 service points, including
8 locations managed by us and 34 locations managed by third parties.

Data center services also enable us to have a more flexible product offering,
including bundling our high performance IP connectivity and managed
services, such as content delivery, along with hosting customers’ appli-
cations. We charge monthly fees for data center services based on the
amount of square footage that the customer leases in our facilities. We
also have relationships with various providers to extend our Performance IP
model into markets with high demand.

CDN Services
Our CDN services enable our customers to quickly and securely stream
and distribute video, audio, advertising, and software to audiences across
the globe through strategically located data centers. Providing capacity-
on-demand to handle large events and unanticipated traffic spikes,
content is delivered with high quality regardless of audience size or geo-
graphic location. Our MediaConsole® content management tool provides
our customers the benefit of a single, easy to navigate system featuring
Media Asset Management, Digital Rights Management, or DRM, support,
and detailed reporting tools. With MediaConsole, our customers can use
one application to manage and control access to their digital assets,
deliver advertising campaigns, view network conditions, and gain insight
into habits of their viewing audience.

Our CDN and monetization services provide a complete turnkey solution
for the monetization of online media. These multi-faceted “live” and
“on-demand” advertisement insertion and advertising placement solutions
include a full campaign management suite, inventory prediction tools,
audience research and metrics, and extensive reporting features to
effectively track advertising campaigns in real-time. Online advertising
solutions enable our customers to offset the costs associated with the
creation, transformation, licensing, and management of online content.
Prior to our acquisition of VitalStream on February 20, 2007, we did not
offer proprietary CDN services, but instead, we were a reseller of third
party CDN services for which results of operations are included in Other
revenues and direct costs of network, sales and services, discussed below.

Other
Other revenues and direct costs of network, sales and services include
our non-segmented results of operations, including certain reseller and
miscellaneous services such as third party CDN services, termination
fee revenue, other hardware sales, and consulting services.

HIGHLIGHTS AND OUTLOOK

• Due to the nature of the services we provide, we generally price

our IP services at a premium compared to the services offered by
conventional Internet connectivity service providers. We believe
customers with business-critical Internet applications will continue
to demand the highest quality of service as their Internet connectivity
needs grow and become even more complex and, as such, will continue
to pay a premium for our high performance managed IP services.

• Our success in executing our premium pricing strategy depends, to
a significant degree, on our ability to differentiate our connectivity
solutions from lower cost alternatives. The key measures of our success
in achieving this differentiation are revenue and customer growth.
During 2007, we added approximately 1,500 net customers (including
approximately 900 VitalStream customers that we added as part
of the VitalStream acquisition), bringing our total to approximately
3,800 enterprise customers as of December 31, 2007. Revenue for
the year ended December 31, 2007 increased 29% to $234.1 million,
compared to revenue of $181.4 million for the year ended
December 31, 2006.

• 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. We experienced a net increase in customers from
2006 to 2007. Conversely, decreases in the number of customers in
an established market lead to decreased facility utilization and increase
the possibility that direct network resources are not cost-efficiently
employed. These factors have a direct bearing on our financial position
and results of operations.

• We offer a 100% operational uptime guarantee for our network

performance management. Coupled with the lowest packet loss and
latency in the industry, we provide our customers with a proactive
industry-leading Service Level Agreement (SLA) that covers the
entire Internet – not just one single network. Unlike our competitors,
we believe so strongly in the consistent performance of our network
that we offer proactive SLA notification and automatic bill credits if
we ever break our SLAs. We believe that this commitment allows us
to provide the best network performance available.

DEVELOPMENTS IN 2007

VitalStream Acquisition. On February 20, 2007, we completed the
previously announced acquisition of VitalStream Holdings, Inc., or
VitalStream, for approximately $214.0 million, whereby VitalStream
became a wholly-owned subsidiary of Internap. VitalStream provides
products and services for storing and delivering digital media to large

INTERNAP | 2007 ANNUAL REPORT 23

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Financial Review 2007

audiences over the Internet and advertisement insertion and related
advertising services to companies that stream digital media over the
Internet. VitalStream enhances our position as a leading provider of
high performance route control products and services by adding com-
plementary service offerings in the rapidly growing content delivery and
on-line advertising markets. Integrating VitalStream’s digital media
delivery platform into our portfolio of products and services enables us
to provide customers with one of the most complete product lines in
content delivery solutions, content monetization and on-line advertising,
while supporting the significant long-term growth opportunities in the
network services market. We also considered the following:

• VitalStream’s services were a logical extension and complement to

our high performance route control products and services.

• We evaluated demand for CDN services within our customer base
and determined that a market for proprietary CDN services existed.

• VitalStream’s services offered our legacy customers additional high

growth and high margin revenue streams.

• We believed that large audio and video files are more effectively delivered
over the Internet with a combination of VitalStream’s platform and
our route management network.

• VitalStream’s initiatives in the rich media advertising services business
present an entirely new set of opportunities and potential customer
relationships for us, as advertisers seek to access a large and growing
base of Internet users that watch increasing amounts of video online.

We accounted for the acquisition using the purchase method of accounting
in accordance with SFAS No. 141, “Business Combinations.” Our results
of operations include the activities of VitalStream from February 21, 2007
through December 31, 2007.

Restructuring Liability. On March 31, 2007, we incurred a restructuring
and impairment charge totaling $10.3 million. The charge was the result
of a review of our business, particularly in light of our acquisition of
VitalStream, and our plan to finalize the overall integration and imple-
mentation plan before the end of the first quarter. The charge to expense
included $7.8 million for leased facilities, representing both the net
present value of costs less anticipated sublease recoveries that will
continue to be incurred without economic benefit to us and costs to
terminate leases before the end of their term. The charge also included
severance payments of $1.1 million for the termination of certain Internap
employees and $1.4 million for impairment of assets. Related expenditures
are estimated to be $10.7 million, of which $3.7 million has been paid
during the year ended December 31, 2007, and the balance continuing
through December 2016, the last date of the longest lease term. The
impairment charge of $1.3 million was related to the leases referenced
above and less than $0.1 million for other assets.

We also incurred a $1.1 million impairment recorded for a sales
order-through-billing system, which was a result of an evaluation of the
existing infrastructure relative to our new financial accounting system
and the acquisition of VitalStream.

Write-Off of Investment. In connection with the preparation of our
quarterly report for the quarter ended June 30, 2007, we wrote-off an
investment, totaling $1.2 million, representing the remaining carrying
value of our investment in series D preferred stock of Aventail Corporation,
or Aventail. We made an initial cash investment of $6.0 million in Aventail
series D preferred stock pursuant to an investment agreement in February
2000. In connection with a subsequent round of financing by Aventail, we
recognized an initial impairment loss on our investment of $4.8 million in
2001. On June 12, 2007, SonicWall, Inc. announced that it had entered into
an agreement to acquire Aventail for approximately $25.0 million in cash.
The transaction closed on July 11, 2007, all shares of series D preferred
stock were cancelled and the holders of series D preferred stock did not
receive any consideration for such shares. Consequently, we recorded
a write-off of our investment in Aventail to reduce our carrying value to $0.

Rights Agreement. On March 15, 2007, the Board of Directors declared
a dividend of one preferred share purchase right, or a Right, for each
outstanding share of common stock, par value $0.001 per share, of the
Company. The dividend was payable on March 23, 2007 to the stockholders
of record on that date. Each Right entitles the registered holder to purchase
from the Company one one-thousandth of a share of Series B Preferred
Stock of the Company, par value $0.001 per share, or the Preferred Shares,
at a price of $100.00 per one one-thousandth of a Preferred Share, subject
to adjustment. The description and terms of the Rights are set forth in a
Rights Agreement between the Company and American Stock Transfer
& Trust Company, as Rights Agent dated April 11, 2007.

Data Center Expansion. On June 12, 2007, we announced that we approved
an investment of up to $40.0 million to fund the expansion of our data
center facilities in several key markets. We anticipate implementing the
expansion over the next several calendar quarters, with at least a portion
of the funding to be provided under our credit agreement, discussed below.
Through December 31, 2007, we have spent less than $10.0 million.

Credit Agreement. On September 14, 2007, we entered into a
$35.0 million credit agreement. We discuss this agreement in note 10
to the consolidated financial statements and the section captioned
“Liquidity and Capital Resources” under “Management’s Discussion and
Analysis of Financial Condition and Results of Operations.” At December 31,
2007, the outstanding balance was $19.8 million, of which we used
$4.4 million to repay prior debt, approximately $7.8 million for capital
expenditures and the balance for general corporate and other purposes.
The availability under the revolving credit facility and term loan was
$1.1 million and $10.0 million, respectively at December 31, 2007.

24 INTERNAP | 2007 ANNUAL REPORT

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Financial Review 2007

CRITICAL ACCOUNTING
POLICIES AND ESTIMATES

The discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which
have been prepared in accordance with accounting principles generally
accepted in the United States. The preparation of these financial state-
ments requires management to make estimates and judgments that
affect the reported amounts of assets, liabilities, revenue, and expense,
and related disclosure of contingent assets and liabilities. On an ongoing
basis, we evaluate our estimates, including those summarized below.
We base our estimates on historical experience and on various other
assumptions that are believed to be reasonable under the 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
financial statements.

Revenue Recognition. The majority of our revenue is derived from high
performance IP services, related data center services, CDN services,
and other ancillary products and services throughout the United States.
Our IP services revenue is derived from the sale of high performance
Internet connectivity services at fixed rates or usage-based pricing to our
customers that desire a DS3 or faster connection. Slower T1 and fractional
DS3 connections are provided at fixed rates. Data center revenue includes
both physical space for hosting customers’ network and other equipment
plus associated services such as redundant power and network connectivity,
environmental controls and security. Data center revenue is based on
occupied square feet and both allocated and variable-based usage. CDN
revenue includes three components, none of which are sold separately:
(1) data storage; (2) streaming/delivery and (3) a user interface/reporting
tool. We provide the CDN service components via internally developed
and acquired technology that resides on our network. CDN revenue is based
on either fixed rates or usage-based pricing. All of the foregoing revenue
arrangements have contractual terms and in many instances, include
minimum usage commitments. Other ancillary products and services
include our Flow Control Platform, or FCP, product, server management
and installation, virtual private networking, managed security, data
backup, remote storage and restoration.

when persuasive evidence of an arrangement exists, the product or service
has been delivered, the fees are fixed or determinable and collectibility
is probable. For most of our IP, data center and CDN revenue, services
are delivered ratably over the contract term. Contracts and sales or
purchase orders are used to determine the existence of an arrangement.
We test for availability or connectivity to verify delivery of our services.
We assess whether the fee is fixed or determinable based on the payment
terms associated with the transaction and whether the sales price is
subject to refund or adjustment. Because the software component of
our FCP is more than incidental to the product as a whole, we recognize
associated FCP revenue in accordance with the American Institute of
Certified Public Accountants’ (AICPA) Statement of Position 97-2, Software
Revenue Recognition.

We derive revenue from the sale of IP services, data center services
and CDN services to customers under contracts that generally commit
the customer to a minimum monthly level of usage on a calendar month
basis and provide the rate at which the customer must pay for actual
usage above the monthly minimum. For these services, we recognize
the monthly minimum as revenue each month provided that an enforceable
contract has been signed by both parties, the service has been delivered
to the customer, the fee for the service is fixed or determinable and
collection is reasonably assured. Should a customer’s usage of our
services exceed the monthly minimum, we recognize revenue for such
excess in the period of the usage. We record the installation fees as
deferred revenue and recognize as revenue ratably over the estimated
life of the customer arrangement. We also derive revenue from services
sold as discrete, non-recurring events or based solely on usage. For these
services, we recognize revenue after both parties have signed an enforceable
contract, the fee is fixed or determinable, the event or usage has occurred
and collection is reasonably assured.

We also enter into multiple-element arrangements or bundled services,
such as combining IP services with data center, CDN services or both.
When we enter into such arrangements, we account for each element
separately over its respective service period or at the time of delivery,
provided that there is objective evidence of fair value for the separate
elements. Objective evidence of fair value includes the price charged
for the element when sold separately. If we cannot objectively determine
the fair value of each element, we recognize the total value of the
arrangement ratably over the entire service period to the extent that we
have begun to provide the services, and other revenue recognition criteria
have been satisfied.

We recognize revenue in accordance with the Securities and Exchange
Commission’s Staff Accounting Bulletin No. 104, Revenue Recognition,
or SAB No. 104, and the Financial Accounting Standards Board’s, or FASB,
Emerging Issues Task Force Issue No. 00-21, Revenue Arrangements
with Multiple Deliverables, or EITF No. 00-21. Revenue is recognized

Deferred revenue consists of revenue for services to be delivered in the
future and consist 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 esti-
mated life of the customer relationship, which was two to three years for each

INTERNAP | 2007 ANNUAL REPORT 25

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Financial Review 2007

of the three years in the period ended December 31, 2007. Revenue for
installation services is deferred and amortized because the installation
service is integral to our primary service offering and does not have value
to a customer on a stand-alone basis. Deferred post-contract customer
support associated with sales of our FCP solution and similar products
are amortized ratably over the contract period, 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 collection is probable. Additionally, we
maintain allowances for doubtful accounts resulting from the inability
of our customers to make required payments on accounts receivable.
The allowance for doubtful accounts is based upon specific and general
customer information, which also includes estimates based on manage-
ment’s best understanding of the customer’s ability to pay. A customer’s
ability to pay takes into consideration payment history, legal status (i.e.,
bankruptcy) and the status of services we are providing. Once we have
exhausted all collection efforts, we write the uncollectible balance off
against the allowance for doubtful accounts.

We record an amount for sales adjustments, which reduces net accounts
receivable and revenue. The amount for sales adjustments is based
upon specific and general customer information, including outstanding
promotional credits, customer disputes, credit adjustments not yet
processed through the billing system, and historical activity.

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. We record rent expense for operating leases in accordance
with FASB Technical Bulletin (FTB) No. 88-1, “Issues Relating to Accounting
for Leases.” This FTB requires lease agreements that include periods of
free rent or other incentives, specific escalating lease payments, or both,
to be recorded on a straight-line or other systematic basis over the initial
lease term and those renewal periods that are reasonably assured. The
difference between rent expense and rent paid is recorded as deferred
rent in non-current liabilities in the consolidated balance sheets.

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 incurred a charge during the three months ended June 30,
2007, totaling $1.2 million, representing the write-off of the remaining
carrying value of our investment in series D preferred stock of Aventail.
See note 6 to the consolidated financial statements for further discussion
of this investment and the recorded loss.

We account for investments that provide us with the ability to exercise
significant influence, but not control, over an investee using the equity
method of accounting. Significant influence, but not control, is generally
deemed to exist if we have an ownership interest in the voting stock of
the investee of between 20% and 50%, although other factors, such as
minority interest protections, are considered in determining whether the
equity method of accounting is appropriate. As of December 31, 2007,
Internap Japan Co, Ltd. (Internap Japan), our joint venture with NTT-ME
Corporation of Japan and NTT Holdings, qualifies for equity method
accounting. We record our proportional share of the income and losses
of Internap Japan one month in arrears on the consolidated balance
sheets as a component of non-current investments and as a separate
caption on the consolidated statement of operations.

Pursuant to our formal investment policy, investments in marketable
securities include high credit quality corporate debt securities, auction
rate securities, commercial paper, and U.S. Government Agency debt
securities. Auction rate securities are variable rate bonds tied to short-term
interest rates with maturities on the face of the securities in excess of
90 days and have interest rate resets through a modified Dutch auction,
at predetermined short-term intervals, usually every 7, 28 or 35 days.
Auction rate securities generally trade at par and are callable at par on
any interest payment date at the option of the issuer. Interest received
during a given period is based upon the interest rate determined through
the auction process. Although these securities are issued and rated as
long term bonds, they are priced and traded as short-term instruments
because of the liquidity provided through the interest rate reset. All
of our marketable securities are classified as available for sale and
are recorded at fair value with changes in fair value reflected 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. As a first step, it requires a comparison of
the book value of net assets to the fair value of the related operations that
have goodwill assigned to them. If the fair value is determined to be
less than book value, a second step is performed to compute the amount
of the impairment. In this process, a fair value for goodwill is estimated,
based in part on the fair value of the operations used in the first step,
and is compared to the carrying value for goodwill. Any shortfall of
the fair value below carrying value represents the amount of goodwill
impairment. SFAS No. 142 requires goodwill to be tested for impairment
annually at the same time every year and when an event occurs or circum-
stances change such that it is reasonably possible that impairment may
exist. We selected August 1 as our annual testing date. We also assess
on a quarterly basis whether any events have occurred or circumstances
have changed that would indicate an impairment could exist.

26 INTERNAP | 2007 ANNUAL REPORT

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Financial Review 2007

Accruals for Disputed Telecommunication Costs. In delivering our
services, we rely on a number of Internet network, telecommunication
and other vendors. We work directly with these vendors to provision
services such as establishing, modifying or discontinuing services for
our customers. Because of the volume of activity, billing disputes inevitably
arise. These disputes typically stem from disagreements concerning the
starting and ending dates of service, quoted rates, usage, and various
other factors. For potential billing errors made in the vendor’s favor, for
example a duplicate billing, we initiate a formal dispute with the vendor
and record the related cost and liability on a range of 5% to 100% of the
disputed amount, depending on our assessment of the likely outcome
of the dispute. Conversely, for billing errors in our favor, such as the
vendor’s failure to invoice us for new service, we record an estimate for
the 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 man-
agement and modified in light of new information or developments, if any.
Conversely, any resolved disputes that will result in a credit over the disputed
amounts are recognized in the appropriate month when the resolution
has been determined. Because estimates regarding disputed costs include
assessments of uncertain outcomes, such estimates are inherently
vulnerable to changes due to unforeseen circumstances that could
materially and adversely affect our consolidated financial condition,
results of operations and cash flows.

Accrued Liabilities. Similar to accruals for disputed telecommunications
costs above, it is necessary for us to estimate other significant costs
such as utilities and sales, use, telecommunications, and other taxes.
These estimates are often necessary either because invoices for 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 modifies 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 circumstances that could materially and
adversely affect our results of operations and cash flows.

estimates and assumptions relative to new information, if any, of which
it becomes aware. Should circumstances warrant, management will
adjust its previous estimates to reflect what it then believes to be a
more accurate representation of expected future costs. Because man-
agement’s estimates and assumptions regarding restructuring costs
include probabilities of future events, such estimates are inherently
vulnerable to changes due to unforeseen circumstances, changes in
market conditions, regulatory changes, changes in existing business
practices, and other circumstances that could materially and adversely
affect our results of operations. A 10% change in our restructuring
estimates in a future period, compared to the $10.1 million restruc-
turing liability at December 31, 2007 would result in an $1.0 million
expense or benefit in the statement of operations during the period in
which the change in estimate occurred.

Deferred Taxes. We record a valuation allowance to reduce our deferred
tax assets to the amount that is more likely than not to be realized.
Historically, 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 reduce the valuation allowance
would increase income in the period such determination was made.

For the year ended December 31, 2007, the tax provision includes a net
benefit of $3.5 million related to the release of the valuation allowance
associated with U.K. deferred tax assets. The gross amount of U.K. deferred
tax assets was $4.4 million, which was offset by a reserve of $0.9 million.
The net tax provision benefit of $3.5 million reduced our loss for the year
ended December 31, 2007.

The reduction in valuation allowance was due to the existence of sufficient
positive evidence as of December 31, 2007 to indicate that our net operating
losses in the U.K. would more likely than not be realized in the future. The
evidence primarily consist s of the results of prior performance in the U.K.
and the expectation of future performance based on historical results. We
will continue to assess in the future the recoverability of U.S. and other
deferred tax assets, and whether or not the valuation allowance should be
reduced relative to the U.S. and other deferred tax assets outside the U.K.

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 assumptions
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

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,” or SFAS No. 123R, and related interpretations. 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,

INTERNAP | 2007 ANNUAL REPORT 27

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Financial Review 2007

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, we did not recognize any expense
for options to purchase our common stock granted with an exercise price
equal to fair market value at the date of grant and did not recognize any
expense in connection with purchases under our employee stock purchase
plans for any periods prior to January 1, 2006.

We elected to adopt SFAS No. 123R using the modified prospective
application method. Under this method, compensation cost recognized
during the period includes: (1) compensation cost for all share-based
payments granted prior to, but not yet vested as of January 1, 2006,
based on the grant date fair value estimated in accordance with the
original provisions of SFAS No. 123 amortized over the awards’ vesting
period, and (2) compensation cost for all share-based payments granted
subsequent to January 1, 2006, based on the grant-date fair value
estimated in accordance with the provisions of SFAS No. 123R amortized
on a straight-line basis over the awards’ vesting period. The fair value
of stock options is estimated at the date of grant using the Black-Scholes
option pricing model with weighted average assumptions for the activity
under our stock plans. Option pricing model input assumptions such as
expected term, expected volatility, and risk-free interest rate, impact
the fair value estimate. Further, the forfeiture rate impacts the amount
of aggregate compensation. These assumptions are subjective and
generally require significant analysis and judgment to develop.

