Results
of Operations
Revenues
.
Revenues are generated primarily from the sale of IP services, data center
services and CDN services. Our revenues typically consist 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:
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costs
for connecting to and accessing NSPs and competitive local exchange
providers;
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facility
and occupancy costs for hosting and operating our and our customers’
network equipment;
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costs
of FCP solutions sold;
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costs
incurred for providing additional third party services to our customers;
and
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royalties
and costs of license fees for operating systems
software.
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To the
extent a network access point is located at a distance from the respective NSP,
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. We amortize the cost of the acquired technologies 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, we include facilities costs associated with the network operations
center 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. We capitalize costs for software to be sold, leased or otherwise
marketed once we establish technological feasibility until the software is
available for general release to customers. We capitalize costs associated with
internal use software when the software enters the application development stage
until the software is ready for its intended use. We expense all other product
development costs 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 web site 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.
Following
is a summary of our results of operations and financial condition, which is
followed by more in-depth discussion and analysis.
For the
year ended December 31, 2008, total revenues were $254.0 million, an increase of
8.5% over the year ended December 31, 2007. Data center services revenue was the
primary growth driver for the year, increasing 31% compared with 2007. We
reported a net loss for the year ended December 31, 2008 of $104.8 million,
which included (1) $99.7 million in impairment charges for goodwill, (2) $2.6
million in impairment charges for other intangible assets and (3) a net
adjustment of $1.0 million to increase our restructuring liability, primarily
related to anticipated sublease recoveries on restructured real
estate.
Cash and
short term investments in marketable securities were $54.1 million at December
31, 2008, compared with $71.6 million at December 31, 2007. The year-end 2007
balance included $7.2 million in auction rate securities which we reclassified
to long-term investments in the first quarter 2008. The outstanding balance on
our credit facility was $20.0 million at December 31, 2008, compared to $19.8
million at December 31, 2007.
Cash flow
from operations for 2008 was $38.0 million for 2008, representing an increase of
38% over the prior year. Capital expenditures for the year ended December 31,
2008 were $51.2 million, primarily for our data center expansion plan, but also
expansion of IP and CDN service points, some of which we implemented earlier
than planned to take advantage of economic opportunities.
The
following table sets forth, as a percentage of total revenue, selected statement
of operations data for the periods indicated:
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Year
Ended December 31,
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2008
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2007
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2006
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Revenues:
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|
|
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IP
services
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48.5
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%
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52.2
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%
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61.9
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%
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Data
center services
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43.2
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35.7
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31.2
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CDN
services
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8.3
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7.6
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—
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Other
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—
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4.5
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6.9
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Total
revenues
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100.0
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100.0
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100.0
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Operating
costs and expenses:
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Direct
costs of network, sales and services, exclusive of depreciation and
amortization, shown below:
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IP
services
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18.0
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18.8
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22.4
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Data
center services
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32.3
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25.4
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25.6
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CDN
services
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3.2
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2.8
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—
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Other
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—
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3.6
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5.6
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Direct
costs of amortization of acquired technologies
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2.6
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1.8
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0.3
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Direct
costs of customer support
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6.4
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7.1
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6.4
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Product
development
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3.3
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2.8
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2.5
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Sales
and marketing
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12.2
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13.4
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15.0
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General
and administrative
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12.1
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12.9
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11.9
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Provision
for doubtful accounts
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2.0
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1.0
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0.3
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Depreciation
and amortization
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9.3
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9.5
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8.7
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Goodwill
impairment
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39.3
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—
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—
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Restructuring
and other impairments
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0.7
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4.9
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0.2
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Other
operating costs and expenses
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—
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0.2
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(0.1
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)
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Total
operating costs and expenses
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141.4
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104.2
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98.8
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(Loss)
income from operations
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(41.4
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)%
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(4.2
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)%
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1.2
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%
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Segment
Information
. We operate in 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” below.
Our
reportable segments are strategic business units that offer different products
and services. As of December 31, 2008, we had approximately 3,600 customers
across more than 20 metropolitan markets.
Revenues
Revenues
for the years ended December 31, 2008, 2007 and 2006 are summarized as follows
(in thousands):
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Year
Ended December 31,
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2008
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2007
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2006
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IP
services
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$
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123,268
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$
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122,205
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$
|
112,250
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Data
center services
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109,679
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83,632
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|
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56,548
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|
CDN
services
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21,042
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|
|
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17,806
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|
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|
—
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Other
|
|
|
—
|
|
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|
10,447
|
|
|
|
12,577
|
|
|
|
$
|
253,989
|
|
|
$
|
234,090
|
|
|
$
|
181,375
|
|
IP
Services
. Revenue for IP services increased $1.1 million, or 1%, to
$123.3 million for the year ended December 31, 2008, compared to $122.2 million
for the year ended December 31, 2007. The increase in IP revenues is driven by
an increase in demand for our services, partially offset by a decline in IP
pricing. We continue to experience increasing demand for our traditional IP
services, with IP traffic increasing approximately 44% for the year ended
December 31, 2008 compared to the year ended December 31, 2007. The increase in
IP traffic has resulted from 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. Ongoing industry-wide
pricing declines over the last several years, however, have offset a large
portion of our gains in IP traffic. The effective price we charge our customers
for IP services, measured in megabits per second, or Mbps, decreased
approximately 33% for the year ended December 31, 2008 compared to the year
ended December 31. 2007. There was a net increase in IP services customers
from December 31, 2007 to December 31, 2008, and these new customers added
approximately $8.1 million of revenue during 2008. While these new customers are
generally using more bandwidth, their additional contribution to revenue was
partially offset by the loss of older customers who were paying higher effective
prices for IP services. IP services revenue also includes FCP sales and other
hardware sales of $4.8 million and $4.6 million for the years ended December 31,
2008 and 2007, respectively.
Revenues
for IP services increased more than $9.9 million, or 9%, to $122.2 million for
the year ended December 31, 2007, compared to $112.3 million for the year ended
December 31, 2006. In addition to the increase in demand, as discussed above, we
experienced an increase in sales of our premise-based FCP products and other
large hardware sales of approximately $1.0 million. IP traffic for the year
ended December 31, 2007 increased approximately 35% from the year ended December
31, 2006. In addition to the demand for greater bandwidth, we added high-traffic
customers through competitive IP pricing and minimum commitments during the year
ended December 31, 2007. However, pricing declines caused the blended rate in
Mbps to decrease approximately 26% 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 primarily to disputes over contractual service
periods.
Data Center
Services
. Data center services are a significant source of revenue growth
for our business. Revenues for data center services increased approximately
$26.0 million, or 31%, to $109.7 million for the year ended December 31, 2008,
compared to $83.6 million for the year ended December 31, 2007. This increase is
primarily due to our data center growth initiative, as discussed below, which we
began executing during 2007 and is on-going. We had a net increase of customers
from December 31, 2007 to December 31, 2008 and new data center services
customers added approximately $7.8 million of revenue during 2008. Furthermore,
customer demand has resulted in a 24% increase in installed cabinets in
2008.
Revenues
for data center services increased $27.1 million, or 48%, to $83.6 million for
the year ended December 31, 2007, compared to $56.5 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 revenues 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 revenues
resulted from both new and existing customers and was largely due to new and
existing customers using more space within our facilities, and the design and
installation revenues from new customers. We also structured our data center
business to accommodate larger, global customers and ensure a platform for
robust traffic growth.
CDN
Services
. Revenues for our CDN services segment increased $3.2 million,
or 18%, to $21.0 million for the year ended December 31, 2008, compared to $17.8
million for the year ended December 31, 2007. Our 2007 results included CDN
activity from the acquisition date of VitalStream on February 20, 2007. We
expect CDN services to be an area of growth and have upgraded and expanded
related infrastructure, including in Europe and Asia, to serve the expected
industry-wide demand. Also, we extended our 100% uptime SLA to customers
purchasing or renewing CDN services after January 1, 2008. CDN services
revenues and operating results for the year ended December 31, 2008 were lower
than projected, primarily due to: (1) integration and reliability issues in the
acquired network, which we have resolved, (2) a strategic shift to larger,
higher credit quality customers and (3) more recently, a highly-competitive
market environment for CDN services that is driving our prices lower. As
discussed in note 8 to the accompanying financial statements and below, we
recorded asset impairment charges of $102.3 million related to our CDN services
goodwill and other intangible assets.
Revenues
for the year ended December 31, 2007 were lower than originally anticipated as
we integrated the VitalStream business with and into our network and
infrastructure. 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 was included in “—Other” below. In the second half of 2007,
we experienced platform instability in our 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 approximately $1.4 million in sales and billing adjustments related to
both service interruptions and disputes over contractual service periods. We
recorded these sales and billing adjustments against revenues. As we
purchased VitalStream in 2007, we did not have revenue in that segment for the
year ended December 31, 2006.
Other
.
Other revenues consist primarily of third party CDN services. Throughout 2007,
the CDN services we began to provide following our acquisition of VitalStream
steadily 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 $1.9 million, or 4%, to $45.8 million
for the year ended December 31, 2008, compared to $43.9 million for the year
ended December 31, 2007. Direct costs of IP network, sales and services were 37%
of IP services revenues for the year ended December 31, 2008 and 36% for the
year ended December 31, 2007. IP services segment profit decreased $0.8 million
to $77.5 million for the year ended December 31, 2008, from $78.3 million for
the year ended December 31, 2007. Connectivity costs vary based upon
customer traffic and other demand-based pricing variables. Costs for IP services
are subject to ongoing negotiations for pricing and minimum commitments. During
the year ended December 31, 2008, we continued to renegotiate our agreements
with our major network service providers, which resulted in higher minimum
commitments but lower bandwidth rates. 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.
Direct
costs of IP network, sales and services, exclusive of depreciation and
amortization, increased $3.2 million, or 8%, to $43.9 million for the year ended
December 31, 2007, compared to $40.7 million for the year ended December 31,
2006. While IP services revenue increased, the direct costs of IP network,
sales and services were approximately 36% of IP services revenue for both 2007
and 2006. We maintained direct costs as a percentage of IP services revenue,
even though we had a change in the mix of revenue with a number of lower margin
high volume customers and FCP and other hardware sales.
Data Center
Services
. The direct costs of data center services, exclusive of
depreciation and amortization, increased $22.6 million, or 38%, to $82.0 million
for the year ended December 31, 2008, compared to $59.4 million for the year
ended December 31, 2007. Data center services contributed $27.7 million of
segment profit for the year ended December 31, 2008, an increase of $3.5 million
from $24.2 million for the year ended December 31, 2007. Direct costs of
data center services as a percentage of corresponding revenues has increased to
75% for the year ended December 31, 2008 from 71% for the year ended December
31, 2007.
The
direct costs of data center services, exclusive of depreciation and
amortization, increased approximately $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. Data center services contributed $24.2 million of
segment profit for the year ended December 31, 2007, an increase of $14.1
million from $10.1 million for the year ended December 31, 2006. As data center
services revenue increased, direct costs of data center services as a percentage
of corresponding revenue decreased to approximately 71% for the year ended
December 31, 2007 from 82% for the year ended December 31, 2006. This trend was
the result of an increase in total occupancy at higher rates, as discussed with
revenues above, while substantial direct costs were subject to previously
negotiated rates.
The
growth in data center revenues and direct costs of data center services largely
follows our expansion of data center space, and we believe the demand for data
center services continues to outpace industry-wide supply. 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. Direct costs of data center services as a
percentage of revenues vary with the mix of usage between sites operated by us
and third parties, referred to as partner sites, as well as the utilization of
total available space. While we recognize some of the initial operating
costs, especially rent, of sites operated by us in advance of revenues, these
sites are more profitable at certain levels of utilization than the use of
partner sites. Conversely, costs in partner sites are more demand-based and
therefore are more closely associated with the recognition of revenues. We
seek to optimize the most profitable mix of available data center space operated
by us and our partners. The increase in initial operating costs of sites
operated by us as well as our increased use of partner sites drove the higher
percentage of direct costs for the year ended December 31, 2008 compared to the
year ended December 31, 2007. We continue to expand the sites operated by us and
expect to have more of this space available to be used in the future as part of
our data center growth initiative. We expect direct costs of data center
services as a percentage of corresponding revenues to decrease as the recently
expanded sites operated by us contribute to revenue and become more fully
utilized.
During
the year ended December 31, 2008, we added approximately 17,000 square feet of
data center space in sites operated by us and 22,000 square feet in partner
sites. At December 31, 2008, we had approximately 218,000 square feet of data
center space with a utilization rate of 77% as compared to approximately 179,000
square feet of data center space with a utilization rate of 75%, at
December 31, 2007. At December 31, 2006, we had approximately 149,000 square
feet of data center space with a utilization rate of 79%. We expect our recent
data center expansion to provide us lower costs per occupied square foot in
future periods, enabling us to increase revenues compared to relatively lower
direct costs of data center services. At December 31, 2008, 121,000 square
feet of occupied data center space, or 55% of our total square feet, was in data
centers operated by us versus partner sites as compared to 104,000 square feet
or 58% of our total square feet at December 31, 2007 and 88,000 square feet or
59% of our total square feet at December 31, 2006. Additionally, 76% and 62% of
our available square feet as of December 31, 2008 and 2007, respectively, were
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 increased $1.5
million to $8.1 million for the year ended December 31, 2008, compared to $6.6
million for the year ended December 31, 2007. Segment profit for CDN services
increased more than $1.7 million to $13.0 million for the year ended December
31, 2008 from $11.2 million for the year ended December 31, 2007. As noted
above, costs for the year ended December 31, 2007 only included activity after
our acquisition of VitalStream on February 20, 2007. Direct costs of CDN
network, sales and services were 38% of CDN services revenues for the year ended
December 31, 2008, compared to 37% for the year ended December 31, 2007. The
direct costs in 2008 include the benefit of lower rates as we have migrated
VitalStream’s former contracts and terms to our own since the
acquisition. However, the increase in direct costs as a percentage of
revenues is primarily related to increased price competition within the
market. Direct costs of CDN network sales and services also include an
allocation of direct costs of IP network sales and services based on the average
cost of actual usage by the CDN segment. The allocation of direct costs of IP
network sales and services was $1.1 million and $0.9 million for the years ended
December 31, 2008 and 2007, respectively. The CDN segment will also further
benefit from the renegotiated rates with our network service providers discussed
above under IP Services. As we purchased VitalStream in 2007, we did not have
costs for that segment for the year ended December 31, 2006.
Other
.
Other direct costs of network, sales and services consist primarily of third
party CDN services. Throughout 2007, the CDN services we began to provide
following our acquisition of VitalStream steadily replaced the activity of the
former third party CDN service provider.
Other
Operating Expenses
Other
than direct costs of network, sales and services, our compensation and
facilities-related costs have the most pervasive impact on operating
expenses. Compensation and benefits comprise our next largest expense after
direct costs of network, sales and services. Cash-basis compensation and
benefits decreased $2.2 million to $50.4 million for the year ended December 31,
2008 from $52.6 million for the year ended December 31, 2007. Stock-based
compensation decreased $1.2 million to $7.5 million for the year ended December
31, 2008 from $8.7 million for the year ended December 31, 2007. The decrease in
cash-basis compensation and benefits is due to the elimination of the bonus
accrual for 2008 compared to an accrual of $2.9 million for 2007, a $2.0 million
reduction in commissions and a larger Georgia Headquarters Tax Credit, or HQC.
The elimination of the bonus accrual for 2008 was the result of our compensation
committee’s decision not to award employee bonuses given that we did not meet
established performance goals. The reduction in commissions was primarily due to
higher sales quotas under a new commission plan, adjustments for failing to meet
sales quotas and an increase in the number of new sales personnel and open sales
positions. The HQC increased to $1.3 million in 2008 from $0.3 million in 2007.
We record the HQC when approved by the Georgia Department of Revenue. These
credits were approved with the stipulation that we apply them against our
payroll tax liability. These decreases are partially offset by annual pay
increases for employees effective April 1, 2008 and having a full 12 months of
CDN employee expense compared to 10 months in 2007. The decrease in stock-based
compensation is primarily due to fewer grants of stock-based awards and
a lower fair value for new awards based on our lower stock price. Total
headcount was relatively consistent increasing to approximately 430 at December
31, 2008 compared to approximately 420 at December 31, 2007.
Cash-basis
compensation and benefits increased more than $11.5 million to $52.6 million for
the year ended December 31, 2007 from $41.0 million for the year ended December
31, 2006. Stock-based compensation increased approximately $2.7 million to $8.7
million for the year ended December 31, 2007 from $5.9 million for the year
ended December 31, 2006. The increases in compensation and benefits were
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, including at the senior management level. Total
headcount increased to approximately 420 at December 31, 2007 compared to
approximately 330 at December 31, 2006.
Stock-based
compensation is summarized by the following financial statement captions (in
thousands):
|
|
|
|
|
|
|
|
|
|
|
|
Year
ended December 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
Direct
costs of customer support
|
|
$
|
1,369
|
|
|
$
|
1,892
|
|
|
$
|
1,102
|
|
Product
development
|
|
|
688
|
|
|
|
856
|
|
|
|
628
|
|
Sales
and marketing
|
|
|
1,782
|
|
|
|
2,135
|
|
|
|
2,145
|
|
General
and administrative
|
|
|
3,660
|
|
|
|
3,798
|
|
|
|
2,067
|
|
Total
stock-based compensation expense included in net income
|
|
$
|
7,499
|
|
|
$
|
8,681
|
|
|
$
|
5,942
|
|
Total
unrecognized compensation costs related to unvested stock-based compensation as
of December 31, 2008 was $16.6 million with a weighted-average remaining
recognition period of 2.6 years.