The expected term represents the weighted average period of time that
granted options are expected to be outstanding, giving consideration to
the vesting schedules and our historical exercise patterns. Because our
options are not publicly traded, assumed volatility is based on the historical
volatility of our stock. The risk-free interest rate is based on the U.S. Treasury
yield curve in effect at the time of grant for periods corresponding to the
expected life of the options. We have also used historical data to estimate
option exercises, employee termination and stock option forfeiture rates.
Changes in any of these assumptions could materially impact our results
of operations in the period the change is made.

RECENT ACCOUNTING PRONOUNCEMENTS

In September 2006, the FASB issued SFAS No. 157, “Fair Value
Measurements,” or SFAS No. 157. SFAS No. 157 defines fair value, estab-
lishes a framework for measuring fair value under generally accepted
accounting principles, or GAAP, and expands disclosures about fair value
measurements. SFAS No. 157 is effective for fiscal years beginning after
December 15, 2007. In February 2008, the FASB issued Staff Position, or
FSP, FAS 157-1, which provides supplemental guidance on the application
of SFAS No. 157, and FSP FAS 157-2, which delays the effective date of

SFAS No. 157 for nonfinancial assets and nonfinancial liabilities. We are
currently in the process of evaluating the impact that the adoption of SFAS
No. 157 will have on our financial position, results of operations and cash flows.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option
for Financial Assets and Financial Liabilities,” or SFAS NO. 159. SFAS
No. 159 permits companies to choose to measure, on an instrument-by-
instrument basis, many financial instruments and certain other assets
and liabilities at fair value that are not currently required to be measured
at fair value. SFAS No. 159 is effective as of the beginning of a fiscal
year that begins after November 15, 2007. While we will not elect to
adopt fair value accounting to any assets or liabilities allowed by SFAS
No. 159, we are currently in the process of evaluating SFAS No. 159
and its potential impact to us.

In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business
Combinations,” or SFAS No. 141R. SFAS No. 141R replaces SFAS No. 141,
“Business Combinations.” SFAS No. 141R establishes principles and
requirements for how an acquiror recognizes and measures in its financial
statements the identifiable assets acquired, the liabilities assumed, any
noncontrolling interest in the acquiree, and the goodwill acquired or a
gain from a bargain purchase. SFAS No. 141R also determines disclosure
requirements to enable the evaluation of the nature and financial effects
of the business combination. SFAS No. 141R applies prospectively to
business combinations for which the acquisition date is on or after the
beginning of a fiscal year that begins on or after December 15, 2008 and
has implications for acquisitions that occur prior to this date. We are
currently in the process of evaluating the impact that the adoption of
SFAS No. 141R will have on our financial position, results of operations
and cash flows.

In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests
in Consolidated Financ ial Statements,” or SFAS No. 160. SFAS No. 160
amends Accounting Research Bulletin 51, “ Consolidated Financial
Statements,” or ARB 51, and requires all entities to report noncontrolling
(minority) interests in subsidiaries within equity in the consolidated
financial statements, but separate from the parent shareholders’ equity.
SFAS No. 160 also requires any acquisitions or dispositions of noncontrolling
interests that do not result in a change of control to be accounted for as
equity transactions. Further, SFAS No. 160 requires that a parent recognize
a gain or loss in net income when a subsidiary is deconsolidated. SFAS
No. 160 is effective for fiscal years beginning on or after December 15,
2008. We do not expect the adoption of SFAS No. 160 will have a significant,
if any, impact on our financial position, results of operations and cash flows.

RESULTS OF OPERATIONS

Revenues. Revenues are generated primarily from the sale of IP services,
data center services and CDN services. Our revenues typically consist

28 INTERNAP | 2007 ANNUAL REPORT

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Financial Review 2007

of monthly recurring revenues from contracts with terms of one year
or more. These contracts usually have fixed minimum commitments
based on a certain level of usage with additional charges for any usage
over a specified limit. We also provide premise-based route optimization
products and other ancillary services, such as server management
and installation services, virtual private networking services, managed
security services, data back-up, remote storage, restoration services,
and professional services.

Direct Costs of Network, Sales and Services. Direct costs of network,
sales and services are comprised primarily of:

• costs for connecting to and accessing Internet network service
providers, or ISPs, and competitive local exchange providers;

• facility and occupancy costs for housing and operating our and

our customers’ network equipment;

• costs of license fees for operating systems software, advertising

royalties to content rights owners and advertising distribution costs;

• costs incurred for providing additional third party services to our

customers; and

• costs of FCP solutions sold.

To the extent a network access point is located a distance from the
respective ISP, 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
fixed in nature. Direct costs of network, sales and services do not include
compensation, depreciation or amortization.

Direct Costs of Amortization of Acquired Technologies. Direct costs of
amortization of acquired technologies are for technologies acquired
through business combinations that are an integral part of the services
and products we sell. The cost of the acquired technologies is amortized
over original lives of three to eight years.

Direct Costs of Customer Support. Direct costs of customer support
consist primarily of compensation and other personnel 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
costs of customer support.

Product Development Costs. Product development costs consist principally
of compensation and other personnel costs, consultant fees and prototype
costs related to the design, development and testing of our proprietary
technology, enhancement of our network management software and

development of internal systems. Costs for software to be sold, leased
or otherwise marketed are capitalized upon establishing technological
feasibility and ending when the software is available for general release
to customers. Costs associated with internal use software are capitalized
when the software enters the application development stage until the
software is ready for its intended use. All other product development
costs are expensed as incurred.

Sales and Marketing Costs. Sales and marketing costs consist of
compensation, commissions and other costs for personnel engaged in
marketing, sales and field service support functions, as well as advertising,
tradeshows, direct response programs, new service point launch events,
management of our website, and other promotional costs.

General and Administrative Costs. General and administrative costs
consist primarily of compensation and other expense for executive,
finance, human resources and administrative personnel, professional
fees, and other general corporate costs.

The following table sets forth, as a percentage of total revenue, selected
statement of operations data for the periods indicated:

Revenues:

Internet protocol (IP) services

Data center services
Content delivery network (CDN) services
Other

Total revenues

Operating costs and expenses:
Direct costs of network, sales and services,

exclusive of depreciation and amortization,
shown below:
IP services

Data center services
CDN services
Other

Direct costs of amortization of

acquired technologies

Direct costs of customer support
Product development
Sales and marketing
General and administrative
Depreciation and amortization
Restructuring and asset impairment
Other operating costs and expenses

Year Ended December 31,

2007

2006

2005

51.2%
35.5
7.6
5.7

60.5%
31.0
–
8.5

68.3%
24.1
–
7.6

100.0

18.7
25.4
2.8
3.7

1.8
7.1
2.8
13.4
13.9
9.5
4.9
0.2

21.9
25.6
–
6.1

0.3
6.4
2.5
15.0
12.2
8.7
0.2
(0.1)

98.8

25.0
22.9
–
5.4

0.4
6.9
3.2
16.8
13.1
9.6
–
–

103.3

Total operating costs and expenses

104.2

(Loss) income from operations

(4.2)%

1.2%

(3.3)%

INTERNAP | 2007 ANNUAL REPORT 29

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Financial Review 2007

REVENUES

Revenues for the years ended December 31, 2007, 2006 and 2005 are
summarized as follows (in thousands):

Revenues:

Internet protocol (IP) services

Data center services
Content delivery network (CDN) services
Other

Year Ended December 31,

2007

2006

2005

$119,848
83,058
17,718
13,466

$109,748
56,152
–
15,475

$105,032
36,996
–
11,689

$234,090

$181,375

$153,717

Segment Information. We have three business segments: IP services,
data center services and CDN services. IP services include managed and
premise-based high performance IP and route optimization technologies.
Data center services include hosting of customer applications directly
on our network to eliminate issues associated with the quality of local
connections. Data center services are increasingly bundled with our high
performance IP connectivity services. CDN services include products
and services for storing, delivering and monetizing digital media to large
global audiences over the Internet. Prior to our acquisition of VitalStream
on February 20, 2007, we did not offer proprietary CDN services, but
instead, we were a reseller of third party CDN services for which revenues
and direct costs are included in other revenues and direct costs of network,
sales and services, discussed below.

Our reportable segments are strategic business units that offer different
products and services. As of December 31, 2007, our customer base totaled
approximately 3,800 customers across more than 20 metropolitan markets.

IP Services. Revenue for IP services increased $10.1 million, or 9%,
to $119.9 million for the year ended December 31, 2007, compared to
$109.7 million for the year ended December 31, 2006. The increase in
IP revenue is driven by an increase in demand, partially offset by a decline
in pricing, and an increase in sales of our premise-based FCP products
and other large hardware sales. We continue to experience increasing
demand for our traditional IP services, with IP traffic for the year ended
December 31, 2007 increasing approximately 35% from the year
ended December 31, 2006. The increase in IP traffic has resulted from
both existing and new customers requiring 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
have continued to add high-traffic customers through competitive IP
pricing and minimum commitments during the year ended December 31,
2007. New IP services customers added approximately $1.7 million of
revenue. Ongoing industry-wide pricing declines over the last 12 months,
however, offset a portion of our gains in customers and IP traffic. The
blended rate in megabits per second, or Mbps, decreased approximately

23% annually from December 31, 2006 to December 31, 2007. We
recorded approximately $0.5 million of sales adjustments in the
fourth quarter of 2007 related predominantly to disputes over contractual
service periods.

Revenue for IP services increased $4.7 million, or 5%, to $109.7 million
for the year ended December 31, 2006, compared to $105.0 million for
the year ended December 31, 2005. This change is due to the increase
in demand for IP traffic, partially offset by declining prices. During the
year ended December 31, 2006, IP traffic over our networks increased
approximately 83% from the year ended December 31, 2005. The
increase in IP traffic 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-traffic customers
through competitive IP pricing and minimum commitments during the
year ended December 31, 2006.

Data Center Services. Data center services are a significant source of
revenue growth for our business. Revenue for data center services increased
$26.9 million, or 48%, to $83.1 million for the year ended December 31,
2007, compared to $56.2 million for the year ended December 31, 2006.
During the year ended December 31, 2007, we (1) implemented a
broad-based rate increase, generating additional revenue of approximately
$8.0 million, (2) began executing a data center growth initiative and
(3) completed the build-out of our Seattle facility. The overall increase
in revenue has resulted from both new and existing customers, with new
customers adding approximately $1.7 million of revenue during 2007.
The remaining increase is largely due to existing customers using more
space within our facilities, and the design and installation revenue from
new customers. We have also structured our data center business to
accommodate larger, global customers and ensure a platform for robust
traffic growth.

Revenue for data center services increased $19.2 million, or 52%,
to $56.2 million for the year ended December 31, 2006, compared to
$37.0 million for the year ended December 31, 2005. The revenue
increase is primarily attributable to growth in new and existing data
center customers. 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.

CDN Services. Revenue for our CDN services segment was $17.7 million
for the year ended December 31, 2007. This activity represents the
operations from our acquisition of VitalStream, which we completed on
February 20, 2007. Revenue for the year was slightly lower than originally
anticipated as we completed the integration of the VitalStream business

30 INTERNAP | 2007 ANNUAL REPORT

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Financial Review 2007

with and into our network and infrastructure. As previously noted, we
did not offer proprietary CDN services prior to our acquisition of VitalStream,
but instead, we were a reseller of third party CDN services, which is
included in Other revenue, below. We expect CDN to be an area of significant
growth and have upgraded and expanded related infrastructure, including
in Europe and Asia, to serve the expected industry-wide demand, particularly
in those regions. In December 2007, we extended our 100% uptime SLA
to CDN services. In the second half of 2007, the Company experienced
platform instability in its CDN business, which caused an increase in
customer dissatisfaction and a higher than historical amount of customer
disputes over service billings. In the fourth quarter of 2007, we recorded
a total of appoximately $1.4 million in sales and billing adjustments
related to both service interruptions and disputes over contractual service
periods. These sales and billing adjustments have been recorded against
revenue. We have substantially completed integrating our combined
networks through technological improvements and systems integration
with operational stability achieved late in the year and expect this inte-
gration to result in a decrease in performance-related adjustments in 2008.

Other. Other revenues primarily include reseller and miscellaneous services
such as third party CDN services, termination fee revenue, referral fees for
other hardware sales, and consulting services. Other revenues decreased
substantially as the revenue streams from our acquisition of VitalStream
replaced the activity of the former third party CDN service provider.

DIRECT COSTS OF NETWORK,
SALES AND SERVICES
(exclusive of depreciation and amortization)

IP Services. Direct costs of IP network, sales and services, exclusive
of depreciation and amortization, increased $3.9 million, or 10%,
to $43.7 million for the year ended December 31, 2007, compared to
$39.7 million for the year ended December 31, 2006. For the year ended
December 31, 2006 compared to the year ended December 31, 2005,
the related direct costs increased $1.4 million, or 4%, to $39.7 million
as of December 31, 2006, compared to $38.4 million as of December 31,
2005. While IP services revenue has increased, the direct costs of
IP network, sales and services has continued to be approximately 36%
of IP services revenue for each of the last three years, even as we have
had a change in the mix of revenue with traditionally higher margin
IP services, lower margin high volume customers, and FCP and other
hardware sales. Connectivity costs vary based upon customer traffic and
other demand-based pricing variables. Costs for IP services are especially
subject to ongoing negotiations for pricing and minimum commitments.
As our IP traffic continues to grow, we expect to have greater bargaining
power for lower bandwidth rates and more opportunities to proactively
manage network costs, such as utilization and traffic optimization among
network service providers.

Data Center Services. The direct costs of data center services, exclusive
of depreciation and amortization, increased $13.0 million, or 28%,
to $59.4 million for the year ended December 31, 2007, compared to
$46.5 million for the year ended December 31, 2006. For the year ended
December 31, 2006 compared to the year ended December 31, 2005,
the related direct costs increased $11.2 million, or 32%, to $46.5 million
as of December 31, 2006, compared to $35.2 million as of December 31,
2005. As data center services revenue has increased, direct costs of
data center services as a percentage of corresponding revenue have
decreased to approximately 72%, 83% and 95% for the year ended
December 31, 2007, 2006 and 2005, respectively. This trend is the result
of an increase in total occupancy at higher rates, as discussed with
revenues above, while substantial direct costs are subject to previously
negotiated rates. Direct costs of data center services, exclusive of
depreciation and amortization, have substantial fixed cost components,
primarily for rent, but also significant demand-based pricing variables,
such as utilities, which are highest in the summer for cooling the facilities.

The growth in data center services largely follows our expansion of
data center space. The demand for data center services is outpacing
industry-wide supply, which contributes to our improvement of data
center direct costs as a percentage of data center revenue. At December 31,
2007, we had approximately 179,000 square feet of data center space
with a utilization rate of approximately 75%, as compared to approximately
149,000 square feet of data center space with a utilization rate of
approximately 79% at December 31, 2006. At December 31, 2005, we
had approximately 124,000 square feet of data center space with a
utilization rate of approximately 76%. Our recent data center expansion
has resulted in the lower utilization rate as of December 31, 2007
compared to December 31, 2006. However, the recent expansion should
provide us lower costs per occupied square foot in future periods,
enabling us to increase revenue compared to relatively lower direct
costs of data center services. At December 31, 2007, 104,000 square
feet, or approximately 58% of total square feet, was in data centers
operated by us versus data centers operated by our vendors, or partner
sites. Additionally, approximately 62% of our available square feet as
of December 31, 2007 are in data centers operated by us.

CDN Services. Direct costs of network, sales and services, exclusive
of depreciation and amortization, for our CDN services segment were
$6.6 million for the year ended December 31, 2007. Direct costs of CDN
network, sales and services were approximately 37% of CDN services
revenue for the year ended December 31, 2007, which was a little more
favorable than our initial expectations. This activity represents the operations
from our acquisition of VitalStream, which was completed on February 20,
2007. The direct costs include the benefit of lower rates throughout the
year as we have migrated VitalStream’s former contracts and terms to
our own. Direct costs of CDN network sales and services also includes
an allocation of $0.7 million from direct costs of IP network sales and

INTERNAP | 2007 ANNUAL REPORT 31

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Financial Review 2007

services based on the average cost of actual usage by the CDN segment.
As previously noted, we did not offer proprietary CDN services prior to
our acquisition of VitalStream, but instead, we were a reseller of third party
CDN services, which is included in Other direct costs, below. We
expect CDN to be an area of significant growth and are expanding
related infrastructure, including in Europe and Asia, to serve the
expected industry-wide demand, particularly in those regions.

Other. Other direct costs of network, sales and services, exclusive of
depreciation and amortization primarily include reseller and miscellaneous
services such as third party CDN services and consulting services.
These costs decreased substantially as the revenue streams from our
acquisition of VitalStream replaced the activity of the former third party
CDN service provider.

OTHER OPERATING EXPENSES

Other than direct costs of network, sales and services, compensation and
facilities-related costs have the most pervasive impact on operating
expenses. Compensation and benefits comprise the largest expenses
after direct costs of network, sales and services. Cash-basis compensation
and benefits increased $12.0 million to $53.4 million for the year ended
December 31, 2007 from $41.4 million for the year ended December 31,
2006. Stock-based compensation increased $2.8 million to $8.7 million
for the year ended December 31, 2007 from $5.9 million for the year
ended December 31, 2006. All of the increases in compensation and
benefits are primarily due to increased headcount, largely attributable
to the additional employees resulting from the VitalStream acquisition.
For the year ended December 31, 2007, the additional VitalStream
employees accounted for $6.6 million of the increase in cash-basis
compensation and $1.3 million of the increase in stock-based compensation.
Compensation also increased due to the hiring of other employees
throughout the Company, including at the senior management level. Total
headcount increased to 420 at December 31, 2007 compared to 330 at
December 31, 2006.

As discussed in note 2 of the consolidated financial statements, we
adopted SFAS No. 123R on January 1, 2006. Accordingly, total operating
costs and expense and net income for 2007 and 2006 includes stock-based
compensation expense in the following amounts:

Total unrecognized compensation costs related to non-vested stock-based
compensation as of December 31, 2007 was $26.9 million with a
weighted-average remaining recognition period of 2.8 years.

Cash-basis compensation and benefits decreased $1.5 million to
$41.4 million for the year ended December 31, 2006 from $42.9 million
for the year ended December 31, 2005, which reflects a net decrease in
salaries and wages and a decrease in employee benefits, partially offset
by a net increase in commissions. The decreases in compensation and
benefits reflect a consistent headcount of approximately 330 full-time
employees for both 2006 and 2005, but favorable experience on self-insured
medical claims in 2006, while the increase in commissions is revenue
driven. Compensation for the year ended December 31, 2006 also includes
an increase of $1.8 million in employee bonuses over the year ended
December 31, 2005.

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,
we did not recognize any expense for options to purchase our common
stock 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
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 significant
number of unvested stock options were forfeited upon the resignation
of Mr. Gregory Peters, our former Chief Executive Officer, thus reducing
the number of outstanding stock options for determining comparative
stock-based compensation expense for the year ended December 31, 2006.

Year Ended December 31,

2007

$1,892
856
2,135
3,798

$8,681

2006

$1,102
628
2,145
2,067

$5,942

Overall, facility and related costs, including repairs and maintenance,
communications and office supplies but excluding direct costs of network,
sales and services, increased $1.0 million, or 17%, to $7.0 million for
the year ended December 31, 2007 compared to $6.0 million for the year
ended December 31, 2006. The increase is primarily due to $0.7 million
of VitalStream post-acquisition operating costs.

Direct costs of customer support
Product development
Sales and marketing
General and administrative

Total stock-based compensation

32 INTERNAP | 2007 ANNUAL REPORT

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Financial Review 2007

Facility and related costs 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.

Other significant operating costs are discussed with the financial
statement captions below:

Direct Costs of Amortization of Acquired Technologies. Direct costs
of amortization of acquired technologies increased $3.7 million from
$0.5 million for the year ended December 31, 2006 to $4.2 million for
the year ended December 31, 2007. The increase in amortization
expense is due to the amortization of the post-acquisition intangible
technology assets of VitalStream.

Direct Costs of Customer Support. Direct costs of customer support
increased 43% from $11.6 million for the year ended December 31, 2006
to $16.5 million for the year ended December 31, 2007. The increase of
more than $4.9 million was primarily due to compensation of employees and
facilities-related costs as discussed above. VitalStream employees
accounted for $1.7 million of added cash-basis compensation and
benefits and $0.5 million of additional stock-based compensation for
the year ended December 31, 2007. Other increases in cash-basis and
stock-based compensation amounted to $1.3 million and $0.3 million,
respectively, whereas facilities-related costs increased $0.6 million.

Direct costs 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 benefits 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, 2007 increased 47% to $6.6 million from $4.5 million
for the year ended December 31, 2006. The increase of $2.1 million is
primarily attributable to the addition of VitalStream employees and
facilities-related costs. For the year ended December 31, 2007, the
additional VitalStream employees accounted for $1.0 million of additional
cash-basis compensation and benefits costs and $0.3 million of
additional stock-based compensation costs. In addition, facilities-related
costs amounted to $0.3 million of this increase.

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 benefits 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 benefits partially reflects 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 specific project in 2005.

Sales and Marketing. Sales and marketing costs for the year ended
December 31, 2007 increased 16% to $31.5 million from $27.2 million
for the year ended December 31, 2006. The increase of more than
$4.3 million is primarily comprised of VitalStream employee costs.
Cash-basis compensation, benefits and commissions related to VitalStream
employees accounted for $2.8 million and stock-basis compensation
for these employees amounted to $0.4 million for the year ended
December 31, 2007.

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 benefits
expenses of $1.4 million, all of which were discussed above. Also, as
discussed with direct costs of customer support above, facilities and
related expenses decreased $0.7 million largely due to more accurate
data allocations of expenses to direct costs of customer support. Outside
professional services decreased $0.3 million and travel, entertainment
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, 2007 increased 47% to $32.5 million from
$22.1 million for the year ended December 31, 2006. The increase of
$10.4 million is primarily due to increases in cash-basis compensation
and benefits, professional services and stock-based compensation. Cash-
basis compensation and benefits for the year ended December 31, 2007
increased $3.6 million, including $1.0 million for the additional VitalStream
employees. As discussed earlier, the other cause for the increase in
cash-basis compensation is the hiring of other employees throughout the
Company, including at the senior management level. The overall increase
in head-count caused us to accrue employee bonuses $0.3 million higher
during 2007 than we did for 2006 and caused higher self-insured medical
claims of $0.6 million compared to 2006. Professional services for the

INTERNAP | 2007 ANNUAL REPORT 33

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Financial Review 2007

year ended December 31, 2007 increased $2.0 million primarily due to
consultation fees on our information technology systems, compliance
activities for domestic and international tax and financial statement
requirements, recruiting fees and contract labor to fill a number of open
job requisitions, and legal fees, including those associated with new proxy
disclosure requirements and ongoing litigation. Bad debt expense increased
approximately $1.7 million to $2.2 million for the year ended December 31,
2007. The increase in bad debt expense is due primarily to our integration
of VitalStream with their legacy customers causing bad debt expense to
be greater than our historical expense. Stock-based compensation costs
increased $1.7 million for the year ended December 31, 2007 due
to annual grants of stock options and unvested restricted common
stock to non-employee directors, the stock options assumed in the
VitalStream acquisition and initial grants and awards to new members
of senior management.

The charge was the result of a review of our business, particularly in
light of our acquisition of VitalStream and our plan to finalize the overall
integration and implementation plan before the end of the first quarter.
The charge to expense included $7.8 million for leased facilities, repre-
senting both the costs less anticipated sublease recoveries that will
continue to be incurred without economic benefit to us and costs to
terminate leases before the end of their term. The charge also included
severance payments of $1.1 million for the termination of certain
employees and $1.4 million for impairment of assets. Net related
expenditures were estimated to be $10.7 million, of which $2.8 million
has been paid during the year ended December 31, 2007, and the balance
continuing through December 2016, the last date of the longest lease term.
These expenditures are expected to be paid out of operating cash flows.
Cost savings from the restructuring were estimated to be approximately
$0.8 million per year through 2016, primarily for rent expense.

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 primarily reflects a
$2.4 million increase in taxes (non-income based), licenses, fees,
a $2.1 million increase in stock-based compensation expense, and a
$1.1 million increase in compensation and employee benefits. 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 benefits is the redeploy-
ment 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 benefits, 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.

Restructuring and Asset Impairment. As discussed in note 4 to the
financial statements, we incurred a restructuring and asset impairment
charge of $10.3 million during the three months ended March 31, 2007.

We incurred a $1.1 million impairment charge during the three months
ended March 31, 2007 for the sales order-through-billing system,
which was a result of an evaluation of the existing infrastructure relative
to our new financial accounting system and the acquisition of VitalStream.

Depreciation and Amortization. For the year ended December 31, 2007,
depreciation and amortization, including other intangible assets but
excluding acquired technologies, increased 40% to $22.2 million compared
to $15.9 million for the year ended December 31, 2006. The increase
of $6.4 million primarily relates to post-acquisition depreciation and
amortization of VitalStream property and equipment and acquired amor-
tizable intangible assets, excluding amortization of acquired technologies.
The VitalStream property and equipment and acquired amortizable
intangible assets account for $5.8 million of the expense for the year
ended December 31, 2007. The remaining increase in depreciation and
amortization relates to the expansion of P-NAPs and on-going expansion
of data center facilities. The restructuring and asset impairment described
above initially reduced depreciation and amortization by approximately
$0.4 million per year, decreasing to $0 in 2009. The amortization of acquired
technologies is included in its own caption and discussed above.

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.

Write-Off of Investment. We incurred a charge of $1.2 million representing
the write-off of the remaining carrying value of our investment in series D
preferred stock of Aventail Corporation, or Aventail. We made an initial
cash investment of $6.0 million in Aventail series D preferred stock pursuant
to an investment agreement in February 2000. In connection with a

34 INTERNAP | 2007 ANNUAL REPORT

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Financial Review 2007

subsequent round of financing by Aventail, we recognized an initial loss
on our investment of $4.8 million in 2001. On June 12, 2007, SonicWall,
Inc. announced that it entered into an agreement to acquire Aventail for
approximately $25.0 million in cash. The transaction closed on July 11,
2007, and all shares of series D preferred stock were cancelled and the
holders of series D preferred stock did not receive any consideration for
such shares. The write-off is included in non-operating (income) expense
in the accompanying consolidated statement of operations.

Income Taxes. The provision for income taxes was a net benefit
of $3.1 million for the year ended December 31, 2007 and expense of
$0.1 million for the year ended December 31, 2006. For the year ended
December 31, 2007, the tax provision includes a $4.4 million benefit related
to the release of the valuation allowance associated with our U.K. deferred
tax assets. The U.K. benefit is offset by a reserve of $0.9 million and a
U.S. deferred tax liability relating to the VitalStream acquisition.

The reduction in valuation allowance was due to the existence of sufficient
positive evidence as of December 31, 2007 to indicate that our net
operating losses in the U.K. would more likely than not be realized in the
future. The evidence primarily consists of the results of prior performance
in the U.K. and the expectation of future performance based on historical
results. We will continue to assess in the future the recoverability of U.S.
and other deferred tax assets, and whether or not the valuation allowance
should be reduced relative to the U.S. and other deferred tax assets
outside the U.K.

LIQUIDITY AND CAPITAL RESOURCES

Cash Flows for the Years Ended
December 31, 2007, 2006 and 2005

Net Cash from Operating Activities. Net cash provided by operating
activities was $27.6 million for the year ended December 31, 2007. Our
net loss, adjusted for non-cash items, generated cash from operations
of $32.1 million while changes in operating assets and liabilities, excluding
effects of the VitalStream acquisition, represented a use of cash from
operations of $4.5 million. The primary non-cash adjustment was
$26.4 million for depreciation and amortization, which includes the
amortizable intangible assets acquired through the acquisition of
VitalStream on February 20, 2007 and the expansion of our P-NAP and
data center facilities throughout 2007. Non-cash adjustments also
include $8.7 million for stock-based compensation expense, which is
discussed above in the section captioned “Results of Operations.” The
change in working capital includes an increase in accounts receivable
of $15.8 million. The increase in accounts receivable results in quarterly
days sales outstanding at December 31, 2007 increasing to 54 days from
38 days as of December 31, 2006. This increase in accounts receivable
is largely due to revenue growth and also, in part, our days’ sales outstanding
trending up from lower than historical levels at December 31, 2006. We

have also experienced some collection delays on certain larger, high credit
quality customers that tend to pay over longer terms and in conjunction
with the migration of some former VitalStream and other customers to
Internap billing and systems platforms. We expect our quarterly days sales
outstanding to improve over the next several quarters. The change in
working capital also includes a net increase in accounts payable of
$7.9 million due to the growth of our business, primarily attributed to
the acquisition of VitalStream and our data center growth initiative.
A portion of the increase is also caused by the implementation near
year-end of a new telecommunications expense management system
for our direct costs. We do not expect this implementation to have an
impact on our accounts payable balance in the future. We anticipate
continuing to generate cash flows from our results of operations, that
is net income (loss) adjusted for non-cash items and manage changes
in operating assets and liabilities towards a net $0 change over time in
subsequent periods. We also expect to use cash flows from operating
activities to fund a portion of our capital expenditures and other require-
ments, to repay our outstanding debt as it becomes due and to meet
our other commitments and obligations as they become due.

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 December 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
were offset by net sources of cash in accrued liabilities of $0.8 million
and deferred revenue of $1.0 million. The increase in receivables at
December 31, 2005 compared to December 31, 2004 was related to the
6% increase in revenue. The decrease in payables is primarily related
to a general decrease in expenses when compared to last year.

INTERNAP | 2007 ANNUAL REPORT 35

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Financial Review 2007

Net Cash from Investing Activities. Net cash used in investing activities
for the year ended December 31, 2007 was $36.4 million primarily due
to capital expenditures of $30.3 million and net purchases of short-term
investments of $6.1 million. Our capital expenditures were principally
for the expansion of our data center facilities, CDN infrastructure and
upgrading our P-NAP facilities and were funded from both cash from
operations and borrowings from the new credit agreement we entered
into on September 14, 2007. We discuss the credit agreement in greater
detail in the section below captioned “Liquidity.” Our forecast for capital
expenditures in 2008 ranges from $45 – $50 million. However, our credit
agreement, discussed below, limits us to unfunded capital expenditures
of $25.0 million per year. Investing activities for the year ended
December 31, 2007 also includes purchases and sales of auction rate
securities. While we have noted auction rate reset failures in the market
and have experienced our own auction rate reset failures subsequent to
year-end, we do not expect to incur any significant liquidity constraints
in the current auction rate securities market and anticipate that, based
on the nature of the underlying assets, we will be able to recover the
full cost basis of the assets within one year.

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 from Financing Activities. Net cash provided by financing
activities for the year ended December 31, 2007 was $15.2 million.
Cash provided by financing activities was primarily due to proceeds
from note payable of $19.7 million, net of discount, and proceeds from
stock compensation plan activity of $8.6 million, partially offset by the
repayment of prior outstanding debt of $11.3 million and payments on
capital leases of $1.6 million. The proceeds from note payable were a
result of entering into the new credit agreement on September 14, 2007.
As a result of these activities, we had balances of $19.8 million in a note
payable (net of discount) and $1.3 million in capital lease obligations
as of December 31, 2007 with $3.2 million in the note payable and capital
leases scheduled as due within the next 12 months. While we anticipate
funding a large portion of our capital expenditures by drawing down on
our credit facility, we expect to meet most of our cash requirements,
including repayment of debt as it becomes due, through cash from
operations, and as needed, cash on hand and short-term investments.
We may also utilize our revolving line of credit if we consider it economically
favorable to do so.

Net cash provided by financing activities for the year ended December 31,
2006 was $2.0 million. Cash provided by financing 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 payments on capital lease obligations
of $0.5 million. As a result of these activities, we had balances of
$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 financing activities for the year ended December 31, 2005
was $5.5 million. Cash used in financing activity included principal
payments on notes payable of $6.5 million and payments on capital lease
obligations of $0.5 million. These payments were partially offset by
proceeds received from the exercise of stock options of $1.5 million. As a
result of these activities, we had balances of $12.0 million in notes payable
and $0.8 million in capital lease obligations as of December 31, 2005.

Liquidity
We recorded a net loss of $5.6 million of the year ended December 31,
2007 and net income of $3.7 million for the year ended December 31, 2006.
As of December 31, 2007, our accumulated deficit was $862.0 million. Our
net loss for the year ended December 31, 2007 includes $13.0 million
in charges for restructuring, asset impairment, write-off of an investment,
and acquired in-process research and development, none of which we
expect to incur on a regular basis. We cannot guarantee that we will return
to profitability given the competitive and evolving nature of the industry
in which we operate. We may not be able to sustain or increase profitability
on a quarterly basis, and our failure to do so would adversely affect our
business, including our ability to raise additional funds.

We expect to meet our cash requirements in 2008 through a combination
of net cash provided by operating activities, existing cash, cash equivalents
and short-term investments in marketable securities, and borrowings
under our credit agreement, especially for capital expenditures. We expect
to incur these capital expenditures primarily for the expansion of our P-NAP
and data center facilities. We may also utilize our revolving line of credit,
particularly if we consider it economically favorable to do so. 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 sufficient cash flows from the sales of our services and
products, we may require greater or additional financing sooner than
anticipated. We can offer no assurance that we will be able to obtain
additional financing on commercially favorable terms, or at all, and

36 INTERNAP | 2007 ANNUAL REPORT

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Financial Review 2007

provisions in our existing credit agreement limit our ability to incur additional
indebtedness. We believe we have sufficient cash to operate our business
for the foreseeable future.

Short-Term Investments. Short-term investments primarily consist of
high credit quality corporate debt securities, auction rate securities whose
underlying assets are state-issued student and educational loans which
are substantially backed by the federal government, commercial paper,
and U.S. Government Agency debt securities. At December 31, 2007, our
balance in short-term investments was $19.6 million, of which $7.2 million
were auction rate securities carrying AAA/Aaa ratings as of December 31,
2007. Auction rate securities are variable rate bonds tied to short-term
interest rates with maturities on the face of the securities in excess of
90 days and have interest rate resets through a modified Dutch auction,
at predetermined short-term intervals, usually every 7, 28 or 35 days.
They generally trade at par and are callable at par on any interest payment
date at the option of the issuer. Interest received during a given period
is based upon the interest rate determined through the auction process.
Although these securities are issued and rated as long-term bonds, they
are priced and traded as short-term instruments because of the liquidity
provided through the interest rate reset. We have also noted auction rate
reset failures in the market and have experienced our own auction
rate reset failures subsequent to year-end, however, we do not expect
to incur any significant liquidity constraints and anticipate that, based
on the nature of the underlying assets, we will be able to recover the full
cost basis of the assets within one year. We expect to hold the auction
rate securities until liquidity improves or the borrower calls the underlying
securities. All short-term investments either (1) have original maturities
greater than 90 days but less than one year or (2) are auction rate securities
expected to be liquidated within one year, are classified as available for
sale, and reported at fair value.

Credit Agreement. On September 14, 2007, we entered into a $35.0 million
credit agreement, or the Credit Agreement, with Bank of America, N.A.,
as administrative agent, and lenders who may become a party to the
Credit Agreement from time to time. VitalStream Holdings, Inc., VitalStream,
Inc., PlayStream, Inc., and VitalStream Advertising Services, Inc., four
of our subsidiaries, are guarantors of the Credit Agreement.

The Credit Agreement replaced the prior credit agreement, a $5.0 million
revolving credit facility and a $17.5 million term loan, which was evidenced
by a Loan and Security Agreement between the Company and Silicon
Valley Bank that was last amended on December 27, 2005. We paid off
and terminated this prior credit agreement concurrently with the execution
of the Credit Agreement.

Our obligations under the Credit Agreement are pledged, pursuant to a
pledge and security agreement and an intellectual property security
agreement by a security interest granted in substantially all of our assets
including the capital stock of our domestic subsidiaries and 65% of the
capital stock of our foreign subsidiaries.

The Credit Agreement provides for a four-year revolving credit facility,
or the Revolving Credit Facility, in the aggregate amount of up to
$5.0 million which includes a $5.0 million sub-limit for letters of credit.
With the prior approval of the administrative agent, we may increase
the total commitments by up to $15.0 million for a total commitment
under the Revolving Credit Facility of $20.0 million. The Revolving Credit
Facility is available to finance working capital, capital expenditures and
other general corporate purposes. As December 31, 2007, no amounts
were outstanding on the Revolving Credit Facility.

The Credit Agreement also provides for a four-year term loan, or the
Term Loan, in the amount of $30.0 million. We borrowed $20.0 million
concurrently with the closing and used a portion of the proceeds from
the Term Loan to pay off our prior credit facility. We intend to use the
remaining proceeds to fund capital expenditures related to the expansion
of our data center facilities.

The interest rate on the Revolving Credit Facility and Term Loan is a tiered
LIBOR-based rate that depends on our 12-month trailing EBITDA. As of
December 31, 2007, the interest rate was 7.075%.

We will only pay interest on the Term Loan during the first 12 months of
its four-year term. Commencing on the last day of the first calendar quarter
after the first anniversary of the closing, the outstanding amount of the
Term Loan will amortize on a straight-line schedule with the payment of
1/16 of the original principal amount of the Term Loan due quarterly. We
will pay all unpaid amounts at maturity, which is September 14, 2011.

The Credit Agreement includes customary representations, warranties,
negative and affirmative covenants, including certain financial covenants
relating to net funded debt to EBITDA ratio and fixed charge coverage ratio,
as well as customary events of default and certain default provisions that
could result in acceleration of the Credit Agreement. As of December 31,
2007, we were in compliance with the financial and other covenants.

INTERNAP | 2007 ANNUAL REPORT 37

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Financial Review 2007

The net proceeds received from the Term Loan were reduced by $0.3 million
for fees paid to Bank of America and its agents. We treated these fees
as a debt discount and will amortize the fees to interest expense using
the interest method over the term of the loan. We recorded less than
$0.1 million of related amortization during the year ended December 31,
2007. As of December 31, 2007, the balance on the Term Loan, net of
the discount, was $19.8 million. We incurred other costs of less than
$0.1 million in connection with entering into the Credit Agreement, which
were recorded as debt issue costs and will amortize over the term of
the Credit Agreement.

As a result of the transactions discussed above, we recorded a loss on
extinguishment of debt of less than $0.1 million during the year ended
December 31, 2007. The loss on extinguishment of debt is included in
Other, net in the non-operating (income) expense section of the consolidated
statements of operations.

Also during the year ended December 31, 2007, we paid off the term loans
and line of credit issued pursuant to the loan and security agreement
assumed in the VitalStream acquisition.

Capital Leases. Our future minimum lease payments on remaining capital
lease obligations at December 31, 2007 totaled $1.4 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 modifications to the terms of those agreements.
Network commitments primarily represent purchase commitments made
to our largest bandwidth vendors and contractual payments to license
data center space used for resale to customers. Our ability to improve
cash used in operations in the future would be negatively impacted if
we do not grow our business at a rate that would allow us to offset the
service commitments with corresponding revenue growth.

The following table summarizes our credit obligations and future contractual commitments as of December 31, 2007 (in thousands):

Note payable (1)
Capital lease obligations
Operating lease commitments
Service commitments

Payments Due by Period

Total

$ 23,815
1,392
220,894
22,014

$268,115

Less Than
1 Year

$ 3,980
922
28,211
12,167

$45,280

1- 3
Years

$11,980
470
50,689
9,847

$72,986

3-5
Years

More Than
5 Years

$ 7,855
–
53,208
–

$61,063

$ –
–
88,786
–

$88,786

(1) As noted in the section captioned “Credit Agreement” under this Item 7, the interest rate on the Term Loan is a tiered LIBOR-based rate that depends on our 12-month trailing EBITDA

as defined in the Credit Agreement. As of December 31, 2007, the interest rate was 7.075%. The projected interest included in the debt payments above incorporates this rate.

Common and Preferred Stock. Our Certificate of Incorporation includes
designation for 3.5 million shares of preferred stock, which includes
0.5 million shares of series B preferred stock. As of December 31, 2007,
no shares of preferred stock were issued or outstanding.

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.

On July 10, 2006, we implemented a one-for-ten reverse stock split and
amended our Certificate 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 out-
standing, earnings per share and warrant and stock option data) have been
retroactively adjusted for all periods presented to reflect 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:

• 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 a ten-year term.

38 INTERNAP | 2007 ANNUAL REPORT

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Financial Review 2007

Employees of the Company 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.

As discussed in note 15 to the consolidated financial 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, 2007.

QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK

Short-Term Investments in Marketable Securities. Short-term
investments primarily consist of high credit quality corporate debt securities,
auction rate securities whose underlying assets are state-issued student and
educational loans which are substantially backed by the federal government,
commercial paper, and U.S. Government Agency debt securities. All of our
investments have original maturities greater than 90 days but less than one
year, except for investments in auction rate securities, further discussed
below. All short-term investments are classified as available-for-sale and
reported at fair value. Due to the short-term nature of our investments in
marketable securities, we do not believe there is any material exposure to
market risk changes in interest rates. We estimate that a change in the
effective yield of 100 basis points would change our interest income by less
than $0.2 million per year.

Auction rate securities are variable rate bonds tied to short-term interest
rates with maturities on the face of the securities in excess of 90 days
and have interest rate resets through a modified Dutch auction, at pre-
determined short-term intervals, usually every 7, 28, or 35 days. Auction
rate securities generally trade at par and are callable at par on any interest
payment date at the option of the issuer. Interest received during a given
period is based upon the interest rate determined through the auction
process. Although these securities are issued and rated as long-term bonds,
they are priced and traded as short-term instruments because of the
liquidity provided through the interest rate resets. Uncertainties in the
credit markets may affect the liquidity of our holdings in auction rate
securities. We did not experience any unsuccessful auction rate resets
during the year ended or the initial rate resets immediately following
December 31, 2007; however, we have experienced failures on each of
our subsequent auction rate resets. Nevertheless, we continue to receive
interest every 28-35 days. While our investments are of high credit quality,
at this time we are uncertain as to whether or when the liquidity issues
relating to these investments will worsen or improve. We do not expect to
incur any significant liquidity constraints and anticipate that, based on

the nature of the underlying assets, we will be able to recover the full cost
basis of the assets within one year. Therefore, we do not believe that adjust-
ing the fair value of our portfolio of auction rate securities is necessary at this
time. We expect to hold the auction rate securities until liquidity improves
or the borrower calls the underlying securities. In the meantime, we believe
we have sufficient liquidity through our cash balances, other short-term
investments and available credit. As of December 31, 2007, we have a
total of $7.2 million invested in auction rate securities.

Other Investments. We have invested $4.1 million in Internap Japan, our
joint venture with NTT-ME Corporation and NTT Holdings. We account for
this investment using the equity-method, and to date we have recognized
$3.3 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 offered by Internap Japan has not
been proven and may never materialize.

Interest Rate Risk. Our objective in managing interest rate risk is to
maintain favorable long-term fixed rate or a balance of fixed and variable
rate debt that will lower our overall borrowing costs within reasonable
risk parameters. Currently, our strategy for managing interest rate risk
does not include the use of derivative securities. We estimate that a
change in the interest rate of 100 basis points would change our interest
expense and payments by less than $0.2 million per year. The table
below presents principal cash flows by expected maturity dates for our
debt obligations that extend beyond one year as of December 31, 2007
(dollars in thousands):

2008

2009

2010

2011

Fair
Value

Long-term debt:
Term loan

Interest rate

$2,500
7.075%

$5,000
7.075%

$7,500

$20,000

7.075%

Foreign Currency Risk. Substantially all of our revenue is currently in
U.S. dollars and from customers primarily in the U.S. We do not believe,
therefore, that we currently have any significant direct foreign currency
exchange rate risk.

CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer
and Principal Accounting Officer, evaluated the effectiveness of our
disclosure controls and procedures as defined in Rule 13a-15(e) under
the Securities Exchange Act of 1934, as amended (the “Exchange Act”)
as of December 31, 2007. Our disclosure controls and procedures are
designed to ensure that information we are required to disclose in the
reports we file or submit under the Exchange Act is accumulated and

INTERNAP | 2007 ANNUAL REPORT 39

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Financial Review 2007

communicated to our management, including our Chief Executive Officer
and Principal Accounting Officer, as appropriate, to allow timely decisions
regarding required disclosures, and is recorded, processed, summarized,
and reported within the time periods specified in the SEC’s rules and forms.
Based upon the evaluation described above our Chief Executive Officer
and Principal Accounting Officer concluded that, as of December 31, 2007,
our disclosure controls and procedures were not effective because of the
material weakness described below in Management’s Report on Internal
Control Over Financial Reporting.

Background
During its review of sales credit activity subsequent to year end,
management identified the activity as an area for further review and
investigation. Management concluded that an investigation was appropriate
to identify the underlying cause and to obtain completeness, accuracy,
valuation, and disclosure of sales adjustments. This investigation caused
the Company to file its annual report on Form 10-K late.

Management’s Report on Internal Control
Over Financial Reporting
Our management is responsible for establishing and maintaining adequate
internal control over financial reporting, as such term is defined in
Exchange Act Rule 13a-15(f).

We assessed the effectiveness of our internal control over financial
reporting as of December 31, 2007. In making this assessment, we used
the criteria set forth by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO) in Internal Control – Integrated Framework.

A material weakness is a deficiency, or a combination of deficiencies, in
internal control over financial reporting, such that there is a reasonable
possibility that a material misstatement of the company’s annual or interim
financial statements will not be prevented or detected on a timely basis.

Management identified the following material weakness in our internal
control over financial reporting as of December 31, 2007:

We did not maintain effective controls over the completeness, accuracy,
valuation, and disclosure of sales adjustments. Specifically, we did not
maintain effective controls, including controls over the analysis of requests
for sales credits and billing adjustments, to provide timely information
for management to assess the completeness, accuracy, valuation, and
disclosure of sales adjustments. This control deficiency resulted in the
misstatement of our revenue, net accounts receivable and related financial
disclosures, and in the revision of the Company’s consolidated
financial statements for the quarter ended September 30, 2007 and in
an adjustment to the consolidated financial statements for the quarter

ended December 31, 2007. Additionally, this control deficiency could
result in misstatements of the aforementioned accounts and disclosures
that would result in a material misstatement of the consolidated financial
statements that would not be prevented or detected. Accordingly, our
management has determined that this control deficiency constitutes a
material weakness.

As a result of the material weakness described above, management
concluded that our internal control over financial reporting was not
effective as of December 31, 2007 based on the criteria established in
Internal Control – Integrated Framework issued by the COSO.

The effectiveness of our internal control over financial reporting as of
December 31, 2007 has been audited by PricewaterhouseCoopers LLP,
an independent registered public accounting firm, as stated in their report,
which is included herein.

Plan for Remediation of the Material Weakness
To remediate the material weakness described above and to enhance
our internal control over financial reporting, management implemented
plans in the first quarter of 2008, or will supplement plans during 2008,
to its existing controls for the analysis of requests for sales adjustments,
which may include but are not limited to, the following additional
processes and controls:

• A single, common logging system for customers to record all disputes,

disconnects and requests for credits;

• A weekly review of a customer request log with appropriate designated
management and approval pursuant to the schedule of authorization;

• A more robust, proactive tracking of customer usage patterns and

overall customer satisfaction; and

• Perform a review by the appropriate designated finance management
of the accounting estimates developed from the relevant, sufficient,
and reliable data collected above.

Notwithstanding the material weakness, management believes that the
financial statements included in this report fairly present in all material
respects our financial position, results of operations and cash flows for
the periods presented.

Changes in Internal Control Over Financial Reporting
No change in our internal control over financial reporting (as defined in
Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during
the quarter ended December 31, 2007 that has materially affected,
or is reasonably likely to materially affect, our internal control over
financial reporting.

40 INTERNAP | 2007 ANNUAL REPORT

CONSOLIDATED STATEMENTS OF OPERATIONS
Financial Review 2007

(In thousands, except per share amounts)

Revenues:

Internet protocol (IP) services

Data center services
Content delivery network (CDN) services
Other

Total revenues
Operating costs and expenses:
Direct costs of network, sales and services, exclusive of depreciation and amortization,

shown below:
IP services

Data center services
CDN services
Other
Direct costs of amortization of acquired technologies
Direct costs of customer support
Product development
Sales and marketing
General and administrative
Depreciation and amortization
Gain on disposals of property and equipment
Restructuring and asset impairment
Acquired in-process research and development
Other
Amortization of deferred stock compensation

Total operating costs and expenses

(Loss) income from operations

Non-operating (income) expense:

Interest income
Interest expense

Write-off of investment
Other, net
Total non-operating (income) expense
(Loss) income before income taxes and equity in earnings of equity-method investment

(Benefit) provision for income taxes

Equity in earnings of equity-method investment, net of taxes

Net (loss) income

Net (loss) income 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,

2007

2006

2005

$119,848
83,058
17,718
13,466

234,090

$109,748
56,152
–
15,475

181,375

$105,032
36,996
–
11,689

153,717

43,681
59,439
6,584
8,690
4,165
16,547
6,564
31,533
32,512
22,242
(5)
11,349
450
50
–

39,744
46,474
–
11,120
516
11,566
4,475
27,173
22,104
15,856
(113)
323
–
–
–

38,377
35,244
–
8,337
577
10,670
4,864
25,864
20,096
14,737
(19)
44
–
–
60

243,801

(9,711)

179,238

2,137

158,851

(5,134)

(3,228)
1,111
1,178
2
(937)
(8,774)
(3,080)
(139)

(2,305)
883
–
(129)
(1,551)
3,688
145
(114)

(1,284)
1,373
–
(176)
(87)
(5,047)
–
(83)

$ (5,555)

$ 3,657

$ (4,964)

$ (0.12)

$ 0.11

$ (0.15)

$ (0.12)

$ 0.10

$ (0.15)

46,942

34,748

35,739

33,939

INTERNAP | 2007 ANNUAL REPORT 41

CONSOLIDATED BALANCE SHEETS
Financial Review 2007

(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 $5,470 and $888, respectively

Inventory

Prepaid expenses and other assets
Deferred tax asset, current portion

Total current assets

Property and equipment, net
Investments
Intangible assets, net
Goodwill
Restricted cash
Deferred tax asset, non-current
Deposits and other assets

Total assets

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Notes payable, current portion
Accounts payable
Accrued liabilities
Deferred revenue, current portion
Capital lease obligations, current portion
Restructuring liability, current portion
Other current liabilities

Total current liabilities

Notes payable, less current portion
Deferred revenue, less current portion
Capital lease obligations, less current portion
Restructuring liability, less current portion
Deferred rent
Deferred tax liability
Other long-term liabilities

Total liabilities

Commitments and contingencies

Stockholders’ equity:
Preferred stock, $0.001 par value, 200,000 shares authorized, no shares issued or outstanding
Common stock, $0.001 par value, 60,000 shares authorized, 49,759 and 35,873 shares issued

and outstanding, respectively

Additional paid-in capital
Accumulated deficit
Accumulated items of other comprehensive income

Total stockholders’ equity

Total liabilities and stockholders’ equity

42 INTERNAP | 2007 ANNUAL REPORT

December 31,

2007

2006

52,030
19,569
36,429
304
8,464
479

117,275

65,491
1,138
43,008
190,677
4,120
3,014
2,287

$ 45,591
13,291
20,282
474
3,818
–

83,456

47,493
2,135
1,785
36,314
–
–
2,519

$ 427,010

$ 173,702

2,413
19,624
10,159
4,807
805
2,396
108

40,312

17,354
2,275
452
7,697
11,011
398
878

80,377

$ 4,375
8,776
8,689
3,260
347
1,400
84

26,931

3,281
1,080
83
3,384
11,432
–
986

47,177

–

50
1,208,191
(862,010)
402

346,633

36
982,624
(856,455)
320

126,525

$ 427,010

$ 173,702

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
AND COMPREHENSIVE (LOSS) INCOME
Financial Review 2007

(In thousands)

Balance, December 31, 2004

Net loss

Change in unrealized gains and losses on investments, net of taxes

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, net of taxes

Foreign currency translation adjustment

Total comprehensive income

Reclassification 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

Net loss

Change in unrealized gains and losses on investments, net of taxes

Foreign currency translation adjustment

Total comprehensive loss

Stock issued in connection with VitalStream acquisition

Stock-based compensation

Stock compensation plans activity

Balance, December 31, 2007

For the Three Years Ended December 31, 2007

Common Stock

33,815

Par
Value

$34

Additional
Paid-In
Capital

Treasury
Stock

Deferred
Stock
Compensation

Accumulated
Deficit

Accumulated
Items of
Comprehensive
Income (Loss)

Total
Stockholders’
Equity

$ 968,255

$ –

$(855,148)

$ 597

$113,738

(4,964)

–

(4,964)

–

353

34,168

–

578

576

551

35,873

–

12,206

420

1,260

–

(420)

(860,112)

–

480

–

1,486

970,221

–

(480)

–

(420)

–

420

5,985

3,030

3,808

982,624

–

208,281

8,705

8,581

(395)

395

–

3,657

–

(856,455)

(5,555)

–

49,759

$50

$1,208,191

(118)

(474)

–

235

–

320

–

(25)

107

–

(118)

(474)

(5,556)

–

1,486

109,728

3,657

235

3,972

–

5,591

3,426

3,808

126,525

(5,555)

(25)

107

(5,473)

208,293

8,706

8,582

See note 2 for information on effect of 10-for-1 reverse stock split in July 2006.

The accompanying notes are an integral part of these consolidated financial statements.

$(862,010)

$ 402

$346,633

INTERNAP | 2007 ANNUAL REPORT 43

CONSOLIDATED STATEMENTS OF CASH FLOWS
Financial Review 2007

(In thousands)

Cash flows from operating activities:
Net (loss) income
Adjustments to reconcile net (loss) income to net cash provided by operating activities:

Year Ended December 31,
2006

2007

2005

$ (5,555)

$ 3,657

$ (4,964)

Depreciation and amortization
Gain on disposal of property and equipment, net
Asset impairment
Acquired in-process research and development
Stock-based compensation expense
Write-off of investment
Equity in earnings from equity-method investment
Provision for doubtful accounts
Non-cash changes in deferred rent
Lease incentives
Deferred income taxes
Other, net

Changes in operating assets and liabilities, excluding effects of acquisition:

Accounts receivable

Inventory, prepaid expenses, deposits and other assets

Accounts payable
Accrued and other liabilities
Deferred revenue
Accrued restructuring liability

Net cash flows provided by operating activities

Cash flows from investing activities:
Purchases of short-term investments in marketable securities
Maturities of short-term investments in marketable securities
Purchases of property and equipment
Proceeds from disposal of property and equipment
Cash received from acquisition, net of costs incurred for the transaction
Change in restricted cash, excluding effects of acquisition

Net cash flows used in investing activities

Cash flows from financing activities:
Proceeds from notes payable, net of discount
Principal payments on notes payable
Payments on capital lease obligations
Debt issuance costs
Proceeds from exercise of stock options and employee stock purchase plan
Proceeds from exercise of warrants
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:
Common stock issued and stock options assumed for acquisition of VitalStream
Cash paid for interest, net of amounts capitalized
Cash paid for income taxes
Non-cash acquisition of property and equipment
Capitalized stock-based compensation

The accompanying notes are an integral part of these consolidated financial statements.

44 INTERNAP | 2007 ANNUAL REPORT

26,407
(5)
2,454
450
8,681
1,178
(139)
2,261
(421)
–
(3,095)
(84)

(15,825)
(2,182)
7,920
(2,466)
2,704
5,309
27,592

(38,508)
32,395
(30,271)
5
3,203
(3,217)
(36,393)

19,742
(11,318)
(1,617)
(65)
8,582
–
(84)
15,240
6,439
45,591
$ 52,030

$208,293
1,152
103
148
25

16,372
(113)
319
–
5,942
–
(114)
548
2,247
–
–
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)
–
3,031
3,808
31
1,957
21,157
24,434
$ 45,591

$ –
793
149
162
44

15,314
(19)
–
–
75
–
(83)
1,431
2,690
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
–

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Financial Review 2007

DESCRIPTION OF THE COMPANY AND
NATURE OF OPERATIONS

Internap Network Services Corporation (“Internap,” “we,” “us,” “our,” or
the “Company”) delivers high performance and reliable Internet solutions
through a suite of network optimization and delivery products and services.
These solutions, combined with progressive and proactive technical support,
enable companies to confidently migrate business-critical applications,
including audio and video streaming and monetization services, to the
Internet. Our suite of products and services support a broad range of Internet
applications. We serve both domestic and international customers in the
financial services, healthcare, technology, retail, travel, media/entertainment
and other markets. Our product and service offerings are complemented
by Internet Protocol, or IP, access solutions such as data center services,
content delivery networks, or CDN, and managed security. We deliver
services through our 54 service points across North America, Europe and
the Asia-Pacific region. Our Private Network Access Points, or P-NAPs,
feature multiple direct high-speed connections to major Internet networks
including AT&T Inc., Sprint Nextel Corporation, Verizon Communications Inc.,
Savvis Inc., Global Crossing Limited, and Level 3 Communications, Inc. We
operate and manage the Company in three business segments: IP services,
data center services and CDN services. Prior to 2007 we operated and
managed the Company as a single business segment.

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
adequate financing, competition within the industry and technology trends.

Although we have been in existence since 1996, we have incurred
significant operational restructurings in recent years, which have included
substantial changes in our senior management team, 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. For the year ended December 31, 2007 we
recognized a year to date net loss $5.6 million. At December 31, 2007, our
accumulated deficit was $862.0 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 financial statements and accompanying notes are prepared
in accordance with accounting principles generally accepted in the United
States of America. The consolidated financial statements include the
accounts of Internap and all majority owned subsidiaries. Significant
inter-company transactions have been eliminated in consolidation.

Estimates and Assumptions

The preparation of these financial 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, accruals, 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 financial institutions and may at times
exceed federally insured limits. We believe that the risk of loss is minimal.
To date, we have not experienced any losses related to cash and
cash equivalents.

Restricted Cash

Restricted cash represents time deposits used to secure letters of credit
on certain of our real estate leases and a capital lease for equipment.
The letters of credit for the real estate leases were secured by our former
credit agreement and are in the process of being secured under our
new credit agreement. The letter of credit securing the capital lease for
equipment was assumed in the VitalStream acquisition.

As discussed in note 18, we revised our quarterly statement of operations
for the quarter ended September 30, 2007 to appropriately record
(1) $0.5 million for sales adjustments, which reduce net accounts
receivable and revenue, and (2) $0.1 million for accretion of interest
income that we initially included as unrealized gain in accumulated
other comprehensive income within stockholders’ equity.

Investments in Marketable Securities

We account for marketable securities in accordance with Statement of
Financial Accounting Standards, or SFAS, No. 115, “Accounting for Certain
Investments in Debt and Equity Securities.” Management determines
the appropriate classification of marketable securities at the time of

INTERNAP | 2007 ANNUAL REPORT 45

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Financial Review 2007

purchase. At December 31, 2007 and 2006, all marketable securities
are classified as available-for-sale. Available-for-sale securities are
carried at fair value, with the unrealized gains and losses reported in
other comprehensive income. Our marketable securities are reviewed
each reporting period for declines in value that are considered to be
other-than-temporary and, if appropriate, written down to their estimated
fair value. Any realized gains or losses or declines in value judged to
be other-than-temporary on available-for-sale securities are included in
other non-operating (income) expense in the consolidated statements of
operations. The cost of securities sold is based on the specific identification
method. Interest on securities classified as available-for-sale is 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 incurred a charge during the three months ended June 30, 2007,
totaling $1.2 million, representing the write-off of the remaining carrying
value of our investment in series D preferred stock of Aventail Corporation,
or Aventail. See note 6 for further discussion of this investment and the
recorded loss. As of December 31, 2006, the carrying value of the Aventail
investment of $1.2 million was recorded in non-current investments in
the accompanying consolidated balance sheet.

We account for investments that provide us with the ability to exercise
significant influence, but not control, over an investee using the equity
method of accounting. Significant influence, but not control, is generally
deemed to exist if we have an ownership interest in the voting stock of
the investee of between 20% and 50%, although other factors, such as
minority interest protections, are considered in determining whether the
equity method of accounting is appropriate. As of December 31, 2007,
Internap Japan Co. Ltd., or Internap Japan, our joint venture with NTT-ME
Corporation and Nippon Telegraph and Telephone Corporation, or NTT
Holdings, qualifies for equity method accounting. We record our proportional
share of the income and losses of Internap Japan one month in arrears
on the consolidated balance sheets as a component of non-current
investments and our share of Internap Japan’s income and losses, net
of taxes, as separate caption in our consolidated statement of operations.

Fair Value of Financial Instruments

Our short-term financial instruments, including cash and cash equivalents,
accounts receivable, accounts payable, note payable, and capital lease
obligations are carried at cost. Our investments in marketable securities
are recorded at fair value. Our marketable securities are designated as
available for sale with changes in fair value reflected in other comprehensive
income. The carrying value of our long-term financial instruments, including
note payable and capital lease obligations, approximate fair value as the
interest rates approximate current market rates of similar debt obligations.