Facilities
and related costs, including repairs and maintenance, communications and office
supplies but excluding direct costs of network, sales and services, is our next
largest recurring expense and increased $0.6 million, or 8%, to $7.6 million for
the year ended December 31, 2008 compared to $7.0 million for the year ended
December 31, 2007. The increase is primarily due to the relocation and
upgrade of one of our sales offices to a new, larger space and having a full 12
months of CDN operating expenses, partly offset by ongoing cost containment
efforts.
Facilities
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 was
primarily attributable to $0.7 million of VitalStream post-acquisition operating
costs.
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 to $6.6 million for the year ended December 31,
2008, from $4.2 million for the year ended December 31, 2007. The increase
of approximately $2.4 million included a $1.9 million impairment in developed
advertising technology due to a strategic change in market focus. See “—Goodwill
Impairment” and “–Restructuring and Other Impairments” below for further
discussion of the impairment of goodwill and other intangible assets. Also
included in direct costs for 2008 is additional amortization expense
attributable to a full 12 months of amortization of post-acquisition intangible
technology assets related to CDN services.
Direct
costs of amortization of acquired technologies increased approximately $3.6
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 was
attributable to the amortization of the post-acquisition intangible technology
assets of VitalStream.
Direct Costs of
Customer Support
. Direct costs of customer support decreased 2% to $16.2
million for the year ended December 31, 2008, from $16.5 million for the year
ended December 31, 2007. The decrease of $0.3 million was primarily due to a
$0.5 million decrease in stock-based compensation, as previously discussed,
partially offset by a $0.3 million increase in cash-basis compensation. The
increase in cash-basis compensation is primarily due to annual employee pay
increases.
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 approximately $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
$1.7 million and $0.3 million, respectively, whereas facilities-related costs
increased $0.6 million.
Product
Development
. Product development costs for the year ended December 31,
2008 increased 29% to $8.5 million from $6.6 million for the year ended December
31, 2007. The product development cost increase of $1.9 million is attributable
to increases in cash-basis compensation and benefits and professional services.
The increase in cash-basis compensation was $1.2 million, and included the
transfer of certain employees to product development that were formerly in
professional services and customer support roles in sales and marketing and
direct costs of customer support. The increase in professional services costs of
$0.7 million was due to the use of third party vendors for certain engineering
services that were previously performed by our employees in 2007, especially
with respect to our CDN services.
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.
Sales and
Marketing
. Sales and marketing costs for the year ended December 31, 2008
decreased 2% to $30.9 million from $31.5 million for the year ended December 31,
2007. The decrease of $0.6 million was comprised primarily of a net $0.4 million
decrease for cash-basis compensation and benefits and a $0.4 million decrease in
stock-based compensation. The net decrease in cash-basis compensation included a
$2.0 million decrease in commissions. The reduction in commissions was primarily
due to higher sales quotas under a new commission plan, adjustments for failing
to meet sales quotas and an increase in the number of new sales personnel and
open sales positions. Stock-based compensation also decreased due to the reasons
previously discussed.
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
approximately $4.3 million was 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.
General and
Administrative
. General and administrative costs for the year ended
December 31, 2008 increased 1% to $30.7 million from $30.3 million for the year
ended December 31, 2007. The increase of $0.4 million reflected a $3.4 million
increase in professional services costs, a $0.4 million increase in facilities
and related costs, partially offset by a $3.2 million decrease in cash-basis
compensation. Professional services costs were higher due primarily to
contract labor, higher accounting fees, especially associated with bringing
current our international statutory audits, use of consultants for process
improvements and other outside services. The increase in facilities and related
costs is discussed above. Cash-basis compensation and benefits decreased due
primarily to a elimination of the bonus accrual of $2.9 million, as
discussed above.
General
and administrative costs for the year ended December 31, 2007 increased 40% to
$30.3 million from $21.6 million for the year ended December 31, 2006. The
increase of $8.7 million was 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 $3.5 million, including $1.0 million for the additional VitalStream
employees. As discussed earlier, the increase in cash-basis compensation was
also due to the hiring of other employees, 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 during 2006 and caused higher
self-insured medical claims of $0.6 million compared to 2006. Professional
services for the year ended December 31, 2007 increased $2.2 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. 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.
On
January 29, 2009, we announced the resignation of James P. DeBlasio from
his positions as President and Chief Executive Officer effective as of March 16,
2009, or the Separation Date. Mr. DeBlasio also has resigned as a director
effective March 15, 2009. Pursuant to the terms of a separation agreement, Mr.
DeBlasio will receive (1) a cash payment of $0.9 million, (2) full vesting of
all equity awards previously granted to him as of the Separation Date and (3) if
he so elects, continued health, dental and vision insurance coverage under our
group health plan for 18 months from the Separation Date at no cost to
him. Mr. DeBlasio has 12 months following the Separation Date in which to
exercise any stock options held by him that were vested as of the Separation
Date. We will record the associated severance in general and administrative
costs during the three months ended March 31, 2009. Also on January 29,
2009, we announced the appointment of J. Eric Cooney as our President and Chief
Executive Officer and as a director, effective March 16, 2009.
Provision for
Doubtful Accounts
. The provision for doubtful accounts increased to $5.1
million for the year ended December 31, 2008, from $2.3 million for the year
ended December 31, 2007. The increase during 2008 resulted from our periodic
review of the aged accounts receivable balances, taking into consideration
current economic conditions and was primarily attributable to our CDN and IP
segments. We believe the ability to collect these valid receivables has become
uncertain due to changes in customer circumstances. A number of the CDN
customers that have been reserved as doubtful accounts were customers in 2007
and early 2008, but have since been disconnected from our service for failing to
remit payment. We will continue to strongly focus on our customers’ ability
to make payment in light of the current economic conditions and put in
additional upfront requirements such as prepayments or deposits for new
customers before commencing delivery of our services given the challenging
economic environment expected to continue in 2009 and beyond.
The
provision for doubtful accounts increased to $2.3 million for the year ended
December 31, 2007, from $0.5 million for the year ended December 31, 2006. The
increase in the provision for doubtful accounts was primarily due to our
integration of VitalStream with its legacy customers causing the provision for
doubtful accounts to be greater than our historical expense.
Depreciation and
Amortization
. For the year ended December 31, 2008, depreciation and
amortization, including other intangible assets but excluding acquired
technologies, increased 7% to $23.9 million compared to $22.2 million for the
year ended December 31, 2007. The increase of approximately $1.6 million
primarily related 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.
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 approximately $6.3 million primarily related to post-acquisition
depreciation and amortization of VitalStream property and equipment and acquired
amortizable intangible assets, excluding amortization of acquired technologies.
The VitalStream property and equipment and acquired amortizable intangible
assets accounted for $5.8 million of the expense for the year ended December 31,
2007. The remaining increase in depreciation and amortization related to
the expansion of P-NAPs and on-going expansion of data center
facilities.
Goodwill
Impairment
. As a result of our August 1, 2008 annual assessment of
goodwill, we recorded a $99.7 million goodwill impairment charge to
adjust goodwill in our CDN services segment to an implied fair value of $54.7
million.
The
goodwill impairment was primarily due to declines in our CDN services revenues
and operating results as compared to our projections and unfavorable changes in
market factors used to estimate fair values. The declines in CDN services
revenues and operating results compared to projections were attributable to
integration and reliability issues in the acquired network that have now been
resolved, a strategic shift to larger, higher credit quality customers and more
recently, a highly-competitive market environment for CDN services that is
driving lower pricing. Changes in market factors included lower market
multiples across the CDN services industry from the time we completed the
VitalStream acquisition and our own current lower market
capitalization. The culmination of these factors leading to our impairment
of goodwill did not occur until the three months ended September 30,
2008. The impairment charge did not have any impact on our
current cash balance or future cash expenditures, or result in violation of any
covenants of our debt instruments.
The
impairment also caused us to reverse a deferred tax liability and create an
income tax benefit of $0.6 million associated with the CDN services
goodwill.
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. We also
assessed the likelihood of triggering events and concluded that none had
occurred that would cause us to re-assess goodwill for impairment subsequent to
August 1, 2008.
Restructuring and
Other Impairments
. In conjunction with our review of our long-term
financial outlook, which includes our annual assessment of goodwill for
impairment, as discussed above, we also performed an analysis of the potential
impairment and re-assessed the remaining asset lives of other identifiable
intangible assets acquired in the VitalStream acquisition. The analysis and
re-assessment of other identifiable intangible assets recorded in the
VitalStream acquisition resulted in:
|
|
|
|
●
|
an
impairment charge of $1.9 million in developed advertising technology due
to a strategic change in market focus,
|
|
●
|
an
impairment charge of $0.8 million in trade names as a result of
discontinuing use of the VitalStream trade name, and
|
|
●
|
a
change in our estimates that resulted in acceleration of amortization
expense of our customer relationships intangible asset over a shorter
estimated useful life (four remaining years instead of the original
estimated nine years) due to customer churn resulting in higher than
expected attrition as of the acquisition
date.
|
The impairment
charge of $1.9 million for developed advertising technology is included in
“Direct costs of amortization of acquired technologies” in the accompanying
consolidated statements of operations. The impairment charge of $0.8
million for the trade name is included in “Restructuring and other impairments”
in the accompanying consolidated statements of operations. None of
the impairment charges had any impact on our current cash balance or future
cash expenditures, or resulted in violation of any covenants of our debt
instruments. The change in accounting estimate for our customer
relationship intangible asset resulted in an increase to our net loss of $0.4
million, or less than $0.01 per basic or diluted share, for the year ended
December 31, 2008.
In
conjunction with the preparation of our financial statements as of and for the
year ended December 31, 2008 and in light of the recent and significant
deterioration in the real estate market, we completed an analysis of our
remaining accrued restructuring liability for leased facilities. After reviewing
the analysis and specifically, the underlying assumptions related to anticipated
sublease recoveries, we concluded that certain of the facilities remaining in
the restructuring accrual were taking longer than expected to sublease or were
otherwise not generating the expected levels of sublease income. The analyses
were based on discounted cash flows using the same credit-adjusted risk-free
rate that we used to measure the initial restructuring liability for leases that
were part of the 2007 restructuring plan and undiscounted cash flows for leases
that were part of the 2001 restructuring plan. The cumulative effect of these
changes was $1.1 million, which we recorded as additional restructuring expense
and an increase to the liability. We also recorded a non-cash benefit of $0.1
million in the three months ended September 30, 2008 to reduce our restructuring
liability for employee separations. This non-cash adjustment removes the
liability for employee separations since we paid all such amounts. Both of these
adjustments to the restructuring liability are reported in “Restructuring and
other impairments” in the accompanying consolidated statement of
operations.
During
the three months ended March 31, 2007, we incurred restructuring and impairment
charges totaling $11.3 million. The charges were 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 of 2007. The charges 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 charges also
included severance payments of $1.1 million for the termination of certain
employees and $1.4 million for impairment of assets. After considering the
adjustments for anticipated changes in sublease income described above, we
estimated net related expenditures for the 2007 restructuring plan to be $12.2
million, of which we paid $4.2 million through December 31, 2008, and the
balance continuing through December 2016, the last date of the longest lease
term. We expected these expenditures to be paid out of operating cash flows. We
estimated cost savings from the restructuring to be approximately $0.8 million
per year through 2016, primarily for rent.
We also
incurred a $1.1 million impairment charge during the three months ended March
31, 2007 for the sales order-through-billing system, which was the result of an
evaluation of the existing infrastructure relative to our new financial
accounting system and the acquisition of VitalStream. This impairment charge was
not related to any specific business segment.
Non-operating
Income and Expense
. For the year ended December 31, 2008, interest income
decreased $1.3 million to $1.9 million from $3.2 million for the year ended
December 31, 2007, a decrease of 42%. The decrease reflects a reduction in total
interest-earning investments, a move toward lower-risk investments and lower
overall interest rates. Other non-operating expense for the year ended December
31, 2008 included a net reduction in fair value of $0.8 million on our auction
rate securities offset by the $0.6 million fair value of our ARS Rights, as
described in note 6 to our accompanying consolidated financial
statements.
During
2007, 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 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.
Provision
(Benefit) for Income Taxes
. The provision for income taxes was $0.2
million for the year ended December 31, 2008 and a net benefit of $3.1 million
for the year ended December 31, 2007. For the year ended December 31, 2007, the
tax provision included 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 consisted 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 the recoverability of U.S. and other deferred tax assets, and
whether the valuation allowance should be reduced relative to the U.S. and other
deferred tax assets outside the U.K. We may recognize deferred tax assets in
future periods when they are estimated to be realizable, such as establishing
expected continuing profitability of us or certain of our foreign
subsidiaries.
Based on
analysis of our projected future U.S. pre-tax income, we may have sufficient
positive evidence within the next 12 months to release the valuation allowance
currently recorded against our U.S. deferred tax assets. Currently, while we
cannot guarantee that our expectations of future positive income will occur, we
may recognize an income tax benefit derived from total U.S. deferred tax assets
upon the release of the valuation allowance. This potential release of the
valuation allowance could be affected by an ownership change as defined by
Section 382 of the Internal Revenue Code which might limit the future use of our
U.S. net operating loss carryovers and thus reduce the potential benefit of such
losses in the future to offset taxable income and reduce cash outflows for
income taxes.
Liquidity
and Capital Resources
Cash
Flows for the Years Ended December 31, 2008, 2007 and 2006
Net
Cash from Operating Activities
. Net cash provided by operating activities
was $38.0 million for the year ended December 31, 2008. Our net loss, adjusted
for non-cash items, generated cash from operations of $41.7 million while
changes in operating assets and liabilities represented a use of cash from
operations of $3.8 million. We anticipate continuing to generate cash flows
from our results of operations, or net (loss) income adjusted for non-cash
items, and manage changes in operating assets and liabilities towards a net $0
change in subsequent periods. We also expect to use cash flows from operating
activities to fund a portion of our capital expenditures and other requirements
and to meet our other commitments and obligations, including outstanding debt,
as they become due.
The
primary non-cash adjustment in the year ended December 31, 2008 was $102.3
million for impairment of goodwill and other intangible assets further discussed
above in the section “Results of Operations—Other Operating Expenses—Goodwill
Impairment.” We also had a non-cash adjustment of $28.7 million for depreciation
and amortization, which included the amortizable intangible assets acquired
through the acquisition of VitalStream in 2007 and the expansion of our P-NAP
and data center facilities throughout 2007 and 2008. Non-cash adjustments in
2008 also included $7.5 million for stock-based compensation expense and $5.1
million for the provision for doubtful accounts, both of which are further
discussed above in the section “Results of Operations—Other Operating Expenses.”
The changes in operating assets and liabilities included increases in inventory,
prepaid expenses, deposits and other assets of $2.9 million, mostly due to
increases in prepaid colocation setup costs and prepaid rent, as well as two
initial deposits required by real estate leases. We had a decrease in accrued
liabilities of $1.4 million given that we did not accrue any amounts for bonuses
for the year ended December 31, 2008, which is discussed above in the section
“Results of Operations—Other Operating Expenses.” We also had a net decrease in
accrued restructuring of $1.1 million due primarily to scheduled cash payments
during the year ended December 31, 2008. These changes were partially offset by
a decrease in accounts receivable of $2.4 million. Accounts receivable as of
December 31, 2007 reflected some collection delays on certain larger, high
credit quality customers that tended to pay over longer terms and an increase
from the migration of legacy VitalStream and other customers to our billing and
systems platforms. Quarterly days sales outstanding at December 31, 2008
decreased to 40 days from 53 days at December 31, 2007. The 53 days sales
outstanding at December 31, 2007 was unusually high and related to an
increased accounts receivable balance, discussed below.
Net cash
provided by operating activities was $27.5 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 included the amortizable
intangible assets acquired through the acquisition of VitalStream in February
2007 and the expansion of our P-NAP and data center facilities throughout 2007.
Non-cash adjustments also included $8.7 million for stock-based compensation
expense, which is discussed above in “—Results of Operations.” The change in
working capital included an increase in accounts receivable of $15.8 million.
The increase in accounts receivable resulted in quarterly days sales outstanding
at December 31, 2007 increasing to 53 days from 38 days as of December
31, 2006. This increase in accounts receivable was largely due to revenue growth
and also, in part, our day sales outstanding trending up from lower than
historical levels at December 31, 2006. We also experienced collection
delays on certain larger, high credit quality customers that tended to pay over
longer terms and in conjunction with the migration of some former VitalStream
and other customers to our billing and systems platforms. The change in working
capital also included 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 was
also caused by the implementation near year-end of a new telecommunications
expense management system for our direct costs.
Net cash
provided by operating activities was $29.4 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 $25.2 million offset by changes in working capital items of
$0.5 million. The changes in working capital items included 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 was primarily related to the timing of payments with the
2006 balance being consistent with our normal operating expenses and payment
terms.
Net
Cash from Investing Activities
. Net cash used in investing activities for
the year ended December 31, 2008 was $41.7 million primarily due to capital
expenditures of $51.2 million, partially offset by net proceeds from the
maturities and sales of short-term investments in marketable securities of $5.2
million and a decrease in restricted cash of $4.1 million. Our capital
expenditures were principally for the continued expansion of our data center
facilities, CDN infrastructure and upgrading our P-NAP facilities. Restricted
cash decreased due to the maturity of certificates of deposit that were securing
certain letters of credit, which we replaced. These letters of credit are now
secured by our revolving credit facility.
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 below in
“Liquidity—Credit Agreement.” Investing activities for the year ended
December 31, 2007 also included purchases and sales of auction rate
securities.