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 and cash equivalents in money market funds and maintain them
with financial institutions with high credit ratings. We also invest in high
credit quality corporate debt securities, auction rate securities whose
underlying assets are state-issued student and educational loans which
are substantially backed by the federal government, commercial paper,
and U.S. Government Agency debt securities pursuant to a formal investment
policy. As of December 31, 2007, we have a total of $7.2 million invested
in auction rate securities. Uncertainties in the credit markets may affect
the liquidity of our holdings in auction rate securities. We did not experience
any unsuccessful auction rate resets during the year ended or on the
initial rate resets immediately following December 31, 2007, however
we have experienced failures on each of our subsequent auction rate
resets. Nevertheless, we continue to receive interest every 28-35 days.
While our investments are of high credit quality, at this time we are
uncertain as to whether or when the liquidity issues relating to these
investments will worsen or improve. We do not believe that it is necessary
at this time to adjust the fair value of our portfolio of auction rate securities.
We also perform periodic evaluations of the relative credit ratings of the
financial institutions with whom we invest as part of our cash management
process. 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 first-in,
first-out method. Cost includes materials related to the assembly of our
Flow Control Platform, or FCP solutions.

46 INTERNAP | 2007 ANNUAL REPORT

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Financial Review 2007

Property and Equipment

Property and equipment are carried at original acquisition cost less
accumulated depreciation and amortization. Depreciation and amortization
are calculated on a straight-line basis over the lesser of the estimated
useful lives of the assets or the lease term. Estimated useful lives used
for network equipment are generally three years; furniture, equipment
and software are three to seven years; and leasehold improvements are
seven years or over the lease term, depending on the nature of the
improvement, but in no event beyond the expected lease term. The duration
of lease obligations and commitments range from 24 months for certain
networking equipment 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 leasehold
improvements in accordance with SFAS No. 13, “Accounting for Leases”
and related literature. Rent expense for operating leases is recorded in
accordance with Financial Accounting Standards Board, or FASB, Technical
Bulletin, or FTB, No. 88-1, “Issues Relating to Accounting for Leases.”
This FTB requires lease agreements that include periods of free rent or
other incentives, specific escalating lease payments, or both, to be recorded
on a straight-line or other systematic basis over the initial lease term
and those renewal periods that are reasonably assured. The difference
between rent expense and rent paid is recorded as deferred rent in
non-current liabilities in the consolidated balance sheets.

Costs of Computer Software Development

In accordance with the American Institute of Certified Public Accountants’
Statement of Position 98-1, “Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use,” we capitalize certain direct costs
incurred developing internal use software. We capitalized $1.6 million
and $0.9 million in internal software development costs for the years
ended December 31, 2007 and 2006, respectively. We did not capitalize
any costs during the year ended December 31, 2005. During the year ended
December 31, 2007, we impaired $1.1 million of software development
costs capitalized prior to December 31, 2005 related to the implementation
of a billing and order entry system initiated during 2004. Subsequent to
our acquisition of VitalStream, we determined that we would utilize our
legacy billing system and abandon the former project because (1) the devel-
oper of our financial software purchased the developer of our legacy billing
system, and (2) the legacy billing system would be more flexible in
integrating the VitalStream business. During the year ended December 31,

2006, we impaired $0.3 million of software development costs capitalized
prior to December 31, 2005 related to the implementation of our financial
system software also initiated during 2004. Amortization expense on
internally developed software commences when the software project is
ready for its intended use.

As of December 31, 2007 and 2006, the balance of unamortized software
costs was $2.7 million and $2.5 million, respectively, and for the year
ended December 31, 2007, amortization expense was $0.2 million. The
software was not ready for its intended use and had not been placed in
service as of December 31, 2006; therefore, no amortization expense
was recorded for the years ended December 31, 2006 or 2005.

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, 2007 or 2006. As of December 31, 2007 and 2006, the
balance of unamortized software costs was $0.1 million and $0.2 million,
respectively. Amortization expense was $0.2 million, $0.2 million,
and $0.4 million for the years ended December 31, 2007, 2006, and
2005, respectively.

Goodwill and Other Intangible Assets

In accordance with SFAS No. 142 “Goodwill and Other Intangible Assets,”
we review our goodwill for impairment annually, or more frequently, if facts
and circumstances warrant a review. The provisions of SFAS No. 142
require that a two-step test be performed to assess goodwill for impairment.
First, the fair value of each reporting unit is compared to its carrying value.
If the fair value exceeds the carrying value, goodwill is not impaired
and no further testing is performed. The second step is performed if
the carrying value exceeds the fair value. The implied fair value of the
reporting unit’s goodwill must be determined and 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 completed our annual goodwill impairment test as
of August 1, 2007 and determined that the carrying amount of goodwill
was not impaired.

Other acquired intangible assets, including developed technologies and
patents, have finite lives and we have recorded these assets at cost less
accumulated amortization. Amortization is calculated on a straight-line
basis over the estimated economic useful life of the assets, which are
three to seven years for developed technologies and fifteen years for patents.

INTERNAP | 2007 ANNUAL REPORT 47

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Financial Review 2007

Valuation of Long-Lived Assets

Accrued Liabilities

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 flows from
such asset is separately identifiable and is estimated to be less than its
carrying value. In that event, a loss is recognized based on the amount
by which the carrying value exceeds the fair value of the long-lived asset.
Fair value is determined primarily using the anticipated cash flows
discounted at a rate commensurate with the risk involved. Losses on
long-lived assets to be disposed of would be determined in a similar
manner, except that fair values would be reduced by the cost of disposal.
Losses due to impairment of long-lived assets are charged to operations
during the period in which the impairment is identified.

Similar to accruals for disputed telecommunications costs above, it is
necessary for us to estimate other significant costs such as utilities and
sales, use, telecommunications, and other taxes. These estimates are
often necessary either because invoices for 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
modifies 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 circumstances that could materially and adversely
affect our results of operations and cash flows.

Accruals for Disputed Telecommunication Costs

Restructuring Liability

In delivering our services, we rely on a number of Internet network,
telecommunication and other vendors. We work directly with these
vendors to provision services such as establishing, modifying or discontinuing
services for our customers. Because of the volume of activity, billing
disputes inevitably arise. These disputes typically stem from disagreements
concerning the starting and ending dates of service, quoted rates, usage,
and various other factors. For potential billing errors made in the vendor’s
favor, for example a duplicate billing, we initiate a formal dispute with
the vendor and record the related cost and liability on a range of 5% to
100% of the disputed amount, depending on our assessment of the likely
outcome of the dispute. Conversely, for billing errors in our favor, such as
the vendor’s failure to invoice us for new service, we record an estimate
for the 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 manage-
ment and modified in light of new information or developments, if any.
Conversely, any resolved disputes that will result in a credit over the disputed
amounts are recognized in the appropriate month when the resolution
has been determined. Because estimates regarding disputed costs include
assessments of uncertain outcomes, such estimates are inherently
vulnerable to changes due to unforeseen circumstances that could
materially and adversely affect our consolidated financial condition,
results of operations and cash flows.

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 assumptions regarding the timing
and costs of future events and activities that represent management’s
best expectations based on known facts and circumstances at the time
of estimation. Management periodically reviews its restructuring estimates
and assumptions relative to new information, if any, of which it becomes
aware. Should circumstances warrant, management will adjust its
previous estimates to reflect what it then believes to be a more accurate
representation of expected future costs. Because management’s estimates
and assumptions regarding restructuring costs include probabilities of
future events, such estimates are inherently vulnerable to changes due
to unforeseen circumstances, changes in market conditions, regulatory
changes, changes in existing business practices, and other circumstances
that could materially and adversely affect our results of operations.

Taxes

We account for income taxes under the liability method. Deferred tax
assets and liabilities are determined based on differences between financial
reporting and tax bases of assets and liabilities, and are measured using
the enacted tax rates and laws that will be in effect when the differences
are expected to reverse. We provide a valuation allowance to reduce our
deferred tax assets to their estimated realizable value.

48 INTERNAP | 2007 ANNUAL REPORT

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Financial Review 2007

In June 2006, the FASB issued FASB Interpretation No. 48, “Accounting
for Uncertainty in Income Taxes – an interpretation of FASB Statement
No. 109,” or FIN 48. FIN 48 clarifies the accounting for uncertainty in
income taxes recognized under SFAS No.109, “Accounting for Income
Taxes.” FIN 48 prescribes a recognition threshold and measurement
attribute for financial statement recognition and measurement of a tax
position taken or expected to be taken in a tax return and also provides
guidance on various related matters such as derecognition, interest and
penalties, and disclosure. We adopted FIN 48 on January 1, 2007. As of
January 1, 2007, no material tax benefit existed for uncertain tax positions.
During 2007, as discussed in Note 12, we recognized a FIN 48 liability
of $0.9 million that was netted on the balance sheet with U.K. deferred
tax assets.

We classify interest and penalties arising from the underpayment of income
taxes in the statement of operations under general and administrative
expenses. As of December 31, 2007, we have no accrued interest or
penalties related to uncertain tax positions, as a result of substantial
U.K. net operating loss carryforwards.

We account for telecommunication, sales and other similar taxes on a
net basis in general and administrative expense.

Stock-Based Compensation

Effective January 1, 2006, we adopted SFAS No. 123 (revised 2004),
“Share-Based Payment,” or SFAS No. 123R, and related interpretations.
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 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 purchase plans
for any periods prior to January 1, 2006.

We elected to adopt SFAS No. 123R using the modified prospective
application method. Under this method, compensation cost recognized
during the period includes: ( 1) compensation cost for all share-based
payments granted prior to, but not yet vested as of January 1, 2006,
based on the grant date fair value estimated in accordance with the
original provisions of SFAS No. 123 amortized over the awards’ vesting
period, and ( 2) compensation cost for all share-based payments granted
subsequent to January 1, 2006, based on the grant-date fair value estimated
in accordance with the provisions of SFAS No. 123R amortized on a
straight-line basis over the awards’ vesting period. The fair value of stock
options is estimated at the date of grant using the Black-Scholes option
pricing model with weighted average assumptions for the activity under
our stock plans. Option pricing model input assumptions such as expected
term, expected volatility, and risk-free interest rate, impact the fair value
estimate. Further, the forfeiture rate impacts the amount of aggregate
compensation. These assumptions are subjective and generally require
significant analysis and judgment to develop.

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 “short-cut” method
to establish the beginning balance of the additional paid-in capital, or 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 flows of the tax effects of employee stock-based
compensation awards that are outstanding upon adoption of SFAS
No. 123R. In 2006, we adopted the alternative transition method provided
in the FASB Staff Position for calculating the tax effects of stock-based
compensation pursuant to SFAS No. 123R. The adoption did not have a
material impact on our results of operations and financial condition.

SFAS No. 123R does not allow the recognition of a deferred tax asset for
unrealized tax benefits associated with the tax deductions in excess of
the compensation recorded (excess tax benefit). At adoption of SFAS
No. 123R on January 1, 2006, we elected to utilize the “with and without”
approach for utilization of tax attributes upon realization of net operating
losses in the future. This method allocates stock compensation benefits
last among other tax benefits recognized. In addition, we elected to adopt
the “direct only” method of calculating the amount of windfalls or shortfalls.

INTERNAP | 2007 ANNUAL REPORT 49

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Financial Review 2007

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 one-for-ten reverse stock split on
our common stock and amended our Certificate 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 reflect this reverse split.

Revenue Recognition and Concentration of Credit Risk

The majority of our revenue is derived from high performance IP services,
related data center services, CDN services, and other ancillary products
and services throughout the United States. Our IP services revenue is
derived from the sale of high performance Internet connectivity services
at fixed rates or usage-based pricing to our customers that desire a
DS3 or faster connection. Slower T1 and fractional DS3 connections are
provided at fixed rates. Data center revenue includes both physical space
for hosting customers’ network and other equipment plus associated services
such as redundant power and network connectivity, environmental controls
and security. Data center revenue is based on occupied square feet
and both allocated and variable-based usage. CDN revenue includes
three components, none of which are sold separately: (1) data storage;
(2) streaming/delivery and (3) a user interface/reporting tool. We provide
the CDN service components via internally developed and acquired
technology that resides on our network. CDN revenue is based on either
fixed rates or usage-based pricing. All of the foregoing revenue arrangements
have contractual terms and in many instances, include minimum usage
commitments. Other ancillary products and services include our Flow
Control Platform, or FCP, product, server management and installation,
virtual private networking, managed security, data backup, remote
storage and restoration.

when persuasive evidence of an arrangement exists, the product or
service has been delivered, the fees are fixed or determinable and
collectibility is probable. For most of our IP, data center and CDN revenue,
services are delivered ratably over the contract term. Contracts and
sales or purchase orders are used to determine the existence of an
arrangement. We test for availability or connectivity to verify delivery of our
services. We assess whether the fee is fixed or determinable based on
the payment terms associated with the transaction and whether the sales
price is subject to refund or adjustment. Because the software component
of our FCP is more than incidental to the product as a whole, we recognize
associated FCP revenue in accordance with the American Institute of
Certified Public Accountants’ (AICPA) Statement of Position 97-2,
Software Revenue Recognition, or SOP 97-2.

We derive revenue from the sale of IP services, data center services and
CDN services to customers under contracts that generally commit the
customer to a minimum monthly level of usage on a calendar month
basis and provide the rate at which the customer must pay for actual
usage above the monthly minimum. For these services, we recognize
the monthly minimum as revenue each month provided that an enforceable
contract has been signed by both parties, the service has been delivered
to the customer, the fee for the service is fixed or determinable and
collection is reasonably assured. Should a customer’s usage of our
services exceed the monthly minimum, we recognize revenue for such
excess in the period of the usage. We record the installation fees as deferred
revenue and recognize as revenue ratably over the estimated life of the
customer arrangement. We also derive revenue from services sold as
discrete, non-recurring events or based solely on usage. For these services,
we recognize revenue after both parties have signed an enforceable
contract, the fee is fixed or determinable, the event or usage has occurred
and collection is reasonably assured.

We also enter into multiple-element arrangements or bundled services,
such as combining IP services with data center and (or) CDN services. When
we enter into such arrangements, we account for each element separately
over its respective service period or at the time of delivery, provided that
there is objective evidence of fair value for the separate elements. Objective
evidence of fair value includes the price charged for the element when
sold separately. If we cannot objectively determine the fair value of each
element, we recognize the total value of the arrangement ratably over
the entire service period to the extent that we have begun to provide the
services, and other revenue recognition criteria have been satisfied.

We recognize revenue in accordance with the Securities and Exchange
Commission’s Staff Accounting Bulletin No. 104, Revenue Recognition,
or SAB No. 104, and the Financial Accounting Standards Board’s, or
FASB, Emerging Issues Task Force Issue No. 00-21, Revenue Arrangements
with Multiple Deliverables, or EITF No. 00-21. Revenue is recognized

Deferred revenue consists of revenue for services to be delivered in the
future and consist 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, which was two to

50 INTERNAP | 2007 ANNUAL REPORT

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Financial Review 2007

three years during the three year period ended December 31, 2007. Revenue
for installation services is deferred and amortized because the installation
service is integral to our primary service offering and does not have value
to customers 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 collection is probable. Additionally, we
maintain allowances for doubtful accounts resulting from the inability
of our customers to make required payments on accounts receivable. The
allowance for doubtful accounts is based upon specific and general customer
information, which also includes estimates based on management’s best
understanding of our customers’ ability to pay and their payment status.
Customers’ ability to pay takes into consideration payment history, legal
status (i.e., 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 record an amount for sales adjustments, which reduces net accounts
receivable and revenue. The amount for sales adjustments is based
upon specific customer information, including outstanding promotional
credits, customer disputes, credit adjustments not yet processed through
the billing system and historical activity. If the financial condition of our
customers were to deteriorate, or management becomes aware of new
information impacting a customer’s credit risk, additional adjustments
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 costs are expensed as incurred.
Research and development costs, which are included in product develop-
ment cost and are expensed as incurred, primarily consist of compensation
related to our development and enhancement of IP routing technology,
progressive download and streaming technology for our CDN, and accel-
eration technologies. Research and development costs were $3.1 million,
$2.4 million and $2.9 million for the years ended December 31, 2007,
2006, and 2005, respectively.

Advertising Costs

We expense all advertising costs as incurred. Advertising costs for the
years ended December 31, 2007, 2006 and 2005 were $1.2 million,
$1.3 million and $0.2 million, respectively.

Net (Loss) Income per Share

Basic and diluted net (loss) income per share has been computed using
the weighted average number of shares of common stock outstanding
during the period. Diluted net (loss) income 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
treasury 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 benefits,
if any, is less than the average stock price during the period presented.
Potentially dilutive shares are excluded from the computation of net
(loss) income per share if their effect is anti-dilutive.

Basic and diluted net (loss) income per share for the years ended
December 31, 2007, 2006 and 2005 are calculated as follows (in thousands,
except per share amounts):

Net (loss) income

Weighted average shares outstanding, basic
Effect of dilutive securities:
Stock compensation plans
Warrants

Year Ended December 31,

2007

2006

2005

$ (5,555)

$ 3,657

$ (4,964)

46,942

34,748

33,939

–
–

984
7

–
–

Weighted average shares outstanding, diluted

46,942

35,739

33,939

Net (loss) income per share:
Basic

$ (0.12)

$ 0.11

$ (0.15)

Diluted

$ (0.12)

$ 0.10

$ (0.15)

Anti-dilutive securities not included in diluted
net (loss) income per share calculation:

Stock compensation plans
Warrants to purchase common stock

3,860
34

3,894

1,408
–

1,408

3,656
1,500

5,156

INTERNAP | 2007 ANNUAL REPORT 51

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Financial Review 2007

Reclassifications

Recent Accounting Pronouncements

Prior to 2007, “Direct costs of amortization of acquired technologies”
were included in the caption “Direct costs of network, sales and services,
exclusive of depreciation and amortization.” In 2007 we reclassified
these costs to a separate caption in the accompanying Consolidated
Statements of Operations with the following effect (in thousands):

Direct costs of network, sales and services, exclusive of
depreciation and amortization show below:

Previously reported
Reclassification

As reclassified

Year Ended December 31,

2006

2005

$97,854
(516)

$82,535
(577)

$97,338

$81,958

A reconciliation of total direct costs of network, sales and services, exclusive
of depreciation and amortization to the accompanying consolidated
statements of operations is shown below (in thousands):

IP services
Data center services
Other

Total

Year Ended December 31,

2006

2005

$39,744
46,474
11,120

$38,377
35,244
8,337

$97,338

$81,958

This reclassification had no effect on previously reported (loss) income
from operations or net (loss) income.

Segment Information

We use the management approach for determining which, if any, of our
services and products, 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. As a result of our acquisition of VitalStream
Holdings, Inc., as discussed in note 3, and the information presented to
executive management, we classified our operations into three reportable
business segments: IP services, data center services and CDN services.
In accordance with SFAS No. 131, “Disclosures about Segments of an
Enterprise and Related Information,” we have presented the corresponding
items of segment information for the years ended December 31, 2006
and 2005.

In September 2006, the FASB issued SFAS No. 157, “Fair Value
Measurements.” SFAS No. 157 defines fair value, establishes a framework
for measuring fair value under GAAP, and expands disclosures about
fair value measurements. SFAS No. 157 is effective for fiscal years
beginning after December 15, 2007. In February 2008, the FASB issued
Staff Position, or FSP, FAS 157-1, which provides supplemental guidance
on the application of SFAS No. 157, and FSP FAS 157-2, which delays
the effective date of SFAS No. 157 for nonfinancial assets and nonfinancial
liabilities. We are currently in the process of evaluating the impact that
the adoption of SFAS No. 157 will have on our financial position, results
of operations and cash flows.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option
for Financial Assets and Financial Liabilities.” SFAS No. 159 permits
companies to choose to measure, on an instrument-by-instrument basis,
many financial instruments and certain other assets and liabilities at
fair value that are not currently required to be measured at fair value.
SFAS No. 159 is effective as of the beginning of a fiscal year that begins
after November 15, 2007. While we will not elect to adopt fair value
accounting to any assets or liabilities allowed by SFAS No. 159, we are
currently in the process of evaluating SFAS No. 159 and its potential
impact to us.

In December 2007, the FASB issued SFAS No. 141 (revised 2007),
“Business Combinations,” or SFAS No. 141R. SFAS No. 141R replaces
SFAS No. 141, “Business Combinations.” SFAS No. 141R establishes
principles and requirements for how an acquirer recognizes and measures
in its financial statements the identifiable assets acquired, the liabilities
assumed, any noncontrolling interest in the acquiree and the goodwill
acquired or a gain from a bargain purchase. SFAS No. 141R also determines
disclosure requirements to enable the evaluation of the nature and
financial effects of the busin ess combination. SFAS No. 141R applies
prospectively to business combinations for which the acquisition date
is on or after the beginning of a fiscal year that begins on or after
December 15, 2008 and there are also implications for acquisitions that
occur prior to this date. We are currently in the process of evaluating
the impact that the adoption of SFAS No. 141R will have on our financial
position, results of operations and cash flows.