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 from Financing Activities
. Net cash used in financing activities for
the year ended December 31, 2008 was $0.8 million, primarily for payments on
capital leases of $0.8 million. We also repaid and re-borrowed $20.0 million on
our credit facility to best manage net interest income and expense. We entered
into the second amendment to our credit agreement on September 30,
2008. This amendment, among other things, converted our term loan balance
into a loan outstanding under the revolving line of credit facility. See
the discussion below in “Liquidity—Credit Agreement,” for more details of our
credit agreement. As a result of these activities, we had balances of $20.0
million in notes payable and $3.5 million in capital lease obligations as of
December 31, 2008 with $0.3 million in the capital leases scheduled as due
within the next 12 months. We may also utilize additional borrowings under our
credit agreement if we consider it economically favorable to do
so.
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 a 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.
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.
Liquidity
We are
continuing to monitor and review our performance and operations in light of the
continuing negative global economic conditions. In particular, 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. A prolonged recession, if it were to occur, may have an adverse impact on
spending by the businesses we serve, resulting in a decline in demand for our
products and services. In addition, deteriorating economic conditions may
make it more difficult for these businesses to meet their obligations to us,
which could result in delayed collection of accounts receivable and an increase
in our provision for doubtful accounts. To date, we have increased our
provision for doubtful accounts, in part after taking into consideration current
economic conditions, as discussed above. Furthermore, current instability
in the market for our auction rate securities has caused us to lower our
estimate of fair value for these securities, which, along with our ARS Rights
described below in “—Non-Current Investments,” represented 19% of our total
financial assets measured at fair value. Although we do not believe that
this reduction has or will have a material adverse effect on our liquidity or
capital resources, we are continuing to monitor these markets closely. We are
similarly monitoring all of our short-term investments to ensure that
instability in liquidity and credit markets do not adversely impact the fair
value of these investments. This includes transferring investments in corporate
debt securities to money market accounts and U.S. Treasury bills as the debt
securities mature.
We expect
to meet our cash requirements in 2009 through a combination of net cash provided
by operating activities, existing cash, cash equivalents and short-term
investments in marketable securities. We may also utilize additional borrowings
under our credit agreement, especially for capital expenditures, particularly if
we consider it economically favorable to do so. We may incur capital
expenditures for the expansion of our P-NAP and data center facilities. 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 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.
We have
experienced significant impairments and operational restructurings in recent
years, which include substantial changes in our senior management team,
streamlining our cost structure, consolidating network access points and
terminating certain non-strategic real estate leases and license arrangements.
We have a history of quarterly and annual period net losses through the year
ended December 31, 2008. For the years ended December 31, 2008 and 2007, we
recorded net losses of $104.8 million and $5.6 million, respectively. As of
December 31, 2008, our accumulated deficit was $966.8 million. Our net loss for
the year ended December 31, 2008 included $99.7 million in impairment charges
for goodwill and $2.6 million in impairment charges for other intangible assets
and approximately $1.0 million for adjustments to our restructuring liability.
Our net loss for the year ended December 31, 2007 included $13.0 million in
charges for restructuring, asset impairment, write-off of an investment and
acquired in-process research and development. We do not expect to incur any of
these charges on a regular basis, but we cannot guarantee that we will not incur
other similar charges in the future or that we will be profitable in the future,
due in part to the competitive and evolving nature of the industry in which we
operate. Also, we are currently in a time of severe deteriorating economic
conditions and have seen signs of slowdowns and cautious behavior from our
customers. 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. We may not be able to sustain or increase
profitability on a quarterly or annual basis, and our failure to do so would
adversely affect our business, including our ability to raise additional
funds.
Short-Term Investments.
Short-term investments primarily consist of high credit quality corporate
debt securities, U.S. Treasury bills and commercial paper. At December 31, 2008,
our balance in short-term investments was $7.2 million. All short-term
investments have original maturities greater than 90 days but less than one
year, are classified as available for sale and are reported at fair
value.
Non-Current
Investments
. Non-current investments include, in part, auction rate
securities whose underlying assets are state-issued student and educational
loans that are substantially backed by the federal government. At December 31,
2008, the carrying value of our auction rate securities was $6.4 million, all of
which carried AAA/Aaa ratings as of December 31, 2008. 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 seven, 28 or 35 days. The securities have
historically traded at par value and are callable at par value 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 have historically been
priced and traded as short-term instruments because of the liquidity provided
through the interest rate resets.
While we
continue to earn and accrue interest on our auction rate securities at
contractual rates, these investments are not currently trading and therefore do
not currently have a readily determinable market value. Accordingly, the
estimated fair value of auction rate securities no longer approximates par
value. Due to the uncertainty as to when the auction rate securities markets
will improve, we have classified our auction rate securities as non-current
investments as of December 31, 2008, versus short-term investments as of
December 31, 2007. In the meantime, we believe we have sufficient liquidity
through our cash balances, other short-term investments and available
credit.
In
October 2008, we received an offer providing us with rights, or ARS Rights, from
one of our investment providers to sell at par value auction rate securities
originally purchased from the investment provider ($7.2 million) at anytime
during a two-year period beginning June 20, 2010. On November 14, 2008, we
accepted the offer and intend to exercise the ARS Rights if we are otherwise
unable to recover par value on the securities at an earlier date. At December
31, 2008, the carrying value of the ARS Rights was $0.6 million.
Credit
Agreement.
On
September 14, 2007, we entered into a $35.0 million credit agreement with Bank
of America, N.A., as the administrative agent, or the Credit
Agreement. Four of our subsidiaries, VitalStream Holdings, Inc.;
VitalStream, Inc.; PlayStream, Inc.; and VitalStream Advertising Services, Inc.,
are guarantors of the Credit Agreement. We subsequently amended the Credit
Agreement on May 14, 2008 and September 30, 2008, as discussed
below.
The
Credit Agreement replaced our prior credit agreement between us 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.
The
Credit Agreement originally provided for a four-year revolving credit facility,
or Revolving Credit Facility, in the aggregate amount of up to $5.0 million,
which included a $5.0 million sub-limit for letters of credit. With the
prior approval of the administrative agent, we could 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 was
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 were 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 originally provided for a term loan in the amount of $30.0
million, or the Term Loan. 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 was a tiered
LIBOR-based rate that depended on our 12-month trailing EBITDA. As of December
31, 2007, the interest rate was 7.075%.
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 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.
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 “Interest expense”
within the “Non-operating (income) expense” section of the accompanying
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, as discussed in note 3 of the accompanying consolidated
financial statements.
We
subsequently amended the Credit Agreement on May 14, 2008 and September 30,
2008, or the Amendment (the Credit Agreement along with the Amendment is
referred to as the Amended Credit Agreement). The Amendment modified the
original Credit Amendment as follows:
|
|
|
|
●
|
converted
the outstanding Term Loan balance of $20.0 million as of September 30,
2008 into a loan under the Revolving Credit Facility;
|
|
●
|
terminated
the Term Loan under the Credit Agreement;
|
|
●
|
increased
the total Revolving Credit Commitment (as defined in the Amended Credit
Agreement) from $5.0 million to $35.0 million;
|
|
●
|
increased
the Letter of Credit Sublimit (as defined in the Amended Credit Agreement)
from $5.0 million to $7.0 million;
|
|
●
|
provided
us and Bank of America with an option to enter into a lease financing
agreement not to exceed $10.0 million; and
|
|
●
|
modified
certain covenants and
definitions.
|
Because
the Amendment caused the Revolving Credit Facility to have substantially
different terms than the Term Loan, it is considered an extinguishment of debt.
We recorded a loss on extinguishment of debt in the amount of $0.2 million
during the year ended December 31, 2008. The loss on extinguishment of debt
is included in the caption “Interest expense” within the “Non-operating (income)
expense” section of the accompanying consolidated statements of operations. We
also incurred other costs of less than $0.1 million in connection with the
Amendment, which we recorded as debt issue costs and will amortize over the
remaining term of the Amended Credit Agreement.
The
interest rate on the Amended Credit Agreement as of December 31, 2008 was 3.0%
and is based on Bank of America’s prime rate less a 0.25% margin. The principal
amount of $20.0 million is due September 14, 2011. As of December 31, 2008, we
had a total of $4.2 million of letters of credit issued and $10.8 million in
borrowing capacity on the Revolving Credit Facility. In January 2009, we repaid
$19.8 million of the outstanding balance.
The
Amended Credit Agreement includes customary representations, warranties,
negative and affirmative covenants (including certain financial covenants
relating to a net funded debt to EBITDA ratio, a debt service coverage ratio and
a minimum liquidity requirement, as well as a prohibition against paying
dividends, limitations on unfunded capital expenditures of $55.0 million for
2008 and $25.0 million or an amount to be mutually agreed upon for 2009 through
2011), customary events of default and certain default provisions that could
result in acceleration of the Amended Credit Agreement. As of December 31, 2008,
we were in compliance with the various covenants in the Amended Credit
Agreement.
Our
obligations under the Amended 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.
Capital
Leases.
Our future minimum lease payments on remaining capital lease
obligations at December 31, 2008 totaled $9.4 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. Service
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, 2008 (in thousands):
|
|
Payments Due by
Period
|
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revolving
line of credit
(1)
|
|
$
|
21,623
|
|
|
$
|
600
|
|
|
$
|
21,023
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Capital
lease obligations
|
|
|
9,441
|
|
|
|
822
|
|
|
|
1,130
|
|
|
|
1,150
|
|
|
|
6,339
|
|
Operating
lease commitments
|
|
|
216,125
|
|
|
|
25,624
|
|
|
|
51,898
|
|
|
|
51,721
|
|
|
|
86,882
|
|
Service
commitments
|
|
|
27,085
|
|
|
|
20,866
|
|
|
|
6,219
|
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
274,274
|
|
|
$
|
47,912
|
|
|
$
|
80,270
|
|
|
$
|
52,871
|
|
|
$
|
93,221
|
|
____________________
|
(1)
|
As
noted in the section captioned “
—
Credit
Agreement,” the interest rate on the Revolving Credit Facility is based on
our bank’s prime rate less a 0.25% margin. As of December 31, 2008, the
interest rate was 3.0% and the projected interest included in the debt
payments above incorporates this rate. We subsequently paid $19.8 million
on the Revolving Credit Facility in January 2009 which would significantly
lower the projected interest included above. We plan to borrow on the
Revolving Credit Facility from time-to-time particularly if we consider it
economically favorable to do
so.
|
Common
and Preferred Stock.
Our Certificate of Incorporation designates 60
million shares of common stock and 20 million shares of preferred
stock.
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-10 reverse stock split and amended our
Certificate of Incorporation to reduce our authorized shares of common stock
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.
At the
time of the reverse stock split, the number of authorized shares of preferred
stock was not similarly reduced. We intended the reverse stock split to reduce
the authorized number of shares of preferred stock. Accordingly, effective June
19, 2008, we reduced the number of authorized shares of preferred stock from 200
million shares to 20 million shares. Of the resulting 20 million authorized
shares of preferred stock, 19.5 million shares are blank check preferred stock,
the terms and conditions of which our board of directors may designate. Our
board of directors previously designated the remaining 0.5 million shares of
preferred stock as series B preferred stock pursuant to a certificate of
designation of rights, preferences and privileges on April 11, 2007. As of
December 31, 2008, no shares of preferred stock were issued or
outstanding.
In June
2006, our stockholders approved a repricing of 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. We implemented
the repricing 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:
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|
|
|
●
|
The
exercise price per share of each replacement option granted in the
exchange offer was $14.46, the average of the closing prices of our 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 one-for-two;
and
|
|
|
|
|
●
|
Each
new option had a three-year vesting period, vesting in equal monthly
installments over three years, so long as the grantee continued to be a
full-time employee and a 10-year
term.
|
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.
Short-Term Investments in Marketable
Securities
Short-term
investments primarily consist of high credit quality corporate debt securities,
U.S. Treasury bills and commercial paper. All of our investments have original
maturities greater than 90 days but less than one year. 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 that we have 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 $0.1 million per year.
Auction
Rate Securities and ARS Rights
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 seven, 28 or 35 days. They have historically
traded at par value and are callable at par value 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 have historically been priced and traded as short-term instruments because
of the liquidity provided through the interest rate resets.
While we
continue to earn and accrue interest on our auction rate securities at
contractual rates, these investments are not currently trading and therefore do
not currently have a readily determinable market value. Accordingly, the
estimated fair value of auction rate securities no longer approximates par
value. Due to the uncertainty as to when the auction rate securities markets
will improve, we have classified our auction rate securities as non-current
investments as of December 31, 2008, versus short-term investments as of
December 31, 2007. Our accompanying consolidated statement of operations for the
year ended December 31, 2008 also includes a net reduction in fair value of $0.8
million related to these investments. In the meantime, we believe we have
sufficient liquidity through our cash balances, other short-term investments and
available credit.
In
October 2008, we received and subsequently accepted an offer providing us with
rights, or ARS Rights, from one of our investment providers to sell at par value
auction rate securities originally purchased from the investment provider
($7.2 million) at anytime during a two-year period beginning June 30, 2010. As
described in note 6, we recorded the ARS Rights as a free standing asset
separate from the auction rate securities. In conjunction with our acceptance of
the ARS Rights, we elected to measure the ARS Rights at fair value under SFAS
No. 159. Also, in conjunction with our acceptance of the ARS Rights, we changed
the investment classification of our auction rate securities to trading from
available for sale. We expect that future changes in the fair value of the ARS
Rights will approximate fair value movements in the related auction rate
securities.
As of
December 31, 2008, the estimated fair values of our auction rate securities and
the ARS Rights were $6.4 million and $0.6 million, respectively. We estimate
that a change in the effective yield of 100 basis points in the auction rate
securities and ARS Rights would change our interest income by $0.1 million per
year.
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 $3.1 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. As of December 31, 2008, our long-term debt consisted of a Revolving
Credit Facility of $20.0 million with an interest rate of 3.0% and is based on
our bank’s prime rate less a 0.25% margin. The principal amount of $20.0 million
is due September 14, 2011. We estimate that a change in the interest rate of 100
basis points would change our interest expense and payments by $0.2 million per
year,
assuming
we maintain a comparable amount of outstanding principal throughout the year. We
subsequently paid $19.8 million on the Revolving Credit Facility in January 2009
and plan to borrow on the Revolving Credit Facility from time-to-time
particularly if we consider it economically favorable to do
so.
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.
Our
accompanying consolidated financial statements, financial statement schedule and
the report of our independent registered public accounting firm appear in Part
IV of this Form 10-K. Our report on internal controls over financial
reporting appear in Item 9A of this Form 10-K.
None.
Evaluation
of Disclosure Controls and Procedures
We
maintain disclosure controls and procedures that are designed to provide
reasonable assurance that information required to be disclosed in our
reports filed under the Exchange Act, is recorded, processed, summarized and
reported with the time periods specified in the SEC’s rules and forms, and that
such information is accumulated and communicated to management, including
our chief executive officer and chief financial officer, as appropriate, to
allow timely decisions regarding required disclosure. Management necessarily has
applied its judgment in assessing the costs and benefits of such controls and
procedures, which, by nature, can provide only reasonable assurance regarding
management’s control objectives.
Our
management, including our chief executive officer and chief financial officer,
does not expect that our disclosure controls can prevent all errors and all
fraud. A control system, no matter how well conceived and operated, can provide
only reasonable, not absolute, assurance that the objectives of the control
system are met. There are inherent limitations in all control systems, including
the realities that judgments in decision-making can be faulty, and that
breakdowns can occur because of simple error, mistake or collusion. The design
of any system of controls also is based in part upon certain assumptions about
the likelihood of future events. While our disclosure controls and procedures
are designed to be effective under circumstances where they should reasonably be
expected to operate effectively, we can offer no assurance that any design will
succeed in achieving its stated goals under all potential future conditions.
Because of the inherent limitations in any control system, misstatements due to
error or fraud may occur and may not be detected.
Under the
supervision and with the participation of our management, including our chief
executive officer and chief financial officer, we conducted an evaluation of our
disclosure controls and procedures, as such term is defined under
Rule 13a-15(e) promulgated under the Exchange Act. Based on this
evaluation, our chief executive officer and our chief financial
officer concluded that our disclosure controls and procedures were effective as
of December 31, 2008 to provide reasonable assurance.
Report
of Management on Internal Control Over Financial Reporting
Our
management is responsible for establishing and maintaining adequate internal
control over financial reporting, as such term is defined in Exchange Act
Rule 13a-15(f). Under the supervision and with the participation of our
management, including our chief executive officer and chief financial
officer, we conducted an evaluation of the effectiveness of our internal control
over financial reporting based on the framework in
Internal Control - Integrated Framework
issued
by the Committee of Sponsoring Organizations of the Treadway Commission, or
COSO.
Based on
our evaluation under the framework in
Internal
Control — Integrated Framework
issued by COSO, our management concluded
that our internal control over financial reporting was effective as of December
31, 2008. The effectiveness of our internal control over financial
reporting as of December 31, 2008 has been audited by PricewaterhouseCoopers
LLP, an independent registered public accounting firm, as stated in their report
which is included herein.
Changes
in Internal Control over Financial Reporting
During
the quarter ended December 31, 2008, the only changes in our internal control
over financial reporting that have materially affected, or are likely to
materially affect, our internal control over financial reporting are discussed
below. These changes include enhancing our existing controls for the analysis of
requests for sales adjustments, which include but are not limited to, the
following additional processes and controls:
|
●
|
A single,
common logging system, or portal, 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,
and
|
|
●
|
A review
by the appropriate designated finance management personnel of the
accounting estimates developed from the relevant, sufficient, and reliable
data collected above.
|
The
portal provides management with a more complete repository of customer issues
for assessing sales credits’ impact on revenues. Since the second quarter of
2008, designated management has met weekly to review and analyze the information
collected by the portal, along with other sources of related information, to
resolve all customer disputes and requests for credits. The results of these
weekly meetings assist finance personnel in determining appropriate accounting
estimates by providing more timely and pertinent information. In addition, we
continued to develop an automated process to monitor customer usage patterns as
a means to better manage customer billing disputes. In the fourth quarter of
2008, we completed our testing of these processes and controls, concluding that
we have remediated the material weakness in our analysis of requests for sales
adjustments.
None.
Information
regarding our directors and executive officers will be included in our
definitive proxy statement for our 2009 annual meeting of stockholders, which
will be filed within 120 days after the end of the fiscal year covered by this
report, and is incorporated in this Form 10-K by reference.
Code
of Conduct
We have
adopted a code of conduct that applies to our officers and all of our employees,
which includes an addendum that applies to our senior executive and financial
officers. A copy of the code of conduct is available on our website at
www.internap.com
. We
will furnish copies without charge upon request at the following address:
Internap Network Services Corporation, Attn: General Counsel, 250 Williams
Street, Atlanta, Georgia 30303.
If we
make any amendments to the code of conduct other than technical, administrative
or other non-substantive amendments, or grant any waivers, including implicit
waivers, from the addendum to this code, we will disclose the nature of the
amendment or waiver, its effective date and to whom it applies on our website or
in a current report on Form 8-K filed with the SEC.
The
information under the captions, “Executive Officers and Compensation” and
“Compensation Committee Report” contained in our definitive proxy statement for
our 2009 annual meeting of stockholders, which will be filed within 120 days
after the end of the fiscal year covered by this report, is hereby incorporated
in this Form 10-K by reference.
The
information under the caption “Security Ownership of Certain Beneficial Owners
and Management” contained in our definitive proxy statement for our 2009 annual
meeting of stockholders, which will be filed within 120 days after the end of
the fiscal year covered by this report, is hereby incorporated in this Form 10-K
by reference.
The
information under the caption “Certain Relationships and Related Transactions”
contained in our definitive proxy statement for our 2009 annual meeting of
stockholders, which will be filed within 120 days after the end of the fiscal
year covered by this report, hereby is incorporated in this Form 10-K by
reference.
The
information under the caption “Ratification of Appointment of Independent
Registered Public Accounting Firm” in our definitive proxy statement for our
2009 annual meeting of stockholders, which will be filed within 120 days after
the end of the fiscal year covered by this report, is hereby incorporated in
this Form 10-K by reference.
|
|
(a)
|
Documents
filed as a part of the report:
|
|
(1)
|
Consolidated
Financial Statements.
|
The
following consolidated financial statements of the Company and its subsidiaries
are filed herewith:
|
|
|
|
|
|
|
Page
|
|
Report
of Independent Registered Public Accounting Firm
|
|
F-2
|
|
Consolidated
Statements of Operations
|
|
F-3
|
|
Consolidated
Balance Sheets
|
|
F-4
|
|
Consolidated
Statement of Stockholders’ Equity and Comprehensive Loss
|
|
F-5
|
|
Consolidated
Statements of Cash Flows
|
|
F-6
|
|
Notes
to Consolidated Financial Statements
|
|
F-8
|
|
(2)
|
Financial
Statement Schedule.
|
The
following financial statement schedule of the Company and its subsidiaries is
filed herewith:
|
|
|
|
|
Page
|
Schedule
II - Valuation and Qualifying Accounts for the Three Years Ended December
31, 2008
|
|
S-1
|
|
|
|
Exhibit
|
|
|
Number
|
|
Description
|
2.1
|
|
Agreement
and Plan of Merger dated October 12, 2006, by and among the Company, Ivy
Acquisition Corp. and VitalStream Holdings, Inc. (incorporated herein by
reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K,
filed on October 12, 2006).
|
|
|
|
3.1
|
|
Certificate
of Incorporation of the Company, as amended (incorporated by reference
herein to Exhibit 4.1 to the Company’s Registration Statement on Form S-3,
filed on September 8, 2003, File No. 333-108573).
|
|
|
|
3.2
|
|
Certificate
of Amendment of Certificate of Incorporation of the Company (incorporated
by reference herein to Exhibit 3.1 to the Company’s Current Report on Form
8-K filed on July 11, 2006).
|
|
|
|
3.3
|
|
Certificate
of Amendment of Certificate of Incorporation of the Company dated June 19,
2008 (incorporated by reference herein to Exhibit 3.1 to the Company’s
Quarterly Report on Form 10-Q for the quarter ended June 30, 2008, filed
on August 11, 2008).
|
|
|
|
3.4
|
|
Amended
and Restated Bylaws of the Company (incorporated by reference herein to
Exhibit 4.2 to the Company’s Registration Statement on Form S-3, filed
September 8, 2003, File No. 333-108573).
|
|
|
|
3.5
|
|
Certificate
of Designation of Rights, Preferences and Privileges of Series B Preferred
Stock (incorporated by reference herein to Exhibit 3.4 to the Company’s
Current Report on Form 8-K filed on April 13, 2007).
|
|
|
|
4.1
|
|
Rights
Agreement, dated as of April 11, 2007, between the Company and American
Stock Transfer & Trust Company, as Rights Agreement (incorporated by
reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K,
filed on April 13, 2007).
|
|
|
|
10.1
|
|
Amended
and Restated Internap Network Services Corporation 1998 Stock Option/Stock
Issuance Plan.* +
|
|
|
|
10.2
|
|
Internap
Network Services Corporation 1999 Non-Employee Directors’ Stock Option
Plan.* +
|
|
|
|
10.3
|
|
First
Amendment to the Internap Network Services Corporation 1999 Non-Employee
Directors’ Stock Option Plan.* +
|
|
|
|
10.4
|
|
Internap
Network Services Corporation 1999 Employee Stock Purchase Plan
(incorporated herein by reference to Exhibit 10.4 to the Company’s
Registration Statement on Form S-1, File No. 333-84035 dated July 29,
1999).+
|
|
|
|
10.5
|
|
Amended
and Restated Internap Network Services Corporation 1999 Stock Incentive
Plan for Non-Officers.*
+
|
|
|
|
10.6
|
|
Amended
Internap Network Services Corporation 1999 Equity Incentive Plan
(incorporated herein by reference to Exhibit 10.7 to the Company’s
Registration Statement on Form S-1, File No. 333-95503 dated January 27,
2000).+
|
|
|
|
10.7
|
|
Form
of 1999 Equity Incentive Plan Stock Option Agreement (incorporated herein
by reference to Exhibit 10.8 to the Company’s Registration Statement on
Form S-1, File No. 333-84035 dated July 29, 1999).+
|
|
|
|
10.8
|
|
Internap
Network Services Corporation 2000 Non-Officer Equity Incentive Plan
(incorporated herein by reference to Exhibit 99.1 to the Company’s
Registration Statement on Form S-8, File No. 333-37400 dated May 19,
2000).+
|
|
|
|
10.9
|
|
Internap
Network Services Corporation 2002 Stock Compensation Plan.*
+
|
|
|
|
10.10
|
|
Form
of Nonstatutory Stock Option Agreement under the Internap Network Services
Corporation 2002 Stock Compensation Plan.* +
|
|
|
|
10.11
|
|
Form
of Employee Confidentiality, Nonraiding and Noncompetition Agreement used
between Company and its Executive Officers (incorporated herein by
reference to Exhibit 10.11 to the Company’s Registration Statement on Form
S-1, File No. 333-84035 dated July 29, 1999).+
|
|
|
|
10.12
|
|
Amended
and Restated 2005 Incentive Stock Plan, dated March 15, 2006 (incorporated
by reference to Appendix B to the Company’s Definitive Proxy Statement
filed May 8, 2008).+
|
|
|
|
10.13
|
|
Employment
Agreement dated as of July 10, 2007 between the Company and James DeBlasio
(incorporated herein by reference to Exhibit 99.1 to the Company’s Current
Report on Form 8-K, filed on July 11, 2007).+
|
|
|
|
10.14
|
|
First
Amendment to Employment Agreement between James P. DeBlasio and the
Company dated November 14, 2007 (incorporated herein by reference to
Exhibit 99.1 to the Company’s Current Report on Form 8-K, filed on
November 19, 2007).+
|
|
|
|
10.15
|
|
Amended
and Restated 2004 Internap Network Services Corporation Employee Stock
Purchase Plan, dated January 11, 2006 (incorporated by reference to
Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the
quarter ended March 31, 2006, filed on May 10, 2006).+
|
|
|
|
10.16
|
|
Form
of Stock Grant Certificate under the Amended and Restated Internap Network
Services Corporation 2005 Incentive Stock Plan (incorporated by reference
to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the
quarter ended June 30, 2006, filed on August 8, 2006).+
|
|
|
|
10.17
|
|
Form
of Stock Option Grant Certificate under the Amended and Restated Internap
Network Services Corporation 2005 Incentive Stock Plan (incorporated by
reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q
for the quarter ended June 30, 2006, filed on August 8,
2006).+
|
|
|
|
10.18
|
|
VitalStream
Holdings, Inc. 2001 Stock Incentive Plan (Third Amended and Restated)
(incorporated by reference to Exhibit 4.4 to the Company’s Registration
Statement on Form S-8, File No. 333-141245 , filed on March 13,
2007).+
|
|
|
|
10.19
|
|
General
Release Agreement dated as of April 9, 2008 between the Company and
Vincent Molinaro (incorporated by reference to Exhibit 10.1 to the
Company’s Current Report on Form 8-K, filed on April 18,
2008).+
|
|
|
|
10.20
|
|
2007
Executive Bonus Award Incentive Plan (incorporated by reference to Exhibit
10.1 to the Company’s Quarterly Report on Form 10-Q for the quarter ended
March 31, 2007, filed on May 10, 2007).+
|
|
|
|
10.21
|
|
Amendment
to the 2007 Executive Bonus Award Incentive Plan (incorporated herein by
reference to Exhibit 99.6 to the Company’s Current Report on Form
8-K, filed on November 19, 2007).+
|
|
|
|
10.22
|
|
2008
Executive Bonus Award Incentive Plan (incorporated herein by reference to
Exhibit 10.1 to the Company’s Current Report on Form 8-K, filed March 24,
2008).+
|
|
|
|
10.23
|
|
2008
Long-Term Incentive Plan (incorporated herein by reference to Exhibit 10.2
to the Company’s Current Report on Form 8-K, filed March 24,
2008).+
|
|
|
|
10.24
|
|
Credit
Agreement dated as of September 14, 2007 by and among the Company, as the
Borrower, Bank of America, N.A., as Administrative Agent, Swing Line
Lender and L/C Issuer, and the other Lenders party thereto (incorporated
by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K,
filed on September 19,
2007).
|
|
|
|
10.25
|
|
Pledge
and Security Agreement dated as of September 14, 2007 among the Company,
and certain of its Subsidiaries party thereto from time to time, as
Grantors, and Bank of America, N.A., as Administrative Agent (incorporated
by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K,
filed on September 19, 2007).
|
|
|
|
10.26
|
|
Intellectual
Property Security Agreement dated as of September 14, 2007 among the
Company, and certain of its Subsidiaries party thereto from time to time,
as Grantors, and Bank of America, N.A., as Administrative Agent
(incorporated by reference to Exhibit 10.3 to the Company’s Current Report
on Form 8-K, filed on September 19, 2007).
|
|
|
|
10.27
|
|
Amendment
No. 1 to Credit Agreement entered into as of May 14, 2008 by and among
Bank of America, N.A. as Administrative Agent, Swing Line Lender, L/C
Issuer and sole Lender, the Company and the Subsidiaries of the Company
party thereto as Guarantors (incorporated herein by reference to Exhibit
10.1 to the Company’s Current Report on Form 8-K, filed May 16,
2008).
|
|
|
|
10.28
|
|
Amendment
No. 2 dated September 30, 2008 to Credit Agreement, dated as of September
14, 2007, by and among the Company, as the Borrower, Bank of America,
N.A., as Administrative Agent, Swing Line Lender and L/C Issuer, and the
other Lenders party thereto (incorporated herein by reference to Exhibit
10.1 to the Company’s Current Report on Form 8-K, filed October 6,
2008).
|
|
|
|
10.29
|
|
Joinder
Agreement to the Employment Security Plan executed by Richard Dobb
(incorporated herein by reference to Exhibit 99.3 to the Company’s Current
Report on Form 8-K, filed on November 19, 2007).+
|
|
|
|
10.30
|
|
Joinder
Agreement to the Employment Security Plan executed by Phil Kaplan
(incorporated herein by reference to Exhibit 99.4 to the Company’s Current
Report on Form 8-K, filed on November 19, 2007).+
|
|
|
|
10.31
|
|
Joinder
Agreement to the Employment Security Plan executed by Vince Molinaro
(incorporated herein by reference to Exhibit 99.5 to the Company’s Current
Report on Form 8-K, filed on November 19, 2007).+
|
|
|
|
10.32
|
|
Joinder
Agreement to the Employment Security Plan executed by George E. Kilguss
(incorporated herein by reference to Exhibit 99.1 to the Company’s Current
Report on Form 8-K, filed on March 28, 2008).+
|
|
|
|
10.33
|
|
Joinder
Agreement to the Employment Security Plan executed by Tim Sullivan.
+
|
|
|
|
10.34
|
|
Offer
Letter between the Company and Eric Cooney, dated January 16, 2009
(incorporated herein by reference to Exhibit 10.1 to the Company’s Current
Report on Form 8-K, filed on February 2, 2009).+
|
|
|
|
10.35
|
|
Joinder
Agreement to the Employment Security Plan executed by Eric Cooney
(incorporated herein by reference to Exhibit 10.2 to the Company’s Current
Report on Form 8-K, filed on February 2, 2009).+
|
|
|
|
10.36
|
|
Agreement
between the Company and James P. DeBlasio, dated January 29, 2009
(incorporated herein by reference to Exhibit 10.3 to the Company’s Current
Report on Form 8-K, filed on February 2, 2009). +
|
|
|
|
21.1
|
|
List
of Subsidiaries (incorporated herein by reference to Exhibit 21.1 to the
Company’s Form 10-K, filed on March 31, 2008).
|
|
|
|
23.1*
|
|
Consent
of PricewaterhouseCoopers LLP, Independent Registered Public Accounting
Firm.
|
|
|
|
31.1*
|
|
Rule
13a-14(a)/15d-14(a) Certification, executed James P. DeBlasio, President,
Chief Executive Officer and Director the Company.
|
|
|
|
31.2*
|
|
Rule
13a-14(a)/15d-14(a) Certification, executed by George Kilguss, III, Vice
President and Chief Financial Officer of the
Company.
|
|
|
|
32.1*
|
|
Section
1350 Certification, executed by James P. DeBlasio, President, Chief
Executive Officer and Director the Company.
|
|
|
|
32.2*
|
|
Section
1350 Certification, executed by George Kilguss, III, Vice President and
Chief Financial Officer of the
Company.
|
|
|
|
|
|
|
|
|
*
|
Documents
filed herewith.
|
|
|
+
|
Management
contracts and compensatory plans and arrangements required to be filed as
exhibits pursuant to Item 15(c) of this
Report.
|
Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, as amended, the Company has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
|
|
|
|
|
INTERNAP
NETWORK SERVICES CORPORATION
|
|
Date:
March 12, 2009
|
|
|
|
|
By:
|
/s/
George E. Kilguss, III
|
|
|
|
George
E. Kilguss, III
|
|
|
|
Vice
President and Chief Financial Officer
|
|
|
|
(Principal
Accounting Officer)
|
|
Pursuant
to the requirements of the Securities Exchange Act of 1934, as amended, this
report has been signed below by the following persons on behalf of the Company
and in the capacities and on the dates indicated:
|
|
|
|
|
Signature
|
|
Title
|
|
Date
|
|
|
|
|
|
/s/
James P. DeBlasio
|
|
|
|
|
James
P. DeBlasio
|
|
President,
Chief Executive Officer and Director (Principal Executive
Officer)
|
|
March
12, 2009
|
|
|
|
|
|
|
|
|
|
|
/s/
George E. Kilguss, III
|
|
|
|
|
George
E. Kilguss, III
|
|
Vice
President and Chief Financial Officer (Principal Accounting
Officer)
|
|
|
|
|
|
|
|
/s/
Eugene
Eidenberg
|
|
|
|
|
Eugene
Eidenberg
|
|
Non-Executive
Chairman and Director
|
|
|
|
|
|
|
|
/s/
Charles
B. Coe
|
|
|
|
|
Charles
B. Coe
|
|
Director
|
|
March 12,
2009
|
|
|
|
|
|
/s/
William
J. Harding
|
|
|
|
|
William
J. Harding
|
|
Director
|
|
|
|
|
|
|
|
/s/
Patricia
L. Higgins
|
|
|
|
|
Patricia
L. Higgins
|
|
Director
|
|
|
|
|
|
|
|
/s/
Kevin
L. Ober
|
|
|
|
|
Kevin
L. Ober
|
|
Director
|
|
|
|
|
|
|
|
/s/
Gary
Pfeiffer
|
|
|
|
|
Gary
Pfeiffer
|
|
Director
|
|
|
|
|
|
|
|
/s/
Daniel
C. Stanzione
|
|
|
|
|
Daniel
C. Stanzione
|
|
Director
|
|
|
|
|
|
Internap
Network Services Corporation
|
Index
to Consolidated Financial Statements
|
|
|
|
|
|
Page
|
Report
of Independent Registered Public Accounting Firm
|
|
F-2
|
Consolidated
Statements of Operations
|
|
F-3
|
Consolidated
Balance Sheets
|
|
F-4
|
Consolidated
Statement of Stockholders’ Equity and Comprehensive (Loss)
Income
|
|
F-5
|
Consolidated
Statements of Cash Flows
|
|
F-6
|
Notes
to Consolidated Financial Statements
|
|
F-8
|
Financial
Statement Schedule
|
|
S-1
|
Report
of Independent Registered Public Accounting Firm
To the
Board of Directors and Stockholders of Internap Network Services
Corporation:
In our
opinion, the consolidated financial statements listed in the accompanying index
present fairly, in all material respects, the financial position of Internap
Network Services Corporation and its subsidiaries at December 31, 2008 and 2007,
and the results of their operations and their cash flows for each of the three
years in the period ended December 31, 2008 in conformity with accounting
principles generally accepted in the United States of America. In addition, in
our opinion, the financial statement schedule listed in the accompanying index
presents fairly, in all material respects, the information set forth therein
when read in conjunction with the related consolidated financial statements.