52 INTERNAP | 2007 ANNUAL REPORT

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Financial Review 2007

In December 2007, the FASB issued SFAS No. 160, “Noncontrolling
Interests in Consolidated Financial Statements.” SFAS No. 160 amends
Accounting Research Bulletin 51, “ Consolidated Financial Statements,”
or ARB 51, and requires all entities to report noncontrolling (minority)
interests in subsidiaries within equity in the consolidated financial
statements, but separate from the parent shareholders’ equity. SFAS
No. 160 also requires any acquisitions or dispositions of noncontrolling
interests that do not result in a change of control to be accounted for as
equity transactions. Further, SFAS No. 160 requires that a parent recognize
a gain or loss in net income when a subsidiary is deconsolidated. SFAS
No. 160 is effective for fiscal years beginning on or after December 15, 2008.
We do not expect the adoption of SFAS No. 160 will have a significant, if
any, impact on our financial position, results o f operations and cash flows.

3. BUSINESS COMBINATION

On February 20, 2007, we completed the previously announced acquisition
of VitalStream Holdings, Inc., or VitalStream, for approximately
$214.0 million, whereby VitalStream became a wholly owned subsidiary
of Internap. VitalStream provides products and services for storing and
delivering digital media to large audiences over the Internet and advertise-
ment insertion and related advertising services to companies that stream
digital media over the Internet. VitalStream also enhances our position
as a leading provider of high performance route control products and
services by adding complementary service offerings in the rapidly growing
content delivery and on-line advertising markets. Integrating VitalStream’s
digital media delivery platform into our portfolio of products and services
enables us to provide customers with one of the most complete product
lines in content delivery solutions, content monetization and on-line
advertising, while supporting the significant long-term growth opportunities
in the network services market. We accounted for the transaction using
the purchase method of accounting in accordance with SFAS No. 141,
“Business Combinations.” Our results of operations include the activities
of VitalStream from February 21, 2007 through December 31, 2007.

Purchase Price

Assets acquired and liabilities assumed were recorded at their fair values
as of February 20, 2007. The total $214.0 million purchase price is
comprised of the following (in thousands):

Value of Internap stock issued
Fair value of stock options assumed
Direct transaction costs

Total purchase price

$197,272
11,021
5,729

$214,022

As a result of the acquisition, we issued approximately 12.2 million shares
of Internap common stock based on an exchange ratio of 0.5132 shares of
Internap common stock for each outstanding share of VitalStream common
stock as of February 20, 2007. This fixed exchange ratio gave effect to
the one-for-ten reverse stock split by Internap implemented on July 11,
2006 and the one-for-four reverse stock split by VitalStream implemented
on April 4, 2006. The average market price per share of Internap common
stock of $16.16 was based on an average of the closing prices for a
range of trading days from October 10, 2006 through October 16, 2006,
which range spanned the announcement date of the transaction on
October 12, 2006.

Under the terms of the merger agreement, each VitalStream stock option
that was outstanding and unexercised was converted into an option to
purchase Internap common stock and we assumed that stock option in
accordance with the terms of the applicable VitalStream stock option plan
and terms of the stock option agreement. Based on VitalStream’s stock
options outstanding at February 20, 2007, we converted options to purchase
approximately 3.0 million shares of VitalStream common stock into options
to purchase approximately 1.5 million shares of Internap common stock.

Purchase Price Allocation

Under the purchase method of accounting, we allocated the total estimated
purchase price to VitalStream’s net tangible and intangible assets based
on their estimated fair values as of February 20, 2007. We recorded the
excess purchase price over the value of the net tangible and identifiable
intangible assets as goodwill. We determined the fair value assigned to
identifiable intangible assets acquired using the income approach, which
discounts expected future cash flows to present value using estimates and
assumptions determined by management. The allocation of the purchase
price and the estimated useful lives are as follows (dollars in thousands):

Net tangible assets
Identifiable intangible assets:
Developed technologies
Customer relationships
Trade name and other
Acquired in-process research and development
Goodwill (1)

Total estimated purchase price

Estimated
Amount Useful Life

$ 12,286

–

8 years
9 years
3-6 years
–
–

36,000
9,000
1,500
450
154,786

$214,022

(1) Subsequent to the finalization of the purchase price allocation, we recorded a net increase of
$0.1 million to goodwill as a result of adjustments to certain pre-acquisition assets and liabilities
and decrease of $0.4 million as a result of the utilization of a portion of VitalStream’s net operating
loss carryforwards.

INTERNAP | 2007 ANNUAL REPORT 53

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Financial Review 2007

Net Tangible Assets. We recorded VitalStream’s tangible assets and
liabilities as of February 20, 2007 at their fair value. Net tangible assets
included restricted and unrestricted cash of $9.8 million, accounts
receivable of $3.2 million, property and equipment of $11.2 million, other
assets of $2.2 million, loan and security agreement (including both
term loans and an outstanding line of credit) and capital lease obligations
of $6.1 million, and accounts payable and other liabilities of $8.0 million.
Subsequent to the acquisition of VitalStream, we paid off the term loans
and line of credit assumed in the VitalStream acquisition.

Identifiable Intangible Assets. Developed technologies relate to VitalStream
products that have reached technological feasibility and include processes
and trade secrets acquired or developed through design and development
of their products. Customer relationships represent contracts with existing
customers. Trade name primarily relates to the VitalStream and other
product names. We valued each of the identifiable intangible assets
using various forms of the income approach, detailed financial projections
and various assumptions, including, among others, the evolution of the
existing technology platforms to future technology, expected net cash
flows, customer attrition rates, tax rates, and discount rates. Amortization
of identifiable intangibles is on a straight-line basis over their respective
useful lives.

In-Process Research and Development. As of the closing date, one project
was in development that has not reached technological feasibility and
therefore qualifies as in-process research and development. The amount
allocated to in-process research and development was charged to the
statement of operations as of the date of acquisition.

Goodwill. Goodwill is the residual of the excess of fair value over the
book value of the acquired entity’s net assets at the date of acquisition.
We note that under SFAS No. 141, an assembled workforce shall not be
recognized apart from goodwill and therefore is embedded in goodwill.
Part of the acquisition included an assembled workforce that is included
as a component of goodwill. Another component of goodwill is the estimated
fair value of the expected synergies and other benefits from combining
ours and VitalStream’s net assets and businesses. Our expected synergies
are significant in this acquisition, including synergies in the sales channel,
our network costs, general and administrative costs, and capital

expenditures. We allocated approximately $154.8 million to goodwill for
the CDN services segment. In accordance with SFAS No. 142, we will
not amortize goodwill but instead will test it for impairment at least
annually, or more frequently if certain indicators are present. A total of
$18.3 million of goodwill will be deductible for tax purposes.

Pro Forma Results (Unaudited)

VitalStream provides products and services for storing and delivering
digital media to large audiences over the Internet and ad insertion and
related advertising services to companies that stream digital media
over the Internet. VitalStream also enhances our position as a leading
provider of high performance route control products and services by
adding complementary service offerings in the rapidly growing content
delivery and on-line advertising markets. Integrating VitalStream’s digital
media delivery platform into our portfolio of products and services enables
us to provide customers with one of the most complete product lines in
content delivery solutions, content monetization and on-line advertising,
while supporting the significant long-term growth opportunities in the
network services market.

The following unaudited pro forma consolidated financial information
reflects the results of our operations for the year ended December 31,
2007 and 2006, as if the acquisition of VitalStream had occurred at the
beginning of each period. Prior to the acquisition, VitalStream was a
customer of ours, and for the years ended December 31, 2007 and 2006
we recognized revenues of $0.4 million and $0.2 million, respectively,
from VitalStream which has been excluded from pro forma revenues below.
The related receivables were settled in the normal course of business. The
pro forma results presented below are not necessarily indicative of what
our operating results would have been had the acquisition actually
taken place at the beginning of each period (in thousands, except per
share amounts):

Pro forma revenues
Pro forma net loss
Pro forma net loss per share, basic and diluted

Year Ended December 31,

2007

2006

$236,418
(14,269)
(0.25)

$205,052
(16,153)
(0.34)

54 INTERNAP | 2007 ANNUAL REPORT

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Financial Review 2007

4. ASSET IMPAIRMENT AND RESTRUCTURING COSTS

During the three months ended March 31, 2007, we incurred a restructuring
and impairment charge of $10.3 million. The charge was the result of a
review of our business, particularly in light of our acquisition of VitalStream
and our plan to finalize the overall integration and implementation plan
before the end of the first quarter. The charge to expense included
$7.8 million for leased facilities, representing both the costs less anticipated
sublease recoveries that will continue to be incurred without economic
benefit to us and costs to terminate leases before the end of their term.
The charge also included severance payments of $1.1 million for the
termination of certain employees and $1.4 million for impairment of
assets. Net related expenditures were estimated to be $10.7 million, of
which $2.8 million has been paid during the year ended December 31,

2007, and the balance continuing through December 2016, the last date
of the longest lease term. These expenditures are expected to be paid
out of operating cash flows. The impairment charge of $1.3 million is
related to the leases referenced above and less than $0.1 million for
other assets. Cost savings from the restructuring were estimated to be
approximately $0.8 million per year through 2016, primarily for rent expense.

In 2001, we implemented significant 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 continued to evaluate our restructuring reserve.
The following table displays the activity and balances for the restructuring
and asset impairment activity for the year ended December 31, 2007
(in thousands):

December 31, 2006
Restructuring
Liability

Restructuring
and Impairment
Charges

Cash Payments

Non-Cash
Write-Downs

Non-Cash
Plan Adjustments

December 31, 2007
Restructuring
Liability

Activity for 2007 restructuring charge:
Real estate obligations
Employee separations
Total restructuring costs

Activity for 2007 impairment charge:

Leasehold improvements

Other

Total asset impairments

Activity for 2001 restructuring charge:
Real estate obligations

Total

$ –
–
–

–
–
–

$ 7,755
1,140
8,895

897
471
1,368

$(2,248)
(615)
(2,863)

–
–
–

4,784
$4,784

–
$10,263

(1,199)
$(4,062)

$ –
–
–

(897)
(471)
(1,368)

–
$(1,368)

$ 805
(119)
686

–
–
–

$ 6,312
406
6,718

–
–
–

(211)
$ 475

3,374
$10,092

The impairment charges referenced in the table above were primarily associated with our data center segment.

We also recorded a $1.1 million impairment during year ended December 31, 2007 for the sales order-through-billing system, described further in
Note 2. This impairment charge was not related to any specific segment.

In 2006, we recorded a nominal charge for changes in estimated expenses related to real estate obligations. The following table displays the activity
and balances for restructuring activity for the year ended December 31, 2006 (in thousands):

Activity for 2001 restructuring charge:
Real estate obligations

December 31, 2005
Restructuring
Liability

Restructuring Charges

Cash Payments

December 31 2006
Restructuring
Liability

$6,277

$(1,497)

$4,784

Also, during the year ended December 31, 2006, we recognized an impairment charge of $0.3 million as a result of the implementation of a new
financial system which began in 2004.

In 2005, we recorded net restructuring charges totaling less than $0.1 million primarily for changes in estimated expenses related to real estate obligations.

INTERNAP | 2007 ANNUAL REPORT 55

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Financial Review 2007

5. OPERATING SEGMENTS

We operate and manage the Company in three business segments:
IP services, data center services and CDN services. IP services primarily
include our high performance Internet connectivity as well as sales of
our FCP products. Data center services primarily include physical space
for hosting customers’ network and other equipment plus associated
services such as redundant power and network connectivity, environmental
controls and security. CDN services primarily include data storage,
streaming/delivery and a user interface/reporting tool, none of which are

sold separately. Other revenues and direct costs represent non-segmented
activities and primarily include reseller and miscellaneous services such
as third party CDN services, termination fee revenue, referral fees for
other hardware sales, and consulting services. In conjunction with the
preparation of our financial statements, we analyzed sales credits activity
for the years ended December 31, 2007, 2006 and 2005 and reclassified
all of the credits to the related operating segments. The following tables
show operating results for our reportable segments, along with reconcilia-
tions from segment gross profit to (loss) income before income taxes and
equity in earnings of equity-method investment:

Revenues
Direct costs of network, sales and services,

exclusive of depreciation and amortization

Segment profit
Other operating expenses
Loss from operations
Non-operating income
Loss before income taxes and equity in earnings

of equity-method investment

Year Ended December 31, 2007

IP Services

$119,848

43,681
$ 76,167

Data Center
Services

$83,058

59,439
$23,619

CDN Services

$17,718

6,584
$11,134

Other

$13,466

8,690
$ 4,776

Total

$234,090

118,394
115,696
125,407
(9,711)
937

$ (8,774)

Direct costs of network, sales and services, exclusive of depreciation and amortization, includes an allocation of $0.7 million from the IP services segment
to the CDN services segment based on the average cost of actual usage by the CDN segment.

Year Ended December 31, 2006

IP Services

$ 109,748

39,744
$ 70,004

Data Center
Services

$ 56,152

46,474
$ 9,678

CDN Services

–

–
–

Other

$15,475

11,120
$ 4,355

Year Ended December 31, 2005

IP Services

$ 105,032

38,377
$ 66,655

Data Center
Services

$ 36,996

35,244
$ 1,752

CDN Services

–

–
–

Other

$11,689

8,337
$ 3,352

Total

$181,375

97,338
84,037
81,900
2,137
1,551

$ 3,688

Total

$ 153,717

81,958
71,759
76,893
(5,134)
87

$ (5,047)

Revenues
Direct costs of network, sales and services,

exclusive of depreciation and amortization

Segment profit
Other operating expenses
Income from operations
Non-operating income
Income before income taxes and equity in earnings

of equity-method investment

Revenues
Direct costs of network, sales and services,

exclusive of depreciation and amortization

Segment profit
Other operating expenses
Loss from operations
Non-operating income
Loss before income taxes and equity in earnings

of equity-method investment

56 INTERNAP | 2007 ANNUAL REPORT

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Financial Review 2007

The following table includes selected segment financial information as of December 31, 2007 and 2006, related to goodwill and total assets:

December 31, 2007:
Goodwill

Total assets

December 31, 2006:
Goodwill

Total assets

IP Services

$ 36,314
148,697

$ 36,314
130,609

Data Center
Services

–
64,498

$ –
41,185

CDN Services

Other

Total

$154,363
211,469

$ –
–

–
2,346

$ –
1,908

$190,677
427,010

$ 36,314
173,702

Through December 31, 2007, neither revenues generated nor long-lived assets located outside the United States were significant (all less than 10%).

INVESTMENTS

Investment in Marketable Securities

Pursuant to our formal investment policy, investments in marketable
securities primarily consist of high credit quality corporate debt securities,
auction rate securities whose underlying assets are state-issued student
and educational loans which are substantially backed by the federal
government, commercial paper and U.S. Government Agency debt
securities. Auction rate securities are variable rate bonds tied to short-term
interest rates with maturities on the face of the securities in excess of
90 days and have interest rate resets through a modified Dutch auction,
at predetermined short-term intervals, usually every 7, 28 or 35 days.
Auction rate securities generally trade at par and are callable at par on
any interest payment date at the option of the issuer. Interest received
during a given period is based upon the interest rate determined through
the auction process. Although these securities are issued and rated as
long term bonds, they are priced and traded as short-term instruments
because of the liquidity provided through the interest rate reset. All
short-term marketable securities either (1) have original maturities
greater than 90 days but less than one year or (2) are auction rate
securities expected to be liquidated within one year, are classified as
available-for-sale and are recorded at fair value with changes in fair
value reflected in other comprehensive income. All proceeds were from
the maturity of the securities or sales of auction rate securities at par
value. Accordingly, we have not recognized any realized gains or losses.

Summaries of our investments in marketable securities are as follows
(in thousands):

Corporate debt securities
Auction rate securities
Commercial paper
Other

Total short-term investments
in marketable securities

Corporate debt securities
Commercial paper
U.S. government agency debt securities
Other

Total short-term investments
in marketable securities

December 31, 2007

Unrealized
Cost Basis Gain (Loss)

Carrying
Value

$ 7,607
7,150
4,787
24

$ 3
–
2
(4)

$ 7,610
7,150
4,789
20

$19,568

$ 1

$19,569

December 31, 2006

Unrealized
Cost Basis Gain (Loss)

$ 4,826
4,755
3,659
24

$ 1
–
(1)
27

Carrying
Value

$ 4,827
4,755
3,658
51

$13,264

$27

$13,291

INTERNAP | 2007 ANNUAL REPORT 57

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Financial Review 2007

Uncertainties in the credit markets may affect the liquidity of our holdings
in auction rate securities. We did not experience any unsuccessful auction
rate resets during the year ended or the initial rate resets immediately
following December 31, 2007, however we have experienced failures on
each of our subsequent auction rate resets. Nevertheless, we continue to
receive interest every 28-35 days. While our investments in auction rate
securities are of high credit quality with AAA/Aaa ratings as of December 31,
2007, at this time we are uncertain as to whether or when the liquidity
issues relating to these investments will worsen or improve. We do not
believe that it is necessary at this time to adjust the fair value of our
portfolio of auction rate securities and we expect to hold the auction
rate securities until liquidity improves or the borrower calls the underlying
securities. However, if uncertainties in the credit and capital markets
continue, these markets deteriorate further or we experience any rating
downgrades on any of the investments in our portfolio, we may incur
temporary or other than temporary impairments, which could negatively
affect our financial condition, results of operations or cash flows. In
addition, a continued deterioration in market conditions that lead us to
conclude our marketable securities are not available to fund current
operations would result in us classifying our auction rate securities as
noncurrent assets. In the meantime, we believe we have sufficient
liquidity through our cash balances, other short-term investments and
available credit.

Investment in Internap Japan

We maintain a 51% ownership interest in Internap Japan, a joint venture
with NTT-ME Corporation and NTT Holdings. We are unable to assert
control over the joint venture’s operational and financial policies and
practices required to account for the joint venture as a subsidiary whose
assets, liabilities, revenue and expense would be consolidated (due to
certain minority interest protections afforded to our joint venture partners).
We are, however, able to assert significant influence over the joint venture
and, therefore, account for our joint venture investment using the
equity-method of accounting pursuant to APB Opinion No. 18 “The Equity
Method of Accounting for Investments in Common Stock” and consistent
with Emerging Issues Task Force No. 96-16 “Investor’s Accounting for
an Investee When the Investor Has a Majority of the Voting Interest but the
Minority Shareholder or Shareholders Have Certain Approval or Veto Rights.”

Our investment activity in the joint venture is as follows (in thousands):

Year Ended December 31,

2007

2006

2005

$ 958
139

$823
114

$ 861
83

Investment balance, January 1,
Proportional share of net income
Unrealized foreign currency translation

gain (loss), net

(121)

Investment balance, December 31,

$1,138

$958

$ 823

Investment in Aventail

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. We incurred a
charge during the three months ended June 30, 2007, totaling $1.2 million,
representing the write-off of the remaining carrying value of our investment
in series D preferred stock of Aventail. We made an initial cash investment of
$6.0 million in Aventail series D preferred stock pursuant to an investment
agreement in February 2000. In connection with a subsequent round of
financing by Aventail, we recognized an initial loss on our investment
of $4.8 million in 2001. On June 12, 2007, SonicWall, Inc. announced
that it entered into an agreement to acquire Aventail for approximately
$25.0 million in cash. The transaction closed on July 11, 2007, with all
shares of series D preferred stock being cancelled and the holders of
series D preferred stock not receiving any consideration for such shares.

7. 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
($1,596 and $1,375 related to capital leases at
December 31, 2007 and 2006, respectively)

December 31,

2007

2006

$ 86,496 $ 65,430
1,596
31,712
100,024

1,596
31,726
111,216

231,034

198,762

(165,543)

(151,269)

$ 65,491 $ 47,493

58 INTERNAP | 2007 ANNUAL REPORT

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Financial Review 2007

During 2007 and 2006, $2.7 million and $8.6 million, respectively, of
fully depreciated assets were retired.

Depreciation and amortization of property and equipment associated
with direct costs of network, sales and services and other depreciation
expense is summarized as follows (in thousands):

Direct costs of network, sales and services
Other depreciation and amortization

Subtotal
Amortization of acquired technologies

Year Ended December 31,

2007

2006

2005

$18,313
3,929

22,242
4,165

$13,250
2,606

15,856
516

$11,804
2,933

14,737
577

Total depreciation and amortization

$26,407

$16,372

$15,314

8. 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 flow method. Based on the results of these analyses
our goodwill was not impaired as of August 1, 2007.