Also in our opinion, the Company maintained, in all material respects, effective
internal control over financial reporting as of December 31, 2008, based on
criteria established in
Internal Control - Integrated
Framework
issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO). 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 on Internal Control Over Financial Reporting appearing under
Item 9A. 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 the 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 Notes 2 and 6 to the consolidated financial statements, in 2008 the
Company changed the manner in which it measures fair value of financial assets
and liabilities in accordance with SFAS No. 157,
Fair Value Measurements
and
SFAS No. 159,
The Fair Value
Option for Financial Assets and Financial Liabilities
.
Additionally,
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.
|
/s/
PricewaterhouseCoopers LLP
|
Atlanta,
Georgia
|
March
12, 2009
|
|
INTERNAP
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
|
CONSOLIDATED
STATEMENTS OF OPERATIONS
|
(In
thousands, except per share
amounts)
|
|
|
|
|
|
|
|
|
|
|
|
|
Year
Ended December 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
Revenues:
|
|
|
|
|
|
|
|
|
|
Internet
protocol (IP) services
|
|
$
|
123,268
|
|
|
$
|
122,205
|
|
|
$
|
112,250
|
|
Data
center services
|
|
|
109,679
|
|
|
|
83,632
|
|
|
|
56,548
|
|
Content
delivery network (CDN) services
|
|
|
21,042
|
|
|
|
17,806
|
|
|
|
—
|
|
Other
|
|
|
—
|
|
|
|
10,447
|
|
|
|
12,577
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
revenues
|
|
|
253,989
|
|
|
|
234,090
|
|
|
|
181,375
|
|
Operating
costs and expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
Direct
costs of network, sales and services, exclusive of depreciation and
amortization, shown below:
|
|
|
|
|
|
|
|
|
|
|
|
|
IP
services
|
|
|
45,782
|
|
|
|
43,925
|
|
|
|
40,723
|
|
Data
center services
|
|
|
82,009
|
|
|
|
59,439
|
|
|
|
46,474
|
|
CDN
services
|
|
|
8,086
|
|
|
|
6,594
|
|
|
|
—
|
|
Other
|
|
|
—
|
|
|
|
8,436
|
|
|
|
10,141
|
|
Direct
costs of amortization of acquired technologies
|
|
|
6,649
|
|
|
|
4,165
|
|
|
|
516
|
|
Direct
costs of customer support
|
|
|
16,217
|
|
|
|
16,547
|
|
|
|
11,566
|
|
Product
development
|
|
|
8,477
|
|
|
|
6,564
|
|
|
|
4,475
|
|
Sales
and marketing
|
|
|
30,888
|
|
|
|
31,533
|
|
|
|
27,173
|
|
General
and administrative
|
|
|
30,675
|
|
|
|
30,251
|
|
|
|
21,556
|
|
Provision
for doubtful accounts
|
|
|
5,083
|
|
|
|
2,261
|
|
|
|
548
|
|
Depreciation
and amortization
|
|
|
23,865
|
|
|
|
22,242
|
|
|
|
15,856
|
|
Goodwill
impairment
|
|
|
99,700
|
|
|
|
—
|
|
|
|
—
|
|
Restructuring
and other impairments
|
|
|
1,741
|
|
|
|
11,349
|
|
|
|
323
|
|
Acquired
in-process research and development
|
|
|
—
|
|
|
|
450
|
|
|
|
—
|
|
Gain
on disposals of property and equipment
|
|
|
(16
|
)
|
|
|
(5
|
)
|
|
|
(113
|
)
|
Other
|
|
|
—
|
|
|
|
50
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
operating costs and expenses
|
|
|
359,156
|
|
|
|
243,801
|
|
|
|
179,238
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Loss)
income from operations
|
|
|
(105,167
|
)
|
|
|
(9,711
|
)
|
|
|
2,137
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-operating
(income) expense:
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
income
|
|
|
(1,884
|
)
|
|
|
(3,228
|
)
|
|
|
(2,305
|
)
|
Interest
expense
|
|
|
1,251
|
|
|
|
1,150
|
|
|
|
883
|
|
Write-off
of investment
|
|
|
—
|
|
|
|
1,178
|
|
|
|
—
|
|
Other,
net
|
|
|
388
|
|
|
|
(37
|
)
|
|
|
(129
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
non-operating (income) expense
|
|
|
(245
|
)
|
|
|
(937
|
)
|
|
|
(1,551
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Loss)
income before income taxes and equity in earnings of equity-method
investment
|
|
|
(104,922
|
)
|
|
|
(8,774
|
)
|
|
|
3,688
|
|
Provision
(benefit) for income taxes
|
|
|
174
|
|
|
|
(3,080
|
)
|
|
|
145
|
|
Equity
in earnings of equity-method investment, net of taxes
|
|
|
(283
|
)
|
|
|
(139
|
)
|
|
|
(114
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
(loss) income
|
|
$
|
(104,813
|
)
|
|
$
|
(5,555
|
)
|
|
$
|
3,657
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
(loss) income per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
(2.13
|
)
|
|
$
|
(0.12
|
)
|
|
$
|
0.11
|
|
Diluted
|
|
$
|
(2.13
|
)
|
|
$
|
(0.12
|
)
|
|
$
|
0.10
|
|
Weighted
average shares used in per share calculations:
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
49,238
|
|
|
|
46,942
|
|
|
|
34,748
|
|
Diluted
|
|
|
49,238
|
|
|
|
46,942
|
|
|
|
35,739
|
|
The
accompanying notes are an integral part of these consolidated financial
statements.
|
INTERNAP
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
|
CONSOLIDATED
BALANCE SHEETS
|
(In
thousands, except per share
amounts)
|
|
|
|
|
|
|
|
|
|
December
31,
|
|
|
|
2008
|
|
|
2007
|
|
ASSETS
|
|
|
|
|
|
|
Current
assets:
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$
|
46,870
|
|
|
$
|
52,030
|
|
Short-term
investments in marketable securities
|
|
|
7,199
|
|
|
|
19,569
|
|
Accounts
receivable, net of allowance for doubtful accounts of $2,777 and $2,351,
respectively
|
|
|
28,634
|
|
|
|
36,429
|
|
Inventory
|
|
|
381
|
|
|
|
304
|
|
Prepaid
expenses and other assets
|
|
|
10,866
|
|
|
|
8,464
|
|
Deferred
tax asset, current portion
|
|
|
1
|
|
|
|
479
|
|
|
|
|
|
|
|
|
|
|
Total
current assets
|
|
|
93,951
|
|
|
|
117,275
|
|
|
|
|
|
|
|
|
|
|
Property
and equipment, net
|
|
|
97,350
|
|
|
|
65,491
|
|
Investments
and other related assets, $7,027 and $0, respectively measured at fair
value
|
|
|
8,650
|
|
|
|
1,138
|
|
Intangible
assets, net
|
|
|
33,942
|
|
|
|
43,008
|
|
Goodwill
|
|
|
90,977
|
|
|
|
190,677
|
|
Restricted
cash
|
|
|
—
|
|
|
|
4,120
|
|
Deposits
and other assets
|
|
|
2,763
|
|
|
|
2,287
|
|
Deferred
tax asset, non-current
|
|
|
2,450
|
|
|
|
3,014
|
|
|
|
|
|
|
|
|
|
|
Total
assets
|
|
$
|
330,083
|
|
|
$
|
427,010
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES
AND STOCKHOLDERS’ EQUITY
|
|
|
|
|
|
|
|
|
Current
liabilities:
|
|
|
|
|
|
|
|
|
Note
payable, current portion
|
|
$
|
—
|
|
|
$
|
2,413
|
|
Accounts
payable
|
|
|
19,642
|
|
|
|
19,624
|
|
Accrued
liabilities
|
|
|
8,756
|
|
|
|
10,159
|
|
Deferred
revenues, current portion
|
|
|
3,710
|
|
|
|
4,807
|
|
Capital
lease obligations, current portion
|
|
|
274
|
|
|
|
805
|
|
Restructuring
liability, current portion
|
|
|
2,800
|
|
|
|
2,396
|
|
Other
current liabilities
|
|
|
116
|
|
|
|
108
|
|
|
|
|
|
|
|
|
|
|
Total
current liabilities
|
|
|
35,298
|
|
|
|
40,312
|
|
|
|
|
|
|
|
|
|
|
Note
payable, less current portion
|
|
|
20,000
|
|
|
|
17,354
|
|
Deferred
revenues, less current portion
|
|
|
2,248
|
|
|
|
2,275
|
|
Capital
lease obligations, less current portion
|
|
|
3,244
|
|
|
|
452
|
|
Restructuring
liability, less current portion
|
|
|
6,222
|
|
|
|
7,697
|
|
Deferred
rent
|
|
|
14,114
|
|
|
|
11,011
|
|
Deferred
tax liability
|
|
|
—
|
|
|
|
398
|
|
Other
long-term liabilities
|
|
|
762
|
|
|
|
878
|
|
|
|
|
|
|
|
|
|
|
Total
liabilities
|
|
|
81,888
|
|
|
|
80,377
|
|
|
|
|
|
|
|
|
|
|
Commitments
and contingencies
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stockholders’
equity:
|
|
|
|
|
|
|
|
|
Preferred
stock, $0.001 par value, 20,000 shares authorized; no shares issued or
outstanding
|
|
|
—
|
|
|
|
—
|
|
Common
stock, $0.001 par value; 60,000 shares authorized; 50,224 and 49,759
shares outstanding at December 31, 2008 and 2007,
respectively
|
|
|
50
|
|
|
|
50
|
|
Additional
paid-in capital
|
|
|
1,216,267
|
|
|
|
1,208,191
|
|
Treasury
stock, at cost, 83 shares at December 31, 2008
|
|
|
(370
|
)
|
|
|
—
|
|
Accumulated
deficit
|
|
|
(966,823
|
)
|
|
|
(862,010
|
)
|
Accumulated
items of other comprehensive income
|
|
|
(929
|
)
|
|
|
402
|
|
|
|
|
|
|
|
|
|
|
Total
stockholders’ equity
|
|
|
248,195
|
|
|
|
346,633
|
|
|
|
|
|
|
|
|
|
|
Total
liabilities and stockholders’ equity
|
|
$
|
330,083
|
|
|
$
|
427,010
|
|
The
accompanying notes are an integral part of these consolidated financial
statements.
INTERNAP
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE (LOSS) INCOME
For
the Three Years Ended December 31, 2008
(In
thousands)
|
|
Common
Stock
|
|
|
|
|
|
Shares
|
|
Par
Value
|
|
Additional
Paid-In
Capital
|
|
Treasury
Stock
|
|
Deferred
Stock
Compensation
|
|
Accumulated
Deficit
|
|
Accumulated
Items
of
Comprehensive
Income
(Loss)
|
|
Total
Stockholders’
Equity
|
|
Balance,
December 31, 2005
|
|
|
34,168
|
|
$
|
34
|
|
$
|
970,221
|
|
$
|
—
|
|
$
|
(420
|
)
|
$
|
(860,112
|
)
|
$
|
5
|
|
$
|
109,728
|
|
Net
income
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
3,657
|
|
|
—
|
|
|
3,657
|
|
Change
in unrealized gains and losses on investments, net of
taxes
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
80
|
|
|
80
|
|
Foreign
currency translation adjustment
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
235
|
|
|
235
|
|
Total
comprehensive income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3,972
|
|
Reclassification
of deferred stock compensation resulting from implementation of SFAS No.
123R
|
|
|
—
|
|
|
—
|
|
|
(420
|
)
|
|
—
|
|
|
420
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Stock
compensation plans activity and stock-based compensation
expense
|
|
|
1,154
|
|
|
2
|
|
|
9,015
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
9,017
|
|
Exercise
of warrants
|
|
|
551
|
|
|
—
|
|
|
3,808
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
3,808
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance,
December 31, 2006
|
|
|
35,873
|
|
|
36
|
|
|
982,624
|
|
|
—
|
|
|
—
|
|
|
(856,455
|
)
|
|
320
|
|
|
126,525
|
|
Net
loss
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(5,555
|
)
|
|
—
|
|
|
(5,555
|
)
|
Change
in unrealized gains and losses on investments, net of
taxes
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(25
|
)
|
|
(25
|
)
|
Foreign
currency translation adjustment
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
107
|
|
|
107
|
|
Total
comprehensive loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(5,473
|
)
|
Stock
issued in connection with VitalStream acquisition
|
|
|
12,206
|
|
|
12
|
|
|
208,281
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
208,293
|
|
Stock
compensation plans activity and stock-based compensation
expense
|
|
|
1,680
|
|
|
2
|
|
|
17,286
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
17,288
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance,
December 31, 2007
|
|
|
49,759
|
|
|
50
|
|
|
1,208,191
|
|
|
—
|
|
|
—
|
|
|
(862,010
|
)
|
|
402
|
|
|
346,633
|
|
Net
loss
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(104,813
|
)
|
|
—
|
|
|
(104,813
|
)
|
Change
in unrealized gains and losses on investments, net of
taxes
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(29
|
)
|
|
(29
|
)
|
Foreign
currency translation adjustment
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(1,302
|
)
|
|
(1,302
|
)
|
Total
comprehensive loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(106,144
|
)
|
Stock
compensation plans activity and stock-based compensation
expense
|
|
|
465
|
|
|
—
|
|
|
8,076
|
|
|
(370
|
)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
7,706
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance,
December 31, 2008
|
|
|
50,224
|
|
$
|
50
|
|
$
|
1,216,267
|
|
$
|
(370
|
)
|
$
|
—
|
|
$
|
(966,823
|
)
|
$
|
(929
|
)
|
$
|
248,195
|
|
See note
2 for information on effect of one-for-10 reverse stock split in July
2006.
The
accompanying notes are an integral part of these consolidated financial
statements.
INTERNAP
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF CASH FLOWS
(In
thousands)
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December
31,
|
|
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
Cash
flows from operating activities:
|
|
|
|
|
|
|
|
|
|
Net
(loss) income
|
|
$
|
(104,813
|
)
|
|
$
|
(5,555
|
)
|
|
$
|
3,657
|
|
Adjustments
to reconcile net (loss) income to net cash provided by operating
activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation
and amortization
|
|
|
28,663
|
|
|
|
26,407
|
|
|
|
16,372
|
|
Gain
on disposal of property and equipment, net
|
|
|
(16
|
)
|
|
|
(5
|
)
|
|
|
(113
|
)
|
Goodwill
and other intangible asset impairments
|
|
|
102,336
|
|
|
|
2,454
|
|
|
|
319
|
|
Acquired
in-process research and development
|
|
|
—
|
|
|
|
450
|
|
|
|
—
|
|
Stock-based
compensation expense
|
|
|
7,499
|
|
|
|
8,681
|
|
|
|
5,942
|
|
Write-off
of investment
|
|
|
—
|
|
|
|
1,178
|
|
|
|
—
|
|
Equity
in earnings from equity-method investment
|
|
|
(283
|
)
|
|
|
(139
|
)
|
|
|
(114
|
)
|
Provision
for doubtful accounts
|
|
|
5,083
|
|
|
|
2,261
|
|
|
|
548
|
|
Non-cash
changes in deferred rent
|
|
|
3,102
|
|
|
|
(421
|
)
|
|
|
2,247
|
|
Deferred
income taxes
|
|
|
644
|
|
|
|
(3,095
|
)
|
|
|
—
|
|
Other,
net
|
|
|
(477
|
)
|
|
|
(150
|
)
|
|
|
—
|
|
Changes
in operating assets and liabilities, excluding effects of
acquisition:
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts
receivable
|
|
|
2,424
|
|
|
|
(15,825
|
)
|
|
|
(1,702
|
)
|
Inventory,
prepaid expenses, deposits and other assets
|
|
|
(2,919
|
)
|
|
|
(2,182
|
)
|
|
|
(1,778
|
)
|
Accounts
payable
|
|
|
18
|
|
|
|
7,920
|
|
|
|
3,010
|
|
Accrued
and other liabilities
|
|
|
(1,404
|
)
|
|
|
(2,466
|
)
|
|
|
1,422
|
|
Deferred
revenue
|
|
|
(836
|
)
|
|
|
2,704
|
|
|
|
1,070
|
|
Accrued
restructuring liability
|
|
|
(1,070
|
)
|
|
|
5,309
|
|
|
|
(1,493
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
cash flows provided by operating activities
|
|
|
37,951
|
|
|
|
27,526
|
|
|
|
29,387
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
flows from investing activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchases
of investments in marketable securities
|
|
|
(21,422
|
)
|
|
|
(38,508
|
)
|
|
|
(17,427
|
)
|
Maturities
and sales of investments in marketable securities
|
|
|
26,591
|
|
|
|
32,395
|
|
|
|
20,277
|
|
Purchases
of property and equipment
|
|
|
(51,154
|
)
|
|
|
(30,271
|
)
|
|
|
(13,382
|
)
|
Proceeds
from disposal of property and equipment
|
|
|
175
|
|
|
|
5
|
|
|
|
133
|
|
Cash
received from acquisition, net of costs incurred for the
transaction
|
|
|
—
|
|
|
|
3,203
|
|
|
|
—
|
|
Change
in restricted cash, excluding effects of acquisition
|
|
|
4,120
|
|
|
|
(3,217
|
)
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
cash flows used in investing activities
|
|
|
(41,690
|
)
|
|
|
(36,393
|
)
|
|
|
(10,399
|
)
|
INTERNAP
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF CASH FLOWS (Continued)
(In
thousands)
|
|
|
|
|
|
|
|
|
|
|
|
Year
Ended December 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
Cash
flows from financing activities:
|
|
|
|
|
|
|
|
|
|
Proceeds
from notes payable, net of discount
|
|
|
20,000
|
|
|
|
19,742
|
|
|
|
—
|
|
Principal
payments on notes payable
|
|
|
(20,000
|
)
|
|
|
(11,318
|
)
|
|
|
(4,375
|
)
|
Payments
on capital lease obligations
|
|
|
(807
|
)
|
|
|
(1,617
|
)
|
|
|
(538
|
)
|
Debt
issuance costs
|
|
|
(14
|
)
|
|
|
(65
|
)
|
|
|
—
|
|
Stock-based compensation
plans
|
|
|
108
|
|
|
|
8,582
|
|
|
|
3,031
|
|
Proceeds
from exercise of warrants
|
|
|
—
|
|
|
|
—
|
|
|
|
3,808
|
|
Other,
net
|
|
|
(108
|
)
|
|
|
(84
|
)
|
|
|
31
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
cash flows (used in) provided by financing activities
|
|
|
(821
|
)
|
|
|
15,240
|
|
|
|
1,957
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Effect
of exchange rates on cash and cash equivalents
|
|
|
(600
|
)
|
|
|
66
|
|
|
|
212
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
(decrease) increase in cash and cash equivalents
|
|
|
(5,160
|
)
|
|
|
6,439
|
|
|
|
21,157
|
|
Cash
and cash equivalents at beginning of period
|
|
|
52,030
|
|
|
|
45,591
|
|
|
|
24,434
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents at end of period
|
|
$
|
46,870
|
|
|
$
|
52,030
|
|
|
$
|
45,591
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental
disclosure of cash flow information:
|
|
|
|
|
|
|
|
|
|
|
|
|
Common
stock issued and stock options assumed in VitalStream
acquisition
|
|
$
|
—
|
|
|
$
|
208,293
|
|
|
$
|
—
|
|
Cash
paid for interest, net of amounts capitalized
|
|
|
1,403
|
|
|
|
1,152
|
|
|
|
793
|
|
Cash
paid for income taxes
|
|
|
361
|
|
|
|
103
|
|
|
|
149
|
|
Non-cash
acquisition of property and equipment
|
|
|
3,069
|
|
|
|
148
|
|
|
|
162
|
|
Capitalized
stock-based compensation
|
|
|
97
|
|
|
|
25
|
|
|
|
44
|
|
The
accompanying notes are an integral part of these consolidated financial
statements.
INTERNAP
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
|
|
1.
|
DESCRIPTION
OF THE COMPANY AND NATURE OF
OPERATIONS
|
Internap
Network Services Corporation (“Internap,” “we,” “us,” “our,” or the “Company”)
delivers high performance and reliable Internet solutions through a suite of
network optimization and delivery products and services. These solutions and our
technical support enable companies to 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
entertainment and media, financial services, healthcare, travel,
e-commerce, retail and technology. Our product and service offerings are
complemented by Internet Protocol, or IP, access solutions such as colocation
and data center services, content delivery networks, or CDN, and managed
security. We deliver services through our 64 service points across North
America, Europe, Asia, India and Australia. Our Private Network Access Points,
or P-NAPs, feature multiple direct high-speed connections to multiple major
Internet backbones, also referred to as network service providers or NSPs,
including AT&T Inc.; Sprint Nextel Corporation; Verizon Communications
Inc.; Global Crossing Limited; and Level 3 Communications, Inc. We operate in
three business segments: IP services, data center services and CDN services.
Prior to February 2007, we operated 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 are described in “Risk
Factors” in this Form 10-K.
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 and terminating certain non-strategic real estate leases and
license arrangements. We have a history of quarterly and annual period net
losses through the year ended December 31, 2005. For the year ended December 31,
2006, we recognized net income in each quarter. For the years ended December 31,
2008 and 2007, we recognized net losses of $104.8 million and $5.6 million,
respectively. At December 31, 2008, our accumulated deficit was $966.8 million.
However, for the years ended December 31, 2008, 2007 and 2006, we generated net
cash flows from operating activities of $38.0 million, $27.5 million and $29.4
million, respectively.
|
|
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, or GAAP. The consolidated financial statements include our accounts and
those of our wholly-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, auction rate securities,
goodwill and 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 we believe 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.
INTERNAP
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Restricted
Cash
Restricted
cash represented time deposits used to secure letters of credit on certain of
our real estate leases and a capital lease for equipment in 2007. The letters of
credit for the real estate leases were secured by our former credit agreement
with Silicon Valley Bank and were in the process of being secured under the
original Credit Agreement executed in 2007. We assumed the letter of
credit securing the capital lease for equipment in the VitalStream acquisition.
As of December 31, 2008, we had no restricted cash, as these letters of credit
were secured by our Amended Credit Agreement, which is defined and described
below in note 11.
Investments
in Marketable Securities
We
determine the appropriate classification of all marketable securities at the
time of purchase, and re-evaluate such classification as of each reporting
period. Available-for-sale securities are carried at fair value, with the
unrealized gains and losses reported in other comprehensive (loss) income,
a component of stockholders’equity in our accompanying consolidated balance
sheets. We also review available-for-sale securities each reporting period for
declines in value that we consider to be other-than-temporary and, if
appropriate, write down the securities to their estimated fair value. Any
declines in value judged to be other-than-temporary on available-for-sale
securities are included in “Non-operating (income) expense” in the accompanying
consolidated statements of operations. Trading securities are carried at fair
value with all changes in fair value reported in “Non-operating (income)
expense” in the accompanying consolidated statements of operations. The cost of
securities sold is based on the specific identification method. At December 31,
2008, the fair value of our short-term investments in marketable securities was
$7.2 million, all designated as available for sale, and the fair value of our
non-current investments in marketable securities was $6.4 million, all
designated as trading. At December 31, 2007, we had $19.6 million of investments
in marketable securities, all of which were classified as short-term and
designated as available for sale. See note 5 for further discussion of our
investments.
Other
Investments
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, 2008, 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 a separate caption in our consolidated statement of
operations.
We
account for investments without readily determinable fair values at historical
cost, as determined by our initial investment. We periodically review the
recorded value of cost basis investments 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, we reduce the cost
basis and record an investment loss. At December 31, 2008, we had no investments
accounted for under the cost method.
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 5 for further discussion of this investment and the recorded
loss.
Fair
Value of Financial Instruments
Effective
January 1, 2008, we adopted the provisions of SFAS No. 157,
Fair Value Measurements
,
which defines fair value and provides guidance for using fair value to measure
assets and liabilities. In accordance with SFAS No. 157 and Staff
Position FAS 157-2,
Effective
Date of FASB Statement No. 157
, we adopted SFAS No. 157
with regard to all financial assets and liabilities in our financial statements
in the first quarter of 2008 and have elected to delay the adoption of
SFAS No. 157 for nonfinancial assets and nonfinancial liabilities
until the first quarter of 2009. SFAS No. 157 is applicable whenever
other standards require or permit assets or liabilities to be measured at fair
value but does not expand the use of fair value in any new circumstances.
Accordingly, the carrying amounts of certain of our financial instruments,
including cash equivalents and marketable securities, continue to be valued at
fair value on a recurring basis.
SFAS
No. 157 introduced new disclosures about how we value certain assets. Much
of the disclosure focuses on the inputs used to measure fair value, particularly
in instances in which the measurement uses significant unobservable inputs. The
fair value estimates presented in this report reflect the information available
to us as of December 31, 2008. See note 6 for further discussion of
the fair value of our financial instruments.
INTERNAP
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The
carrying amounts of our financial instruments, including cash and cash
equivalents, accounts receivable, and other current liabilities, approximate
fair value due to the short-term nature of these assets and liabilities. The
fair value of our debt approximates the carrying value due to the nature of our
credit facility.
We
elected to record rights, or ARS Rights, from one of our investment providers at
fair value. The ARS Rights are more fully described in note 5. Recording the ARS
Rights at fair value enables us to match changes in the fair value of the ARS
Rights to changes in the fair value of the associated auction rate
securities.
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. We also have invested, in accordance with our formal
investment policy, in high credit quality corporate debt securities, U.S.
Treasury bills and commercial paper. Our investments in marketable securities
also include auction rate securities whose underlying assets are state-issued
student and educational loans which are substantially backed by the federal
government. Under our current investment policy, new or additional auction rate
securities are not eligible investment instruments, but we will hold our
existing auction rate securities until liquidity returns or we exercise our ARS
Rights, as discussed below. As of December 31, 2008 and 2007, our investments in
auction rate securities having a par value of $7.2 million had carrying values
of $6.4 million and $7.2 million, respectively. The carrying amount at
December 31, 2008 includes a reduction in fair value of $0.8 million. While
we continue to earn and accrue interest on our auction rate securities at
contractual rates, these investments are not currently trading.
During
2008, we classified our auction rate securities as non-current investments on
our accompanying consolidated balance sheet versus short-term investments as of
December 31, 2007. This change in classification was initially due to
the uncertainty as to when the auction rate securities markets would
improve.
As described in note 5, in October 2008, we received and
subsequently accepted rights, or ARS Rights, from one of our investment
providers to sell at par value auction rate securities originally purchased
from the investment provider ($7.2 million) at any time during a two-year
period beginning June 30, 2010. The fair value and carrying value of the ARS
Rights was $0.6 million as of December 31, 2008.
Inventory
We carry
inventory 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.
Property
and Equipment
We carry
property and equipment at original acquisition cost less accumulated
depreciation and amortization. We calculate depreciation and amortization 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. We capitalize additions and improvements that increase the value or
extend the life of an asset. We expense maintenance and repairs as incurred. We
charge gains or losses from disposals of property and equipment to
operations.
Leases
and Leasehold Improvements
We record
leases in which we have substantially all of the benefits and risks of ownership
as capital leases and all other leases as operating leases. For leases
determined to be capital leases, the assets held under capital lease and related
obligations are recorded at the lesser of the present value of aggregate future
minimum lease payments or the fair value of the assets held under capital lease.
The assets are amortized over the shorter of the lease term or the estimated
useful life. For leases determined to be operating leases, lease expense is
recorded on a straight-line basis over the lease term. Certain leases include
renewal options that, at the inception of the lease, are considered reasonably
assured of being renewed. The lease term begins when the Company controls the
leased property, which is typically before lease payments begin under the terms
of the lease. The difference between the expense recorded in the consolidated
statements of operations and the amount paid is recorded as deferred rent and is
included in the consolidated balance sheets.
INTERNAP
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Costs
of Computer Software Development
We
capitalize certain direct costs incurred developing internal use software. We
capitalized $1.4 million, $1.6 million and $0.9 million in internal software
development costs for the years ended December 31, 2008, 2007 and 2006,
respectively. During the year ended December 31, 2007, we impaired $1.1 million
of software development costs capitalized prior to December 31, 2006 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
developer 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 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, 2008 and 2007, the balance of unamortized software costs was $3.8
million and $2.7 million, respectively, and for the years ended December 31,
2008 and 2007, amortization expense was $0.4 million and $0.2 million,
respectively. 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 year ended December 31, 2006.
Valuation
of Long-Lived Assets
We
periodically evaluate the carrying value of our long-lived assets, including,
but not limited to, property and equipment. 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, we would recognize a loss 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.
Goodwill
and Other Intangible Assets
We
perform our annual goodwill impairment test as of August 1 of each calendar
year, following our annual strategic planning cycle. Our assessment of
goodwill for impairment includes comparing the fair value to the net book value
of each of our four reporting units. Our IP services operating segment is
comprised of two reporting units: services and products. Our data center center
services and CDN services operating segments each represent a single reporting
unit; however, the data center services segment does not have any recorded
goodwill.
We
estimate fair value using a combination of discounted cash flow models and
market approaches. If the fair value of a reporting unit exceeds its net
book value, goodwill is not impaired and no further testing is
necessary. If the net book value of a reporting unit exceeds its fair
value, we perform a second test to measure the amount of impairment loss, if
any. To measure the amount of any impairment loss, we determine the implied
fair value of goodwill in the same manner as if the affected reporting unit were
being acquired in a business combination. Specifically, we allocate the fair
value of the affected reporting unit to all of the assets and liabilities of
that unit, including any unrecognized intangible assets, in a hypothetical
calculation that would yield the implied fair value of goodwill. If the implied
fair value of goodwill is less than the goodwill recorded on our balance sheet,
we record an impairment charge for the difference.
As a
result of our August 1, 2008 assessment, we recorded a
$99.7 million goodwill impairment charge to adjust goodwill in our CDN
services segment to an implied fair value of $54.7 million. The goodwill
impairment charge is presented separately in the accompanying statement of
operations for the year ended December 31, 2008. The goodwill impairment is
primarily due to declines in our CDN services revenues and operating results as
compared to our projections and unfavorable changes in market factors used to
estimate fair values. The declines in CDN services revenues and operating
results compared to projections are attributable to integration and reliability
issues in the acquired network and have now been resolved, a strategic shift to
larger, higher credit quality customers and more recently, a highly-competitive
market environment for CDN services that is driving lower pricing. Changes
in market factors include lower market multiples across the CDN services
industry from when we completed the acquisition of VitalStream and our own
now-lower market capitalization. The culmination of these factors leading
to our impairment of goodwill did not occur until the three months ended
September 30, 2008. The impairment charge does not have any impact on
our current cash balance or result in violation of any covenants of our debt
instruments.
We also
assessed the likelihood of triggering events that might cause us to re-assess
goodwill on an interim basis and concluded that no such triggering events have
occurred that would cause us to re-assess goodwill for impairment subsequent to
August 1, 2008.
INTERNAP
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Other
intangible assets, including developed technologies and patents, have finite
lives and we have recorded these assets at cost less accumulated amortization.
We calculate amortization on a straight-line basis over the estimated economic
useful life of the assets, which are three to seven years for developed
technologies and 15 years for patents.
In
conjunction with our review of our long-term financial outlook, we also
performed an analysis of the potential impairment and re-assessed the remaining
asset lives of other identifiable intangible assets acquired in the VitalStream
acquisition. The analysis and re-assessment of other identifiable intangible
assets recorded in the VitalStream acquisition resulted in:
|
|
|
|
●
|
An
impairment charge of $1.9 million in developed advertising technology due
to a strategic change in market focus,
|
|
|
An
impairment charge of $0.8 million in trade names as a result of
discontinuing use of the VitalStream trade name,
and
|
|
|
a
change in our estimates that resulted in acceleration of amortization
expense of our customer relationships intangible asset over a shorter
estimated useful life (four remaining years instead of the original
estimated useful life of nine years) due to customer churn resulting in
higher than expected attrition as of the acquisition
date.
|
The
impairment analysis of goodwill is based on estimated fair values. The valuation
of goodwill requires assumptions and estimates of many critical factors,
including revenue and market growth, operating cash flows, market multiples and
discount rates. Adverse changes in expected operating results and/or unfavorable
changes in other economic factors used to estimate fair values could result in
an additional non-cash impairment charge in the future.
Accruals
for Disputed Telecommunication Costs and Other Accrued Liabilities
In
delivering our services, we rely on a number of Internet network,
telecommunication, utilities and other vendors. We work directly with these
vendors to establish, modify or discontinue services for our customers. Because
of the volume of activity, billing disputes inevitably arise, and it is often
necessary to estimate certain costs of providing services to our customers given
that we may not receive invoices on a timely basis or due to the complexity
surrounding such costs. 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 up 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 based on the full amount that we should have
been invoiced. If 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.
We
research all disputed costs with vendors on an ongoing basis until ultimately
resolved. We periodically review and modify estimates in light of new
information or developments, if any. We recognize any resolved disputes that
will result in a credit over the disputed amounts 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.
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, we 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 our best expectations based on known facts and circumstances at the
time of estimation. Should circumstances warrant, we will adjust our
previous estimates to reflect what we then believe to be a more accurate
representation of expected future costs. Because our estimates and assumptions
regarding restructuring costs include probabilities of future events, such as
our ability to find a sublease tenant within a reasonable period of time or the
rate at which a sublease tenant will pay for the available space, such estimates
are inherently vulnerable to changes due to unforeseen 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 $9.0 million
restructuring liability at December 31, 2008, would result in a $0.9 million
expense or benefit in the statement of operations during the period in which the
change in estimate occurred. If we do not find a sublease tenant for one of our
more significant restructured locations by the end of the second quarter of 2010
or if we do not obtain a certain rate per square foot for the available space,
we will need to take an additional charge in our statement of operations that
may be material. We monitor market conditions at each period end reporting date
and will continue to assess our key assumptions and estimates used in the
calculation of our restructuring accrual.
Taxes
We
account for income taxes under the liability method. We determine deferred tax
assets and liabilities based on differences between financial reporting and tax
bases of assets and liabilities, and we measure the tax assets and liabilities
measured using the enacted tax rates and laws that will be in effect when we
expect the differences to reverse. We provide a valuation allowance to reduce
our deferred tax assets to their estimated realizable value. We may realize
deferred tax assets in future periods when they are estimated to be realizable,
such as establishing expected continuing profitability of the Company or certain
of our foreign subsidiaries.