The assumptions, inputs and judgments used in performing the valuation
analysis are inherently subjective and reflect estimates based on known
facts and circumstances at the time the valuation is performed. The use
of different assumptions, inputs and judgments, or changes in circum-
stances, could materially affect the results of the valuation. Adverse
changes in the value of our reporting units would necessitate an impairment
charge of our goodwill. In connection with our acquisition of VitalStream
on February 20, 2007, we recorded $154.8 million of additional goodwill
based on our allocation of the VitalStream purchase price, as discussed
in note 3. In December 2007, a decrease of $0.4 million was recorded
to goodwill as a result of the utilization of a portion of VitalStream’s net
operating loss carryforwards. The total recorded amount of goodwill
was $190.7 million and $36.3 million as of December 31, 2007 and
December 31, 2006, respectively.

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.

The components of our amortizing intangible assets are as follows
(in thousands):

December 31, 2007

December 31, 2006

Gross

Carrying Accumulated
Amount Amortization

Carrying Accumulated
Amortization
Amount

Contract based
Technology based

$25,018
41,911

$(15,403)
(8,518)

$14,518
5,911

$(14,291)
(4,353)

$66,929

$(23,921)

$20,429

$(18,644)

Amortization expense for identifiable intangible assets during 2007, 2006
and 2005 was $5.3 million, $0.5 million and $0.6 million, respectively.
As of December 31, 2007, estimated amortization expense for the next
five years is as follows (in thousands):

2008
2009
2010
2011
2012
Thereafter

$ 6,243
6,243
6,056
5,728
5,728
13,010

$43,008

9. ACCRUED LIABILITIES

Accrued liabilities consist of the following (in thousands):

Compensation payable
Telecommunications, sales, use and other taxes
Other

December 31,

2007

$ 4,942
2,317
2,900

$10,159

2006

$4,075
2,005
2,609

$8,689

INTERNAP | 2007 ANNUAL REPORT 59

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Financial Review 2007

10. REVOLVING CREDIT FACILITY AND NOTE PAYABLE

On September 14, 2007, we entered into a $35.0 million credit agreement,
or the Credit Agreement, with Bank of America, N.A., as administrative
agent, and lenders who may become a party to the Credit Agreement from
time to time. VitalStream Holdings, Inc., VitalStream, Inc., PlayStream, Inc.,
and VitalStream Advertising Services, Inc., four of our subsidiaries, are
guarantors of the Credit Agreement.

The Credit Agreement replaced our prior credit agreement, which was
evidenced by a Loan and Security Agreement between the Company and
Silicon Valley Bank that was last amended on December 27, 2006. We
paid off and terminated this prior credit facility concurrently with the
execution of the Credit Agreement.

Our obligations under the Credit Agreement are pledged, pursuant to
a pledge and security agreement and an intellectual property security
agreement, by substantially all of our assets including the capital
stock of our domestic subsidiaries and 65% of the capital stock of our
foreign subsidiaries.

The Credit Agreement provides for a four-year revolving credit facility,
or the Revolving Credit Facility, in the aggregate amount of up to $5.0 million,
which includes a $5.0 million sub-limit for letters of credit. With the
prior approval of the administrative agent, we may increase the total
commitments by up to $15.0 million for a total commitment under the
Revolving Credit Facility of $20.0 million. The Revolving Credit Facility
is available to finance working capital, capital expenditures and other
general corporate purposes. As of December 31, 2007 we had a total of
$8.0 million of letters of credit issued (including $3.9 million which are
secured by the Revolving Credit Facility and the balance secured by
restricted cash) and $1.1 million in borrowing capacity on the Revolving
Credit Facility. There were no amounts outstanding on the Revolving Credit
Facility as of December 31, 2007.

The Credit Agreement also provides for a four-year term loan, or the Term
Loan, in the amount of $30.0 million. We borrowed $20.0 million concurrently
with the closing and used a portion of the proceeds from the Term Loan
to pay off the prior credit agreement. The Term Loan had $10.0 million
in borrowing capacity as of December 31, 2007.

The interest rate on the Revolving Credit Facility and Term Loan is a tiered
LIBOR-based rate that depends on our 12-month trailing EBITDA. As of
December 31, 2007, the interest rate was 7.075%.

We will only pay interest on the Term Loan during the first 12 months of its
four-year term. Commencing on the last day of the first calendar quarter
after the first anniversary of the closing, the outstanding amount of the
Term Loan will amortize on a straight-line schedule with the payment of
1/16 of the original principal amount of the Term Loan due quarterly. We
will pay all unpaid amounts at maturity, which is September 14, 2011.

The Credit Agreement includes customary representations, warranties,
negative and affirmative covenants, including certain financial covenants
relating to net funded debt to EBITDA ratio and fixed charge coverage
ratio, as well as a prohibition against paying dividends, limitations on
unfunded capital expenditures of $25.0 million per year, customary events
of default and certain default provisions that could result in acceleration
of the Credit Agreement.

The net proceeds received from the Term Loan were reduced by $0.3 million
for fees paid to Bank of America and its agents. We treated these fees
as a debt discount and will amortize the fees to interest expense using
the interest method over the term of the loan. We recorded less than
$0.1 million of related amortization during the year ended December 31,
2007. As of December 31, 2007, the balance on the Term Loan, net of
the discount, was $19.8 million. We incurred other costs of less than
$0.1 million in connection with entering into the Credit Agreement, which
we recorded as debt issue costs and will amortize over the term of the
Credit Agreement.

As a result of the transactions discussed above, we recorded a loss on
extinguishment of prior debt of less than $0.1 million during the year
ended December 31, 2007. The loss on extinguishment of debt is included
in the caption Other, net within the Non-operating (income) expense
section of the consolidated statements of operations.

The future maturity of the Term Loan at December 31, 2007, which does
not reflect the debt discount, is as follows (in thousands):

2008
2009
2010
2011

Total maturities and principal payments
Less: current portion

$ 2,500
5,000
5,000
7,500

20,000
(2,500)

$17,500

Also during the year ended December 31, 2007, we paid off the term loans
and line of credit issued pursuant to the loan and security agreement
assumed in the VitalStream acquisition, as discussed in note 3.

60 INTERNAP | 2007 ANNUAL REPORT

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Financial Review 2007

At December 31, 2006, we had a $5.0 million revolving credit facility
and a $17.5 million term loan (note payable) under the former loan and
security agreement with Silicon Valley Bank. The note payable had a
fixed interest rate of 7.5% and was paid off in connection with the new
Credit Agreement discussed above. There were $3.9 million of letters of
credit previously outstanding under the former revolving credit facility
which have been secured with restricted cash and are in the process of
being secured by the new Revolving Credit Facility. There was no outstanding
balance under the former revolving credit facility as of December 31, 2006.

The carrying value of our notes payable as of December 31, 2007 and
2006, approximate fair value as the interest rates approximate current
market rates of similar debt obligations.

11. 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,
2007, our capital leases have expiration dates ranging from May 2009
to March 2010.

Future minimum capital lease payments together with the present value
of the minimum lease payments as of December 31, 2007, are as follows
(in thousands):

2008
2009
2010

Remaining capital lease payments
Less: amounts representing imputed interest

Present value of minimum lease payments
Less: current portion

$ 922
456
14

1,392
(135)

1,257
(805)

$ 452

One capital lease assumed in the VitalStream acquisition requires us to
maintain a restricted cash balance of $0.7 million.

12. INCOME TAXES

The current and deferred income tax (benefit) provision were as follows
for the years ended December 31, 2007 and 2006 (in thousands):

Current:
Federal
State
Foreign

Total current provision

Deferred:
Federal
State
Foreign

Total deferred benefit

Year Ended December 31,

2007

2006

$ 15
–
921

936

356
42
(4,414)

(4,016)

$145
–
–

145

–
–
–

–

Net income tax (benefit) provision

$(3,080)

$145

We account for income taxes under the liability method. Deferred tax assets
and liabilities are determined based on differences between financial
reporting and tax bases of assets and liabilities, and are measured using
the enacted tax rates and laws that will be in effect when the differences
are expected to reverse. We provide a valuation allowance to reduce our
deferred tax assets to their estimated realizable value. We had no income
tax provision or benefit for the year ended December 31, 2005.

A reconciliation of the effect of applying the federal statutory rate and the
effective income tax rate on our income tax provision (benefit) is as follows:

Federal income tax (benefit) expense
at statutory rates
State income tax (benefit) expense
Stock compensation expense
Tax reserves
Other
Change in valuation allowance

Effective tax rate

Year Ended December 31,

2007

2006

2005

(34)%
(4)
6
11
–
(14)

(35)%

34%
4
8
–
1
(43)

(34)%
(4)
–
–
1
37

–%

INTERNAP | 2007 ANNUAL REPORT 61

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Financial Review 2007

Temporary differences between the financial statement carrying amounts
and tax bases of assets and liabilities that give rise to significant portions
of deferred taxes relate to the following (in thousands):

December 31,

2007

2006

Current deferred income tax assets:
Provision for doubtful accounts
Accrued compensation
Other accrued expenses
Deferred revenue
Restructuring costs
Foreign net operating loss carryforwards – current portion
Other

$ 593 $ 115
132
–
1,225
532
–
390

233
196
1,648
910
479
77

Current deferred income tax assets
Less: valuation allowance

4,136
(3,625)

511

2,394
(2,379)

Non-current deferred income tax assets:
Property and equipment

Investments

21,488
–
717
Deferred revenue, less current portion
2,925
Restructuring costs, less current portion
4,184
Deferred rent
2,620
Stock Compensation
U. S. net operating loss carryforwards
136,963
Foreign net operating loss carryforwards, less current portion 13,717
2,271
Capital loss carryforwards
180
Tax credit carryforwards
502
Other

20,315
1,824
386
1,286
4,344
216
128,527
14,574
–
165
–

Non-current deferred income tax assets
Less: valuation allowance

Non-current deferred income tax liabilities:
Purchased intangibles
FIN 48 liability related to net operating loss carryforwards
Goodwill

Non-current deferred income tax assets (liabilities), net

185,567
(180,133)

171,637
(170,568)

5,434

1,069

(1,531)
(921)
(398)

2,584

(1,084)
–
–

(15)

Net deferred tax assets

$ 3,095 $ –

As of December 31, 2007, we have U.S. net operating loss carryforwards
for federal tax purposes of approximately $589.4 million that will
expire through 2026. Of the total U.S. net operating loss carryforwards,
$13.3 million of net operating losses relate to the deduction of stock
compensation that will be tax-effected and the benefit credited to additional
paid in capital when realized. In addition, we have alternative minimum
tax credit carryforwards of approximately $0.2 million, which have an
indefinite carryforward period, and foreign net operating loss carryforwards
of approximately $39.3 million that will begin to expire in 2008.

The future utilization of the U.S. net operating losses is subject to certain
limitations imposed by Section 382 of the Internal Revenue Code. Under

62 INTERNAP | 2007 ANNUAL REPORT

this provision, we will be precluded from utilizing approximately
$215.7 million of our $589.4 million in net operating losses. Also, 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 future utilization of our U.S. net operating losses.

As prescribed under SFAS No. 109, we periodically evaluate the recoverability
of the deferred tax assets and the appropriateness of the valuation
allowance. For U.S. tax purposes, a valuation allowance of approximately
$173.7 million has been established against the U.S. deferred tax assets
that we do not believe are more likely than not to be realized. We will
continue to assess the requirement for a valuation allowance on a quarterly
basis and, at such time when it is determined that it is more likely than
not that the deferred tax assets will be realized, the valuation allowance
will be reduced accordingly.

During the fourth quarter of 2007, we concluded that it was more likely
than not that U.K. deferred tax assets will be realized in future years.
The U.K. deferred tax assets primarily consist of net operating loss
carryforwards in the amount of $11.6 million as of December 31, 2007.
We therefore released $4.4 million of the valuation allowance associated
with U.K. deferred tax assets, which resulted in the recognition of a
$4.4 million tax benefit. The tax benefit was offset by a liability for uncertain
tax positions of $0.9 million, discussed below, for a net recognized tax
benefit of $3.5 million. On the accompanying balance sheet, $0.5 million
of the tax benefit is reflected as a current deferred tax asset because
realization is anticipated to occur within the next 12 months. The resulting
non-current deferred tax asset is $3.0 million.

As discussed in note 3 we acquired VitalStream in February 2007, resulting
in the addition of $13.5 million in deferred tax assets, primarily consisting
of $34.5 million in net operating loss carryforwards. The acquisition of
VitalStream was a stock-for-stock transaction treated as a tax-free
reorganization. The difference between the tax basis and the net book
value of VitalStream assets is treated as a temporary difference and is
reported as a deferred tax asset in the table above.

It is our policy to reinvest foreign earnings indefinitely within each country
when foreign operations become profitable. Accordingly, no deferred
taxes have been recorded for the difference between our financial and
tax basis investment in foreign entities. A portion of these earnings were
distributed to the U.S. and resulted in U.S. dividend income (eliminated
in consolidation for financial statement purposes) and reduced the U.S.
net operating loss carryforward. The distribution was not subject to
withholding taxes. No other foreign distributions have occurred and no
provision or benefit is made for income taxes that would be payable upon
the distribution of future foreign earnings. Because it is the intention of
management to reinvest future profits within each country, it is not
practicable to determine the amount of the unrecognized deferred
income tax liability related to future foreign earnings.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Financial Review 2007

Effective January 1, 2007, we adopted the provisions of FIN 48. FIN 48
clarifies the accounting for uncertainty in income taxes recognized in a
company’s financial statements in accordance with SFAS No. 109. FIN
48 requires a company to determine whether it is more likely than not
that a tax position will be sustained upon examination based upon the
technical merits of the position. If the more-likely-than-not threshold is
met, a company must measure the tax position to determine the amount
to recognize in the financial statements.

Upon the adoption of FIN 48 on January 1, 2007, we recognized no increase
in our liability for unrecognized tax benefits. A reconciliation of the beginning
and ending amount of unrecognized tax benefits is as follows (in thousands):

Unrecognized tax benefits balance at January 1, 2007
Additions for tax positions of prior years
Reductions for tax positions of prior years settlements
Additions for tax positions of current year
Lapse of statute of limitations

Unrecognized tax benefits balance at December 31, 2007

$ –
–
–
921
–

$921

All of the $0.9 million addition would impact our effective income tax rate
in the respective period of change. We classify interest and penalties
arising from the underpayment of income taxes in the statement of
operations as a component of general and administrative expenses. As
of December 31, 2007, we have no accrued interest or penalties related
to uncertain tax positions. Our federal income tax returns remain open to
examination for the tax years 2007, 2006 and 2005, as do returns filed
in other taxing jurisdictions to which we are also subject to examination
for years prior to 2005.

13. EMPLOYEE RETIREMENT PLAN

We sponsor a defined contribution retirement savings plan that qualifies
under Section 401(k) of the Internal Revenue Code. Plan participants
may elect to have a portion of their pre-tax compensation contributed
to the plan, subject to certain guidelines issued by the Internal Revenue
Service. Employer contributions are discretionary and were $0.8 million,
$0.7 million and $0.6 million for the years ended December 31, 2007,
2006 and 2005, respectively.

14. COMMITMENTS, CONTINGENCIES,

CONCENTRATIONS OF RISK AND LITIGATION

Operating Leases

We, as a lessee, have entered into leasing arrangements relating to office
and service point rental space and office equipment that are classified
as operating leases. Initial lease terms range from two 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. Certain leases require
that we maintain letters of credit or restricted cash balances to ensure
payment. Future minimum lease payments on non-cancelable operating
leases are as follows at December 31, 2007 (in thousands):

2008
2009
2010
2011
2012
Thereafter

$ 28,211
25,510
25,179
26,135
27,073
88,786

$220,894

Rent expense was $15.1 million, $18.8 million and $13.6 million for the
years ended December 31, 2007, 2006 and 2005, respectively. Sublease
income, recorded as a reduction of rent expense, was $0.5 million,
$0.6 million and $0.2 million during the years ended December 31, 2007,
2006 and 2005, respectively.

Service Commitments

We have entered into service commitment contracts with Internet network
service providers to provide interconnection services and data center
providers to provide data center services for our customers. Future minimum
payments under these service commitments having terms in excess of
one year are as follows at December 31, 2007 (in thousands):

2008
2009
2010

Vendor Disputes

$12,167
7,457
2,390

$22,014

INTERNAP | 2007 ANNUAL REPORT 63

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Financial Review 2007

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 financial statements, we wrote off the $1.3 million liability
amount as we believed the obligation no longer existed. In the fourth quarter
of 2006, we received an inquiry from the vendor, ADC Telecommunications,
Inc., or ADC, regarding the status of the former $1.3 million payable and
on March 19, 2007, ADC sued us in Minnesota state court. We settled
this suit on June 29, 2007 for less than $0.1 million, which we expensed
when we incurred the settlement cost and associated legal costs.

Concentrations of Risk

We participate in an industry that is characterized by relatively high
volatility and strong competition for market share. We and others in the
industry encounter aggressive pricing practices, evolving customer demands
and continual technological developments. Our operating results could
be negatively affected should we not be able to adequately address pricing
strategies, customers’ demands, and technological advancements.

We depend on other companies to supply various key elements of our
infrastructure including the network access local loops between our network
access points and our Internet network service providers and the local
loops between our network access points and our customers’ networks.
In addition, the routers and switches used in our network infrastructure
are currently supplied by a limited number of vendors. Furthermore, we
do not carry significant supply inventories of the products and equipment
that we purchase and use, and we have no guaranteed supply arrangements
with our vendors. A loss of a significant vendor could delay build-out of
our infrastructure and increase our costs. If our limited source of suppliers
fails to provide products or services that comply with evolving Internet
standards or that interoperate with other products or services we use in
our network infrastructure, we may be unable to meet all or a portion
of our customer service commitments, which could adversely affect our
business, results of operations and financial condition.

Litigation

We are subject to legal proceedings, claims and litigation arising in the
ordinary course of business. Although the outcome of these matters is
currently not determinable, we do not expect that the ultimate costs to
resolve these matters will have a material adverse effect on our financial
condition, results of operations or cash flows.

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 significantly lower apportionment percentages to New York. The
adjustment for the revised New York assessment, as well as other tax
accruals based on our best estimate of probable liabilities, resulted in a
reduction of non-income based tax expenses of approximately $1.7 million
as of March 31, 2005. These tax adjustments are reflected in accrued
liabilities and general and administrative expense in the accompanying
financial statements.

15. CONVERTIBLE PREFERRED STOCK
AND STOCKHOLDERS’ EQUITY

Convertible Preferred Stock

Effective September 14, 2004, all shares of our outstanding series A
convertible preferred stock were mandatorily converted into common
stock in accordance with the terms of our Certificate of Incorporation.
We have no shares of series A convertible preferred stock outstanding.

Rights Agreement

On March 15, 2007, the Board of Directors declared a dividend of one
preferred share purchase right, or a Right, for each outstanding share of
common stock, par value $0.001 per share, of the Company. The dividend
was payable on March 23, 2007 to the stockholders of record on that date.
Each Right entitles the registered holder to purchase from the Company
1/1000 of a share of Series B Preferred Stock of the Company, par
value $0.001 per share, or the Preferred Shares, at a price of $100.00 per
1/1000 of a Preferred Share, subject to adjustment. Our Certificate of
Designation of Rights, Preferences and Privileges of Series B Preferred
Stock designates 0.5 million shares of Series B Preferred Stock. The
description and terms of the Rights are set forth in a Rights Agreement
between the Company and American Stock Transfer & Trust Company,
as Rights Agent, dated April 11, 2007.

Common Stock

In July 2004, we received an assessment from the New York State
Department of Taxation and Finance for $1.4 million, including interest
and penalties, resulting from an audit of our state franchise tax returns
for the years 2000-2002. The assessment related to an unpaid license
fee due upon our entry into the state for the privilege of doing business
in the state. Management recorded its best estimate of the probable
liability resulting from the assessment in accrued liabilities and general
and administrative expense as of June 30, 2004 and engaged a professional

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, or AMEX, effective
September 17, 2006.

On July 10, 2006, we implemented a one-for-ten 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

64 INTERNAP | 2007 ANNUAL REPORT

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Financial Review 2007

stockholders’ 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 reflect the reverse stock split.

Executive Officer. This deferred compensation was reflected 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 reclassified
to additional paid-in capital.

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

On October 20, 2003, we issued warrants to purchase less than 0.1 million
shares of common stock at an exercise price of $9.50 in connection with
a private placement of our common stock. These warrants continue to
be outstanding and expire on August 22, 2008.