INTERNAP
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
We accrue
liabilities for uncertain tax positions and, as of December 31, 2008 and 2007,
we recognized associated liabilities of $0 and $0.9 million, respectively that
were netted on the balance sheet with U.K. deferred tax assets. We have recorded
nominal interest and penalties arising from the underpayment of income taxes in
the statement of operations under general and administrative expenses. As of
December 31, 2008 and 2007, we had 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
Stock-based
compensation cost is measured at the grant date based on the calculated fair
value of the award. We recognize the expense over the employees’ requisite
service period, generally the vesting period of the award.
For
performance-based awards, we periodically assess whether the performance
conditions are probable of being met and record compensation expense based on
this assessment of probability.
We estimate the fair value of stock
options at the grant date 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.
When we
elect to pay certain bonuses in shares of stock, the total amount to be paid is
determined similarly to cash bonuses and the number of shares to be granted is
determined based on the fair value of our stock at the date of
grant.
We do not
recognize a deferred tax asset for unrealized tax benefits associated with the
tax deductions in excess of the compensation recorded (excess tax benefit). We
apply 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 apply the “direct only” method of calculating the amount of
windfalls or shortfalls.
Treasury
Stock
As
permitted by our stock-based compensation plans, we acquire, from time-to-time,
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.
Shares of treasury stock acquired in 2008 will also be subsequently reissued as
part of our stock-based compensation plans. When we reissue the shares, 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. We did not acquire shares of treasury stock
during 2007.
Reverse
Stock Split
On July
10, 2006, we implemented a one-for-10 reverse stock split on our common stock
and amended our Certificate of Incorporation to reduce our authorized shares of
common stock 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
The
majority of our revenues are derived from high performance IP services, related
data center services, CDN services and other ancillary products and services
throughout the United States. We derive our IP services revenues from the sale
of high performance Internet connectivity services at fixed rates or usage-based
pricing to our customers that desire a DS-3 or faster connection. We provide
slower T-1 and fractional DS-3 connections at fixed rates. Data center
revenues include 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 revenues are
based on occupied square feet and both allocated and variable-based
usage. CDN services revenues include three components: (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 services revenues are 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
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 both parties have signed an enforceable contract, we
have delivered the service to the customer, the fee for the service is fixed or
determinable and collection is reasonably assured. If a customer’s usage of our
services exceeds 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. Other ancillary products and services include our FCP product, server
management and installation, virtual private networking, managed security
,
data backup
,
remote storage and
restoration.
We use
contracts and sales or purchase orders as evidence 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 product 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’
Statement of Position 97-2,
Software Revenue
Recognition
.
INTERNAP
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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 we have satisfied other revenue recognition
criteria.
Deferred
revenue consists of revenues for services to be delivered in the future and
consists primarily of advance billings, which we amortize over the respective
service period. We defer and amortize revenues associated with billings for
installation of customer network equipment over the estimated life of the
customer relationship, which was two to three years during the three-year period
ended December 31, 2008. We defer and amortize revenues for installation
services because the installation service is integral to our primary service
offering and does not have value to customers on a stand-alone basis. We also
defer and amortize the associated incremental direct costs. We amortize deferred
post-contract customer support associated with sales of our FCP product and
similar products ratably over the contract period, which is generally one
year.
We
routinely review the collectability of our accounts receivable 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 our 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 we have exhausted all collection efforts, we
write the uncollectible balance off against the allowance for doubtful
accounts.
We record
an amount for service level agreements and other sales adjustments, which
reduces net accounts receivable and revenues. Adjustments for service level
agreements are identified within the billing period and revenues are reduced
accordingly.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
deteriorates, or if we become aware of new information impacting a customer’s
credit risk, we may make additional adjustments.
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. Research and development costs, which we include in product
development cost and expense as incurred, primarily consist of
compensation related to our development and enhancement of IP
routing technology, progressive download and streaming technology for our
CDN, acceleration and cloud technologies. Research and development costs
were $5.0 million, $3.1 million and $2.4 million for the years ended December
31, 2008, 2007 and 2006, respectively. We also expense as incurred those costs
that do not qualify for capitalization as software development
costs.
Advertising
Costs
We
expense all advertising costs as incurred. Advertising costs for the years ended
December 31, 2008, 2007 and 2006 were $1.3 million, $1.2 million and $1.3
million, respectively.
INTERNAP
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Net
(Loss) Income Per Share
We
compute basic and diluted net (loss) income per share using the weighted average
number of shares of common stock outstanding during the period. We compute
diluted net (loss) income per share using the weighted average number of common
and potentially dilutive shares outstanding during the period. Potentially
dilutive shares consist of the incremental shares of common stock 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, 2008, 2007
and 2006 is calculated as follows (in thousands, except per share
amounts):
|
|
|
|
|
|
|
|
|
|
|
|
Year
Ended December 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
Net
(loss) income
|
|
$
|
(104,813
|
)
|
|
$
|
(5,555
|
)
|
|
$
|
3,657
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average shares outstanding, basic
|
|
|
49,238
|
|
|
|
46,942
|
|
|
|
34,748
|
|
Effect
of dilutive securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock
compensation plans
|
|
|
—
|
|
|
|
—
|
|
|
|
984
|
|
Warrants
|
|
|
—
|
|
|
|
—
|
|
|
|
7
|
|
Weighted
average shares outstanding, diluted
|
|
|
49,238
|
|
|
|
46,942
|
|
|
|
35,739
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
(loss) income per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
(2.13
|
)
|
|
$
|
(0.12
|
)
|
|
$
|
0.11
|
|
Diluted
|
|
$
|
(2.13
|
)
|
|
$
|
(0.12
|
)
|
|
$
|
0.10
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Anti-dilutive
securities not included in diluted net (loss) income per share
calculation:
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock
compensation plans
|
|
|
3,651
|
|
|
|
3,860
|
|
|
|
1,408
|
|
Warrants
to purchase common stock
|
|
|
—
|
|
|
|
34
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3,651
|
|
|
|
3,894
|
|
|
|
1,408
|
|
Reclassifications
Beginning
in 2008, we classified all revenues and direct costs of network, sales and
services previously reported in other, non-segmented results, except for third
party CDN services, in the most closely-related business segments to provide a
more accurate view of the results of operations of the business
segments. Financial information for 2007 and 2006 has also been
reclassified to conform to the current period presentation. None of the
reclassifications had any effect on previously reported total revenues, total
direct costs of network, sales and services, exclusive of depreciation and
amortization or net (loss) income.
INTERNAP
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The
effect of these reclassifications on revenues and direct costs of network, sales
and services is shown below (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
IP
Services
|
|
|
Data
Center
Services
|
|
|
CDN
Services
|
|
|
Other
|
|
|
Total
|
|
Year
ended December 31, 2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Previously
reported
|
|
$
|
119,848
|
|
|
$
|
83,058
|
|
|
$
|
17,718
|
|
|
$
|
13,466
|
|
|
$
|
234,090
|
|
Reclassification
of termination fees and professional and reseller products and
services
|
|
|
2,357
|
|
|
|
574
|
|
|
|
88
|
|
|
|
(3,019
|
)
|
|
|
—
|
|
Revised
|
|
$
|
122,205
|
|
|
$
|
83,632
|
|
|
$
|
17,806
|
|
|
$
|
10,447
|
|
|
$
|
234,090
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Direct
costs of network, sales and services, exclusive of depreciation and
amortization:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Previously
reported
|
|
$
|
43,681
|
|
|
$
|
59,439
|
|
|
$
|
6,584
|
|
|
$
|
8,690
|
|
|
$
|
118,394
|
|
Reclassification
of professional and reseller products and services
|
|
|
244
|
|
|
|
—
|
|
|
|
10
|
|
|
|
(254
|
)
|
|
|
—
|
|
Revised
|
|
$
|
43,925
|
|
|
$
|
59,439
|
|
|
$
|
6,594
|
|
|
$
|
8,436
|
|
|
$
|
118,394
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year
ended December 31, 2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Previously
reported
|
|
$
|
109,748
|
|
|
$
|
56,152
|
|
|
$
|
—
|
|
|
$
|
15,475
|
|
|
$
|
181,375
|
|
Reclassification
of termination fees and professional and reseller products and
services
|
|
|
2,502
|
|
|
|
396
|
|
|
|
—
|
|
|
|
(2,898
|
)
|
|
|
—
|
|
Revised
|
|
$
|
112,250
|
|
|
$
|
56,548
|
|
|
$
|
—
|
|
|
$
|
12,577
|
|
|
$
|
181,375
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Direct
costs of network, sales and services, exclusive of depreciation and
amortization:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Previously
reported
|
|
$
|
39,744
|
|
|
$
|
46,474
|
|
|
$
|
—
|
|
|
$
|
11,120
|
|
|
$
|
97,338
|
|
Reclassification
of professional and reseller products and services
|
|
|
979
|
|
|
|
—
|
|
|
|
—
|
|
|
|
(979
|
)
|
|
|
—
|
|
Revised
|
|
$
|
40,723
|
|
|
$
|
46,474
|
|
|
$
|
—
|
|
|
$
|
10,141
|
|
|
$
|
97,338
|
|
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. We have presented the corresponding items of segment information for
the year ended December 31, 2006.
Recent
Accounting Pronouncements
Effective
January 1, 2008, we adopted 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 157-1,
Application of FASB Statement No.
157 to FASB Statement No. 13 and Its Related Interpretive Accounting
Pronouncements That Address Leasing Transactions
, which provides
supplemental guidance on the application of SFAS No. 157, and Staff
Position 157-2,
Effective Date
of FASB Statement No. 157
, which delays the effective date of SFAS
No. 157 for nonfinancial assets and nonfinancial liabilities, except those
that are recognized or disclosed at fair value on at least an annual basis until
2009. In accordance with Staff Position 157-2, we have only adopted the
provisions of SFAS No. 157 with respect to our financial assets and liabilities
that are measured at fair value within the financial statements as of December
31, 2008. The provisions of SFAS No. 157 have not been applied to nonfinancial
assets and nonfinancial liabilities. The major categories of assets and
liabilities that are measured at fair value, for which we have not applied the
provisions of SFAS No. 157, include reporting units measured at fair value in
the first step of a goodwill impairment test under SFAS No. 142,
Goodwill and Other Intangible
Assets
. The adoption of SFAS No. 157 did not have a material impact
on our financial position, results of operations and cash
flows.
INTERNAP
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
In
October 2008, the FASB issued Staff Position FAS 157-3,
Determining the Fair Value of a
Financial Asset When the Market for That Asset Is Not Active
which
clarifies the application of SFAS No. 157 in a market that is not active and
provides an example to illustrate key considerations in determining the fair
value of a financial asset when the market for that financial asset is not
active. Some of the key principles illustrated include:
|
|
|
|
|
determining
fair value in a dislocated market depends on facts and circumstances, and
may require the use of significant judgment about whether individual
market transactions are forced liquidations or distressed sales and
therefore poor indicators of fair value;
|
|
|
|
|
|
when
relevant observable market data is not available, the use of assumptions
about future cash flows and discount rates may be appropriate in
determining fair value; and
|
|
|
|
|
|
the
value of broker quotes in determining fair value depends on facts and
circumstances, particularly when an active market does not
exist.
|
Staff
Position FAS 157-3 was effective immediately, including with respect to prior
periods for which financial statements have not been issued. We have
consistently used the methodology described in this Staff Position in
calculating the fair value of our auction rate securities throughout
2008.
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 was effective
as of the beginning of a fiscal year that begins after November 15, 2007.
The adoption of SFAS No. 159 did not have a material impact on our financial
condition, results of operations and cash flows since we elected to apply the
fair value option only for our ARS Rights. See note 6 for discussion
of the fair value election of our ARS Rights.
In
December 2007, the FASB issued SFAS No. 141 (revised 2007),
Business Combinations
, or
SFAS No. 141R. This pronouncement 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 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 there are also implications for acquisitions that occur prior to this
date. We do not expect that the adoption of SFAS No. 141R will have an
immediate material impact on our financial position, results of operations and
cash flows.
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
, 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 material impact on our financial position, results of operations and cash
flows.
In
March 2008, the FASB issued SFAS No. 161,
Disclosures about Derivative
Instruments and Hedging Activities, an amendment of FASB Statement
No. 133
. SFAS No. 161 amends and expands the disclosure
requirements of SFAS No. 133 with the intent to provide users of financial
statements with an enhanced understanding of: (1) how and why an entity uses
derivative instruments; (2) how derivative instruments and related hedged items
are accounted for under SFAS No. 133 and its related interpretations and
(3) how derivative instruments and related hedged items affect an entity’s
financial position, financial performance and cash flows. This statement is
effective for financial statements issued for fiscal years and interim periods
beginning after November 15, 2008. We do not expect the adoption of SFAS
No. 161 to have a material impact on our financial position, results of
operations and cash flows.
In April
2008, the FASB issued Staff Position FAS 142-3,
Determination of the Useful Life of
Intangible Assets
. Staff Position FAS 142-3 amends the factors that
should be considered in developing renewal or extension assumptions used to
determine the useful life of a recognized intangible asset under SFAS
No. 142. This Staff Position is effective for financial statements issued
for fiscal years beginning after December 15, 2008. We do not expect the
adoption of Staff Position FAS 142-3 to have a material impact on our financial
position, results of operations and cash flows.
INTERNAP
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
In June
2008, the FASB issued Staff Position No. EITF 03-6-1,
Determining Whether Instruments
Granted in Share-Based Payment Transactions are Participating Securities
.
Staff Position No. EITF 03-6-1 provides that unvested share-based
payment awards that contain nonforfeitable rights to dividends are participating
securities and shall be included in the computation of earnings per share
pursuant to the two class method. This Staff Position is effective for financial
statements issued for fiscal years beginning after December 15, 2008 and
interim periods within those years. For the quarter ended March 31, 2009,
upon adoption, we are required to retrospectively adjust earnings per share data
to conform to the provisions in this Staff Position. We do not expect this Staff
Position to have a material impact on our calculation of earnings per
share.
In
November 2008, the FASB issued EITF 08-6,
Equity Method Investment Accounting
Considerations
. The goal of EITF 08-6 is to clarify the accounting for
certain transactions and impairment considerations involving equity method
investments. This issue is effective for fiscal years beginning on or after
December 15, 2008. Early adoption is not permitted. We do not expect the
adoption of EITF 08-6 to have a material impact on our financial position,
results of operations and cash flows.
On
February 20, 2007, we completed the acquisition of VitalStream Holdings, Inc.,
or VitalStream, for approximately $214.0 million, whereby VitalStream became our
wholly-owned subsidiary. The acquisition allows us to provide products and
services for storing and delivering digital media to large audiences over the
Internet. The acquisition 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 markets. 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.
Purchase
Price
We
recorded assets acquired and liabilities assumed 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
|
|
$
|
197,272
|
|
Fair
value of stock options assumed
|
|
|
11,021
|
|
Direct
transaction costs
|
|
|
5,729
|
|
Total purchase
price
|
|
$
|
214,022
|
|
As a
result of the acquisition, we issued approximately 12.2 million shares of
our common stock based on an exchange ratio of 0.5132 shares of our 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-10 reverse stock
split we implemented on July 11, 2006 and the one-for-four reverse stock
split VitalStream implemented on April 4, 2006. The average market price
per share of our 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 our 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 our 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):
|
|
|
|
|
|
|
|
|
|
Amount
|
|
Estimated
Useful
Life
|
|
Net
tangible assets
|
|
$
|
12,286
|
|
|
—
|
|
Identifiable
intangible assets:
|
|
|
|
|
|
|
|
Developed
technologies
|
|
|
36,000
|
|
|
8
years
|
|
Customer
relationships
|
|
|
9,000
|
|
|
9
years
|
|
Trade
name and other
|
|
|
1,500
|
|
|
3-6
years
|
|
Acquired
in-process research and development
|
|
|
450
|
|
|
—
|
|
Goodwill
(1)
|
|
|
154,786
|
|
|
—
|
|
Total
estimated purchase price
|
|
$
|
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
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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 products acquired in the VitalStream acquisition that
have reached technological feasibility and include processes and trade secrets
acquired or developed through design and development of 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. See note 8 for discussion of the impairment
charge recorded during the year ended December 31, 2008 for developed
technologies and trade names, as well as a change in estimated life of customer
relationships.
In-Process
Research and Development
As of the
closing date, one project was in development that had not reached technological
feasibility and therefore qualified 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. Pursuant to the guidance in SFAS
No. 141, an assembled workforce is not recognized apart from goodwill and
therefore is embedded in goodwill. We acquired an assembled workforce in the
VitalStream acquisition that we included as a component of
goodwill. Another component of goodwill is the estimated fair value of the
expected synergies and other benefits from combining the net assets and business
of us and VitalStream. We expected significant synergies 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. See note 8 for discussion of the goodwill impairment charge recorded
during the year ended December 31, 2008. A total of $17.1 million of
goodwill will be deductible for tax purposes.
Pro
Forma Results (Unaudited)
VitalStream
provided 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. The acquisition enhanced
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 market. 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, 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 were 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):
INTERNAP
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
|
|
Year
Ended December 31,
|
|
|
|
2007
|
|
|
2006
|
|
Pro
forma revenues
|
|
$
|
236,418
|
|
|
$
|
205,052
|
|
Pro
forma net loss
|
|
|
(14,269
|
)
|
|
|
(16,153
|
)
|
Pro
forma net loss per share, basic and diluted
|
|
|
(0.25
|
)
|
|
|
(0.34
|
)
|
We
operate 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.