16. STOCK-BASED COMPENSATION PLANS

General

We have adopted SFAS No. 123R and related interpretations, using the
modified 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 APB Opinion No. 25 and related inter-
pretations. 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. As a result of adopting SFAS No. 123R on January 1, 2006, our
income before taxes and net income was $6.5 million and $5.1 million
lower, or $0.14 and $0.15 per basic and $0.13 and $0.14 per diluted
share, lower for the years ended December 31, 2007 and 2006, respectively,
than had we continued to account for stock-based compensation under
APB Opinion No. 25.

Deferred compensation related to 0.1 million shares of restricted stock
was granted in connection with the September 30, 2005 employment
agreement between the Company and its current President and Chief

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 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 modified. The measurement was based on the share price and
other pertinent factors at the date of modification.

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, 2007 and 2006 (in thousands):

INTERNAP | 2007 ANNUAL REPORT 65

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Financial Review 2007

Year Ended December 31,

Stock Compensation and Option Plans

Direct costs of customer support
Product development
Sales and marketing
General and administrative

Total stock-based compensation expense

included in net income

2007

$1,892
856
2,135
3,798

2006

$1,102
628
2,145
2,067

$8,681

$5,942

Less than $0.1 million of stock-based compensation was capitalized
during each of the years ended December 31, 2007 and 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 year ended December 31, 2005
(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

$ (4,964)

(9,678)

$(14,567)

$ (0.15)
(0.43)

Note that the above pro forma disclosure was not presented for the
twelve months ended December 31, 2007 and 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 fair values of outstanding stock options have been estimated at the
date of grant using a Black-Scholes option pricing model. The significant
weighted average assumptions used for estimating the fair value of the
activity under our stock option plans for the years ended December 31,
2007, 2006 and 2005, were expected terms of 6.2, 5.7 and 4.0 years,
respectively; historical volatilities of 114%, 123% and 118%, respectively;
risk free interest rates of 4.44%, 4.63% and 4.22%, respectively and no
dividend yield. The weighted average estimated fair value per share of
our employee stock options at grant date was $13.71, $7.75 and $3.50 for
the years ended December 31, 2007, 2006 and 2005, respectively. The
expected term represents the weighted average period of time that granted
options are expected to be outstanding, giving consideration to the vesting
schedules and our historical exercise patterns. Because our options are
not publicly traded, assumed volatility is based on the historical volatility
of our stock. The risk-free interest rate is based on the U.S. Treasury yield
curve in effect at the time of grant for periods corresponding to the expected
life of the options. We have also used historical data to estimate option
exercises, employee termination and stock option forfeiture rates.

On June 23, 2005, we adopted the Internap Network Services Corporation
2005 Incentive Stock Plan, or the 2005 Plan, which was amended and
restated on March 15, 2006. 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 are 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 specified preexisting plans, but each of the
specified 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,
2007, 3.0 million options were outstanding, 0.7 million shares of non-
vested restricted stock awards were outstanding and 2.3 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.

As a result of the acquisition of VitalStream as discussed in note 3,
we assumed the VitalStream Stock Option/Stock Issuance Plan, or the
VitalStream Plan, and all of the corresponding options to purchase stock.
Under the terms of the merger agreement, each VitalStream stock option
that was outstanding and unexercised was converted into an option to
purchase Internap common stock and we assumed that stock option in
accordance with the terms of the applicable VitalStream stock option plan
and terms of the stock option agreement. Based on VitalStream’s stock
options outstanding at February 20, 2007, we converted options to purchase
approximately 3.0 million shares of VitalStream common stock into
options to purchase approximately 1.5 million shares of Internap common
stock. We determined the fair value of the outstanding options using a
Black-Scholes valuation model with the following assumptions: volatility
of 48.8% to 120.1%; risk-free interest rates ranging from 4.7% to 5.1%;
remaining expected lives ranging from 0.18 to 6.25 years; and dividend
yield of zero.

The VitalStream Plan provided for the granting of incentive stock options,
non-statutory stock options or shares of common stock directly to certain
key employees, members of the board of directors, consultants, and

66 INTERNAP | 2007 ANNUAL REPORT

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Financial Review 2007

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. However, we may also use
treasury stock to satisfy option exercises.

During 2006, we completed an internal review of our prior stock option
granting practices. As a result of the review, we determined that approxi-
mately $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 FIN 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 financial 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 accompanying statement of operations.

independent contractors according to the terms of the plan. There were
5.4 million VitalStream shares, or 2.8 million Internap shares on a
post-converted basis, reserved for issuance under the plan and 0.5 million
VitalStream shares, or 0.3 million Internap shares on a post-converted
basis, available for grant. Generally, the assumed options had exercise
prices equal to the stock price on the date of grant and had contractual
terms of 5 years. Vesting schedules ranged from quarterly periods over
one year to four years with 1/4 th vesting after one year and 1/16 th vesting
each quarter thereafter.

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-qualified 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 option for 8,000 shares
of our common stock on the date such person is first 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 affiliates.
On January 18, 2007, the Board of Directors approved certain changes,
effective as of January 1, 2007, to compensation for non-employee
Directors. The annual stock option grant to each director is now an option
to acquire up to 5,000 shares instead of an option to acquire up to
2,000 shares of our common stock. These options also have an exercise
price equal to 100% of the fair market value of our common stock on
the date of grant and are fully vested and exercisable as of the date of
grant. Each Director also receives an annual grant of 2,500 restricted
stock awards , which vest ratably over a three-year period, subject to
the terms of the 2005 Plan, under which these restricted stock awards
are granted. In addition, new non-employee Directors receive a grant of
12,500 restricted stock awards , which vest ratably over a three-year period,
subject to the terms of the 2005 Plan and the stock grant agreement under
which the restricted stock awards are granted. As of December 31, 2007,
0.1 million options were outstanding and 0.2 million shares 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.

INTERNAP | 2007 ANNUAL REPORT 67

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Financial Review 2007

Option activity for each of the three years ended December 31, 2007, 2006, and 2005 under all of our stock option plans is as follows
(shares in thousands):

Balance, December 31, 2004
Granted
Exercised
Forfeitures and post-vesting cancellations

Balance, December 31, 2005
Granted
Exercised
Forfeitures and post-vesting cancellations

Balance, December 31, 2006
Granted

Assumed with the VitalStream Plan
Exercised
Forfeitures and post-vesting cancellations

Balance, December 31, 2007

Weighted
Average
Exercise Price

$16.96
4.92
4.51
19.15
13.49
9.30
5.84
19.94
11.07
15.74
10.81
6.74
14.23
$13.29

4,395
948
(202)
(1,585)
3,556
752
(497)
(1,112)
2,699
897
1,496
(1,241)
(678)
3,173

The total intrinsic value of options exercised was $11.8 million, $2.6 million and $0.2 million for the years ended December 31, 2007, 2006
and 2005, respectively.

The following table summarizes information about options outstanding at December 31, 2007 (shares in thousands):

Options Outstanding

Weighted
Average
Remaining
Contractual Life
(In Years)

4.1
7.5
8.1
5.4
4.3
9.0
4.6
6.5

Number of
Shares

172
608
624
484
518
456
311
3,173

Weighted
Average
Exercise Price

$ 4.05
4.80
7.54
11.60
16.55
18.82
35.60
$13.29

Options Exercisable

Weighted
Average
Remaining
Contractual Life
(In Years)

4.00
7.42
6.67
4.90
3.17
6.16
4.57
5.22

Number of
Shares

169
387
191
368
316
4
239
1,674

Weighted
Average
Exercise Price

$ 4.04
4.80
6.56
11.53
16.68
18.80
40.58
$13.80

Exercise Prices

$ 0.75 – $ 4.60
$ 4.80 – $ 4.80
$ 5.20 – $ 9.15
$ 9.40 – $ 13.64
$14.17 – $ 18.70
$18.80 – $ 18.82
$18.83 – $345.00
$ 0.75 – $345.00

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, 2007 of all options outstanding and expected to vest was $3.6 million. The total intrinsic value at December 31,
2007 of all options exercisable was $2.4 million.

68 INTERNAP | 2007 ANNUAL REPORT

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Financial Review 2007

Restricted stock activity for each of the three years ended December 31,
2007, 2006, and 2005 is as follows (shares in thousands):

Non-vested balance, December 31, 2004
Granted
Vested

Non-vested balance, December 31, 2005
Granted
Vested
Forfeited

Non-vested balance, December 31, 2006
Granted
Vested
Forfeited

Weighted-
Average
Grant Date
Fair Value

–
104
(4)

100
568
(158)
(90)

420
657
(161)
(237)

$ –
4.78
4.30

4.80
6.18
5.68
5.61

6.17
15.66
10.21
9.60

Non-vested balance, December 31, 2007

679

$13.19

The total fair value of restricted stock awards vested during the years
ended December 31, 2007, 2006, and 2005 was $2.3 million, $2.1 million,
and less than $0.1 million, respectively. The cumulative effect of the
change in the forfeiture rate for non-vested restricted stock was upon
the adoption of SFAS No. 123R was immaterial and recorded as part of
operating expense. The total intrinsic value at December 31, 2007 of all
non-vested restricted stock awards was $5.7 million.

Total unrecognized compensation costs related to non-vested stock-based
compensation as of December 31, 2007 and 2006, is summarized as
follows (dollars in thousands):

Unrecognized compensation
Weighted-average remaining
recognition period (in years)

Unrecognized compensation
Weighted-average remaining

recognition period (in years)

December 31, 2007

Stock Restricted
Stock

Options

Total

$10,532

$10,448

$20,980

2.7

3.0

2.9

December 31, 2006

Stock
Options

Restricted
Stock

Total

$ 9,309

$ 3,088

$12,397

2.7

3.0

2.8

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 purpose
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,” 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.

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 first day of the purchase period or 85% of such closing
price on the last day of the purchase period. The 2004 ESPP was intended
to be a non-compensatory plan for both tax and financial reporting purposes.
However, upon our adoption of SFAS No. 123R in the first quarter of
2006, we recognized compensation expense of $0.1 million during the
year ended December 31, 2006, representing the estimated fair value
of the benefit 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 first day of the offering period as a basis for determining the purchase
price. This amendment restored the plan to being non-compensatory for
financial reporting purposes and was 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. Less
than 0.1 million and approximately 0.1 million shares were granted under
the 2004 ESPP during each of the years ended December 31, 2007 and
2006, respectively. Cash received from participation in the 2004 ESPP
was $0.2 million and $0.5 million for the years ended December 31, 2007
and 2006, respectively. At December 31, 2007, 0.3 million shares were
reserved for future issuance under the 2004 ESPP.

At December 31, 2007, total shares reserved for future awards under all
plans were 6.0 million shares. Cash received from all stock-based
compensation arrangements was $8.6 million, $3.0 million and $1.5 million
for the years ended December 31, 2007, 2006 and 2005, respectively.

INTERNAP | 2007 ANNUAL REPORT 69

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Financial Review 2007

17. RELATED PARTY TRANSACTIONS

As discussed in note 6, we had an investment in Aventail, who was also
a customer for data center and connectivity services. We invoiced Aventail
$0.2 million during 2007 and $0.3 million during both 2006 and 2005.
As of December 31, 2007 and 2006, our outstanding receivable balance
with Aventail was less than $0.1 million. As discussed in note 4, we incurred
a charge during the period ended June 30, 2007, totaling $1.2 million,
representing the write-off of the remaining carrying value of our investment
in series D preferred stock of Aventail.

One of our executive officers has a material equity ownership interest in and
is a member of the board of directors of a customer of ours, Surfline/
Wavetrak, Inc., or Surfline. We invoiced Surfline $0.1 million during 2007,
of which $0.1 million was outstanding as of December 31, 2007. Surfline
was not a customer prior to 2007.

We have entered into indemnification agreements with our directors and
executive officers for the indemnification of and advancement of expense
to such persons to the fullest extent permitted by law. We also intend to
enter into these agreements with our future directors and executive officers.

18. UNAUDITED QUARTERLY RESULTS

The following table sets forth selected unaudited quarterly data for the years ended December 31, 2007 and 2006. We have revised our quarterly
statement of operations for the quarter ended September 30, 2007 to appropriately record (1) $0.5 million for sales adjustments, which reduce net
accounts receivable and revenue, and (2) $0.1 million for accretion of interest income that we initially included as unrealized gain in accumulated other
comprehensive income within stockholders’ equity. The effect of these revisions had no impact on our consolidated statement of cash flows. We have
determined that these adjustments are not material to our consolidated financial statements for any of the affected quarterly periods. Accordingly, we
have not revised the 2007 quarterly financial statements included in our previously filed Form 10-Q for the quarterly periods ended March 31, June 30
and September 30, 2007 for these adjustments. The quarterly operating results below are not necessarily indicative of those in future periods (in thousands,
except for share data).

2007

Revenues (1)
Direct costs of network, sales and services, exclusive of depreciation and amortization
Direct costs of amortization of acquired technologies
Direct costs of customer support
Restructuring and asset impairment
Acquired in-process research and development
Write-off of investment
Net (loss) income (2)
Basic and diluted net (loss) income per share (3)

March 31

$ 53,534
28,629
654
3,388
11,349
450
–
(10,695)
(0.26)

Quarter Ended

June 30

$58,494
29,617
1,054
4,330
–
–
1,178
(1,683)
(0.03)

September 30

December 31

$60,426
29,272
1,228
4,495
–
–
–
1,383
0.03

$61,636
30,876
1,229
4,334
–
–
–
5,440
0.11

(1) Amounts included in this table for the third quarter of 2007 are approximately $0.5 million lower than the amounts previously reported in our Form 10-Q for the quarterly period ended September 30, 2007.

(2) Amounts included in this table for the third quarter of 2007 are approximately $0.4 million lower than the amounts previously reported in our Form 10-Q for the quarterly period ended September 30, 2007.

(3) Amounts included in this table for the third quarter of 2007 are approximately $0.01 lower than the amounts previously reported in our Form 10-Q for the quarterly period ended September 30, 2007.

2006

Revenues
Direct costs of network, sales and services, exclusive of depreciation and amortization
Direct costs of amortization of acquired technologies
Direct costs of customer support
Restructuring and asset impairment
Net income
Basic and diluted net income per share

March 31

$ 42,625
22,217
137
2,897
–
541
0.02

Quarter Ended

June 30

$43,905
23,606
138
2,769
–
713
0.02

September 30

December 31

$45,874
25,236
137
2,930
319
195
0.01

$48,971
26,279
104
2,970
4
2,208
0.06

70 INTERNAP | 2007 ANNUAL REPORT

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Financial Review 2007

To the Board of Directors and Stockholders of
Internap Network Services Corporation

In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of operations, of stockholders’ equity
and comprehensive income (loss) and cash flows present fairly, in all
material respects, the financial position of Internap Network Services
Corporation and its subsidiaries, at December 31, 2007 and 2006, and the
results of their operations and their cash flows for each of the three years
in the period ended December 31, 2007 in conformity with accounting
principles generally accepted in the United States of America. Also in our
opinion, the Company did not maintain, in all material respects, effective
internal control over financial reporting as of December 31, 2007, based
on criteria established in Internal Control – Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO) because a material weakness in internal control over
financial reporting related to the completeness, accuracy, valuation and
disclosure of sales adjustments existed at that date. A material weakness
is a deficiency, or a combination of deficiencies, in internal control over
financial reporting, such that there is a reasonable possibility that a
material misstatement of the annual or interim financial statements will
not be prevented or detected on a timely basis. The material weakness
referred to above is described in Management’s Report on Internal Control
Over Financial Reporting appearing under Item 9A. We considered this
material weakness in determining the nature, timing, and extent of
audit tests applied in our audit of the 2007 consolidated financial
statements, and our opinion regarding the effectiveness of the Company’s
internal control over financial reporting does not affect our opinion on
those consolidated financial statements. The Company’s management
is responsible for these financial statements and financial statement
schedule, for maintaining effective internal control over financial reporting
and for its assessment of the effectiveness of internal control over
financial reporting, included in management’s report referred to above.
Our responsibility is to express opinions on these financial statements,
on the financial statement schedule, and on the Company’s internal control
over financial reporting based on our integrated audits. We conducted our
audits in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and
perform the audits to obtain reasonable assurance about whether the
financial statements are free of material misstatement and whether
effective internal control over financial reporting was maintained in all
material respects. Our audits of financial statements included examining,
on a test basis, evidence supporting the amounts and disclosures in the
financial statements, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall

financial statement presentation. Our audit of internal control over financial
reporting included obtaining an understanding of internal control over
financial reporting, assessing the risk that a material weakness exists,
and testing and evaluating the design and operating effectiveness of
internal control based on the assessed risk. Our audits also included
performing such other procedures as we considered necessary in the
circumstances. We believe that our audits provide a reasonable basis
for our opinions.

As discussed in Note 2 to the consolidated financial statements, the
Company changed the manner in which it accounts for share-based
compensation in 2006 and the manner in which it accounts for uncertain
tax positions in 2007.

A company’s internal control over financial reporting is a process designed
to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes
in accordance with generally accepted accounting principles. A company’s
internal control over financial reporting includes those policies and
procedures that (i) pertain to the maintenance of records that, in reasonable
detail, accurately and fairly reflect the transactions and dispositions of
the assets of the company; (ii) provide reasonable assurance that
transactions are recorded as necessary to permit preparation of financial
statements in accordance with generally accepted accounting principles,
and that receipts and expenditures of the company are being made
only in accordance with authorizations of management and directors
of the company; and (iii) provide reasonable assurance regarding
prevention or timely detection of unauthorized acquisition, use, or
disposition of the company’s assets that could have a material effect
on the financial statements.

Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that
the degree of compliance with the policies or procedures may deteriorate.

Atlanta, GA
March 28, 2008

INTERNAP | 2007 ANNUAL REPORT 71

STOCK PERFORMANCE GRAPH
Financial Review 2007

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 and the Hemscott Group Index, resulting from an initial assumed investment of $100 in each on December 31, 2002,
assuming the reinvestment of any dividends, ending at December 31, of each year, 2003 – 2007, respectively.

COMPARISON OF 5-YEAR CUMULATIVE TOTAL RETURN
AMONG INTERNAP NETWORK SERVICES CORP.,
NASDAQ MARKET INDEX AND HEMSCOTT GROUP INDEX

$700

$600

$500

$400

$300

$200

$100

2002

2003

2004

2005

2006

2007

Internap Network Services Corporation
Hemscott Group Index

NASDAQ Market Index

Assumes $100 Invested on Dec. 31, 2002
Assumes Dividend Reinvested
Fiscal Year Ending Dec. 31, 2007

72 INTERNAP | 2007 ANNUAL REPORT

STOCKHOLDER INFORMATION

Corporate Headquarters
Internap Network Services Corporation
250 Williams Street
Atlanta, GA 30303
404-302-9700
www.internap.com

Investor Relations
Andrew McBath
Director, Investor Relations
404-302-9700

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

Annual Report
A copy of Internap’s 2007 Annual Report on Form 10-K/A
for the year ended December 31, 2007, 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
Our 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 Small Cap Market from October 4, 2002
through February 17, 2004. The following table presents,
for the periods indicated, the range of high and low per
share sales prices for our common stock, as reported
on the NASDAQ Global Market since September 19,
2006 and on the American Stock Exchange prior to
September 19, 2006.

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On July 11, 2006, we implemented a one-for-ten reverse
stock split of our common stock. The information in the
following table has been adjusted to reﬂect this stock
split. Our ﬁscal year ends on December 31.

ﬂ

ﬁ

Year Ended December 31, 2007
Fourth Quarter
Third Quarter
Second Quarter
First Quarter

Year Ended December 31, 2006
Fourth Quarter
Third Quarter
Second Quarter
First Quarter

High

Low

$17.18
16.15
19.33
20.98

$21.25
16.80
15.50
10.60

$ 8.14
13.04
12.95
15.60

$14.10
9.30
9.00
4.20

As of March 6, 2008, the number of stockholders of record
of our common stock was approximately 24,600.
We have never declared or paid any cash dividends on our capital stock, and
we do not anticipate paying cash dividends in the foreseeable future. We are
prohibited from paying cash dividends under covenants contained in our
current credit agreement. We currently intend to retain our earnings, if any,
for future growth. Future dividends on our common stock, if any, will be at
the discretion of our Board of Directors and will depend on, among other
things, our operations, capital requirements and surplus, general ﬁnancial
condition, contractual restrictions and such other factors as our Board of
Directors may deem relevant.

ﬁﬁ

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.
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.

Corporate Headquarters

250 Williams Street

Atlanta, GA 30303

404-302-9700

www.inter nap.com

NASDAQ: INAP