Other revenues and direct costs represent third party CDN services prior to the
acquisition of VitalStream. The following tables show operating results for our
reportable segments, along with reconciliations from segment gross profit to
(loss) income before income taxes and equity in earnings of equity-method
investment (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year
Ended December 31, 2008
|
|
|
|
IP
Services
|
|
|
Data
Center
Services
|
|
|
CDN
Services
|
|
|
Other
|
|
|
Total
|
|
Revenues
|
|
$
|
123,268
|
|
|
$
|
109,679
|
|
|
$
|
21,042
|
|
|
$
|
—
|
|
|
$
|
253,989
|
|
Direct
costs of network, sales and services, exclusive of depreciation and
amortization
|
|
|
45,782
|
|
|
|
82,009
|
|
|
|
8,086
|
|
|
|
—
|
|
|
|
135,877
|
|
Segment
profit
|
|
$
|
77,486
|
|
|
$
|
27,670
|
|
|
$
|
12,956
|
|
|
$
|
|
|
|
|
118,112
|
|
Other
operating expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
223,279
|
|
Loss
from operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(105,167
|
)
|
Non-operating
income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
245
|
|
Loss
before income taxes and equity in earnings of equity-method
investment
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
(104,922
|
)
|
Direct
costs of network, sales and services, exclusive of depreciation and
amortization, includes an allocation of $1.1 million from the IP services
segment to the CDN services segment based on the average cost of actual usage by
the CDN segment for 2008.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year
Ended December 31, 2007
|
|
|
|
IP
Services
|
|
|
Data
Center
Services
|
|
|
CDN
Services
|
|
|
Other
|
|
|
Total
|
|
Revenues
|
|
$
|
122,205
|
|
|
$
|
83,632
|
|
|
$
|
17,806
|
|
|
$
|
10,447
|
|
|
$
|
234,090
|
|
Direct
costs of network, sales and services, exclusive of depreciation and
amortization
|
|
|
43,925
|
|
|
|
59,439
|
|
|
|
6,594
|
|
|
|
8,436
|
|
|
|
118,394
|
|
Segment
profit
|
|
$
|
78,280
|
|
|
$
|
24,193
|
|
|
$
|
11,212
|
|
|
$
|
2,011
|
|
|
|
115,696
|
|
Other
operating expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
125,407
|
|
Loss
from operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(9,711
|
)
|
Non-operating
income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
937
|
|
Loss
before income taxes and equity in earnings of equity-method
investment
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
(8,774
|
)
|
Direct
costs of network, sales and services, exclusive of depreciation and
amortization, included an allocation of $0.9 million from the IP services
segment to the CDN services segment based on the average cost of actual usage by
the CDN segment for 2007.
INTERNAP
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
|
|
Year
Ended December 31, 2006
|
|
|
|
IP
Services
|
|
|
Data
Center
Services
|
|
|
CDN
Services
|
|
|
Other
|
|
|
Total
|
|
Revenues
|
|
$
|
112,250
|
|
|
$
|
56,548
|
|
|
$
|
—
|
|
|
$
|
12,577
|
|
|
$
|
181,375
|
|
Direct
costs of network, sales and services, exclusive of depreciation and
amortization
|
|
|
40,723
|
|
|
|
46,474
|
|
|
|
—
|
|
|
|
10,141
|
|
|
|
97,338
|
|
Segment
profit
|
|
$
|
71,527
|
|
|
$
|
10,074
|
|
|
$
|
—
|
|
|
$
|
2,436
|
|
|
|
84,037
|
|
Other
operating expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
81,900
|
|
Income
from operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,137
|
|
Non-operating
income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,551
|
|
Income
before income taxes and equity in earnings of equity-method
investment
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
3,688
|
|
The
following table includes selected segment financial information as of December
31, 2008 and 2007, related to goodwill and total assets (in
thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
IP
Services
|
|
|
Data
Center
Services
|
|
|
CDN
Services
|
|
|
Other
|
|
|
Total
|
|
December
31, 2008:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Goodwill
|
|
$
|
36,314
|
|
|
$
|
—
|
|
|
$
|
54,663
|
|
|
$
|
—
|
|
|
$
|
90,977
|
|
Total
assets
|
|
|
151,839
|
|
|
|
69,317
|
|
|
|
108,927
|
|
|
|
—
|
|
|
|
330,083
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December
31, 2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Goodwill
|
|
$
|
36,314
|
|
|
$
|
—
|
|
|
$
|
154,363
|
|
|
$
|
—
|
|
|
$
|
190,677
|
|
Total
assets
|
|
|
148,697
|
|
|
|
64,498
|
|
|
|
211,469
|
|
|
|
2,346
|
|
|
|
427,010
|
|
As
discussed in note 8, we recorded impairment charges in the CDN services segment
of $99.7 million for goodwill and $2.6 million for other intangible
assets.
Through
December 31, 2008, neither revenues generated nor long-lived assets located
outside the United States were significant (all less than 10%).
Investment
in Marketable Securities
Pursuant
to our formal investment policy, investments in marketable securities primarily
consist of high credit quality corporate debt securities, U.S. Treasury bills
and commercial paper. All short-term investments in marketable securities have
original maturities greater than 90 days but less than one year, are designated
as available for sale and are recorded at fair value with changes in fair value
reflected in other comprehensive (loss) income, a component of stockholders’
equity in our accompanying consolidated balance sheets, unless the change in
fair value is determined to be an other-than-temporary impairment. Our
investments in marketable securities also include auction rate securities whose
underlying assets are state-issued student and educational loans which are
substantially backed by the federal government. Under our current investment
policy, new or additional auction rate securities are not eligible instruments,
but we will hold the existing auction rate securities until liquidity returns or
we exercise our ARS Rights, as discussed below.
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 seven, 28 or 35 days. Auction rate securities generally
trade at par value and are callable at par value 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 have historically been
priced and traded as short-term instruments because of the liquidity provided
through the interest rate resets. While we continue to earn and accrue interest
on our auction rate securities at contractual rates, these investments are not
currently trading. During 2008, we classified our auction rate securities as
non-current investments on our accompanying consolidated balance sheet versus
short-term investments as of December 31, 2007. This change in classification
was initially due to the uncertainty as to when the auction rate securities
markets would improve. In November 2008, as further described below, we accepted
an offer for the ARS Rights on our auction rate securities. In conjunction with
our acceptance of the ARS Rights, we changed the designation of the auction rate
securities to trading from available for sale and continue to classify the
securities as non-current investments as of December 31, 2008.
INTERNAP
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Summaries
of our investments in short-term available for sale securities are as follows
(in thousands):
|
|
December
31, 2008
|
|
|
|
Cost
Basis
|
|
|
Unrealized
Gain
(Loss)
|
|
|
Carrying
Value
|
|
Corporate
debt securities
|
|
$
|
5,706
|
|
|
$
|
(7
|
)
|
|
$
|
5,699
|
|
U.S.
Treasury bills
|
|
|
1,500
|
|
|
|
—
|
|
|
|
1,500
|
|
Total
short-term investments in marketable securities
|
|
$
|
7,206
|
|
|
$
|
(7
|
)
|
|
$
|
7,199
|
|
|
|
December
31, 2007
|
|
|
|
Cost
Basis
|
|
|
Unrealized
Gain
(Loss)
|
|
|
Carrying
Value
|
|
Corporate
debt securities
|
|
$
|
7,607
|
|
|
$
|
3
|
|
|
$
|
7,610
|
|
Auction
rate securities
|
|
|
7,150
|
|
|
|
—
|
|
|
|
7,150
|
|
Commercial
paper
|
|
|
4,787
|
|
|
|
2
|
|
|
|
4,789
|
|
Other
|
|
|
24
|
|
|
|
(4
|
)
|
|
|
20
|
|
Total
short-term investments in marketable securities
|
|
$
|
19,568
|
|
|
$
|
1
|
|
|
$
|
19,569
|
|
Proceeds
from the sale of short-term available-for-sale securities, primarily commercial
paper, were $3.2 million during the year ended December 31, 2008. The related
gross realized gains and losses were less than $0.1 million. For the year ended
December 31, 2007, all proceeds on short-term marketable securities were from
the maturity of the securities or sales of auction rate securities at par
value. Accordingly, we did not recognize any realized gains or losses on
short-term marketable securities.
In
October 2008, we received an offer providing us with rights, or the ARS Rights,
from one of our investment providers to sell at par value auction rate
securities originally purchased from the investment provider ($7.2 million)
at anytime during a two-year period beginning June 30, 2010. On November 14,
2008, we accepted the offer. By accepting the offer, we are able to sell our
auction rate securities back to our investment provider at par value, which is
defined as the price equal to the liquidation preference of the auction rate
securities plus accrued but unpaid dividends or interest, during the period of
June 30, 2010 to July 2, 2012. In consideration for the ARS Rights, we granted
the investment provider the right to sell or otherwise dispose of, and/or enter
orders in the auction process for our auction rate securities until July 2, 2012
without prior notification, so long as we receive payment of par value upon any
sale or disposition.
The ARS
Rights represent a firm agreement in accordance with SFAS No. 133, which defines
a firm agreement as an agreement with an unrelated party, binding on both
parties and usually legally enforceable, with the following
characteristics: (1) the agreement specifies all significant terms,
including the quantity to be exchanged, the fixed price and the timing of the
transaction, and (2) the agreement includes a disincentive for nonperformance
that is sufficiently large to make performance probable. The enforceability
of the rights results in a put option and should be recognized as a free
standing asset separate from the auction rate securities. The ARS Rights
cannot be net settled, so they do not meet the definition of a derivative
instrument under SFAS No. 133. Therefore, we have elected to measure the
ARS Rights at fair value under SFAS No. 159, which permits an entity to elect
the fair value option for selected recognized financial assets, in order to
match the changes in the fair value of the auction rate securities. As a
result, changes in fair value will be included in earnings in future
periods. For the year ended December 31, 2008, we have recorded an
unrealized gain of $0.6 million on the ARS Rights, representing the fair value
as of December 31, 2008. The unrealized gain is included in “Non-operating
(income) expense” in the accompanying consolidated statements of operations
and the fair value is included in “Investments and other related assets” in the
accompanying consolidated balance sheets.
In
connection with our acceptance of the ARS Rights in November 2008, we
transferred our auction rate securities from investments available for sale to
trading securities in accordance with SFAS No. 115,
Accounting for Certain Investments
in Debt and Equity Securities
. The transfer to trading securities
reflects our intent to exercise the ARS Rights during the period June 30, 2010
to July 2, 2012. As a result of the transfer, we immediately recognized in
earnings the other-than-temporary impairment on our auction rate securities
previously recorded in other comprehensive income (loss). For the year
ended December 31, 2008, we recorded a cumulative other-than-temporary
impairment and net change in fair value of $0.8 million on the auction rate
securities, included in “Non-operating (income) expense” in the accompanying
consolidated statements of operations.
INTERNAP
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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.
Our
investment activity in the joint venture is included in the IP services
operating segment and summarized as follows (in thousands):
|
|
Year
Ended December 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
Investment
Balance, January 1,
|
|
$
|
1,138
|
|
|
$
|
958
|
|
|
$
|
823
|
|
Proportional
share of net income
|
|
|
283
|
|
|
|
139
|
|
|
|
114
|
|
Unrealized
foreign currency translation gain, net
|
|
|
201
|
|
|
|
41
|
|
|
|
21
|
|
Investment
Balance, December 31,
|
|
$
|
1,622
|
|
|
$
|
1,138
|
|
|
$
|
958
|
|
Investment
in Aventail
We
account for investments without readily determinable fair values at cost. We
include realized gains and losses and declines in value of securities judged to
be other-than-temporary 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.
|
|
6.
|
FAIR
VALUE MEASUREMENTS
|
Effective
January 1, 2008, we adopted SFAS No. 157. We also adopted SFAS No. 159 for
our ARS Rights, as described in note 5. SFAS No. 157 describes a fair value
hierarchy based on three levels of inputs, of which the first two are considered
observable and the last unobservable, that may be used to measure fair value.
See note 2 for a further description of this standard. The fair value
hierarchy is summarized as follows:
|
|
|
|
●
|
Level
1: Quoted prices in active markets for identical assets or
liabilities;
|
|
●
|
Level
2: Inputs other than Level 1 that are observable, either directly or
indirectly, such as quoted prices for similar assets or liabilities;
quoted prices in markets that are not active or other inputs that are
observable or can be corroborated by observable market data for
substantially the full term of the assets or liabilities;
and
|
|
●
|
Level
3: Unobservable inputs that are supported by little or no market activity
and that are significant to the fair value of the assets or
liabilities.
|
The
following table represents the fair value hierarchy for our financial assets
(cash equivalents and investments in marketable securities) measured at fair
value on a recurring basis as of December 31, 2008 (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Level
1
|
|
|
Level
2
|
|
|
Level
3
|
|
|
Total
|
|
Money
market funds and other
|
|
$
|
21,877
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
21,877
|
|
Corporate
debt securities
|
|
|
—
|
|
|
|
5,699
|
|
|
|
—
|
|
|
|
5,699
|
|
U.S.
Treasury bills
|
|
|
—
|
|
|
|
1,500
|
|
|
|
—
|
|
|
|
1,500
|
|
Auction
rate securities
|
|
|
—
|
|
|
|
—
|
|
|
|
6,378
|
|
|
|
6,378
|
|
ARS
Rights
|
|
|
—
|
|
|
|
—
|
|
|
|
649
|
|
|
|
649
|
|
Total
|
|
$
|
21,877
|
|
|
$
|
7,199
|
|
|
$
|
7,027
|
|
|
$
|
36,103
|
|
INTERNAP
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Level 3
assets consist of auction rate securities whose underlying assets are
state-issued student and educational loans that are substantially backed by the
federal government and the ARS Rights. While we continue to earn and accrue
interest on our auction rate securities at contractual rates, these investments
are not currently trading and therefore do not currently have a readily
determinable market value. Accordingly, the estimated fair value of auction rate
securities no longer approximates par value. Given that observable auction rate
securities market information was not available to determine the fair value of
our auction rate securities, we estimated the fair value of the auction rate
securities based on a wide array of market evidence related to each security’s
collateral, ratings and insurance to assess default risk, credit spread risk and
downgrade risk that we believe market participants would use in pricing the
securities in a current transaction. These assumptions could change
significantly over time based on market conditions. We then used a
trinomial discount model where the future cash flows of the auction rate
securities were priced by summing the present value of the future principal and
forecasted interest payments. We also considered probabilities of default,
auction failure, a successful auction at par value or repurchase at par value
and recovery rates in default for each of the securities. We then discounted the
weighted average cash flow for each period back to present value at the
determined discount rate for each auction rate security.
Similar
to the auction rate securities, observable market information was not available
to determine the fair value of the ARS Rights. We estimated the fair value of
the ARS Rights based on a valuation approach commonly used for forward contracts
in which one party agrees to sell a financial instrument (generating cash flows)
to another party at a particular time for a predetermined price. In this
approach we subtracted the present value of all expected future cash flows from
the current fair value of the security, and calculated the resulting value as a
future value at an interest rate reflective of counterparty risk.
The
following table provides a summary of changes in fair value of our Level 3
financial assets as of December 31, 2008 (in thousands):
|
|
|
|
|
|
|
|
|
Auction
Rate
Securities
|
|
|
ARS
Rights
|
|
Balance,
December 31, 2007
|
|
$
|
7,150
|
|
|
$
|
—
|
|
Net
realized loss included in earnings
|
|
|
(772
|
)
|
|
|
—
|
|
Issuance
of ARS Rights
|
|
|
—
|
|
|
|
649
|
|
Balance,
December 31, 2008
|
|
$
|
6,378
|
|
|
$
|
649
|
|
|
|
|
|
|
|
|
|
|
7.
|
PROPERTY
AND EQUIPMENT
|
Property
and equipment consists of the following (in thousands):
|
|
|
|
|
|
|
|
|
December
31,
|
|
|
|
2008
|
|
|
2007
|
|
Network
equipment
|
|
$
|
96,958
|
|
|
$
|
86,496
|
|
Network
equipment under capital lease
|
|
|
1,596
|
|
|
|
1,596
|
|
Furniture,
equipment and software
|
|
|
33,853
|
|
|
|
31,726
|
|
Leasehold
improvements
|
|
|
147,835
|
|
|
|
111,216
|
|
Buildings
under capital lease
|
|
|
3,003
|
|
|
|
—
|
|
Property
and equipment, gross
|
|
|
283,245
|
|
|
|
231,034
|
|
Less:
Accumulated depreciation and amortization ($1,721 and $1,596 related to
capital leases at December 31, 2008 and 2007,
respectively)
|
|
|
(185,895
|
)
|
|
|
(165,543
|
)
|
|
|
$
|
97,350
|
|
|
$
|
65,491
|
|
During
2008, we retired $2.0 million of assets with accumulated depreciation of $1.9
million. During 2007, we retired $2.7 million of fully depreciated assets. We
capitalized $0.3 million of interest during the year ended December 31, 2008.
For the years ended December 31, 2007 and 2006, we capitalized less than $0.1
million each year.
INTERNAP
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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):
|
|
Year
ended December 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
Direct
costs of network, sales and services
|
|
$
|
20,650
|
|
|
$
|
18,313
|
|
|
$
|
13,250
|
|
Other
depreciation and amortization
|
|
|
3,215
|
|
|
|
3,929
|
|
|
|
2,606
|
|
Subtotal
|
|
|
23,865
|
|
|
|
22,242
|
|
|
|
15,856
|
|
Amortization
of acquired technologies
(1)
|
|
|
6,649
|
|
|
|
4,165
|
|
|
|
516
|
|
Total
depreciation and amortization
|
|
$
|
30,514
|
|
|
$
|
26,407
|
|
|
$
|
16,372
|
|
__________________
(1)
Amortization of acquired technologies for 2008 included an impairment
charge of $1,850 for developed advertising technology. See note 8 for further
details.
8.
|
GOODWILL
AND OTHER INTANGIBLE ASSETS
|
Goodwill
Goodwill
represents the premium paid over the fair value of the net tangible and
intangible assets we have acquired in business combinations. We
recorded $154.7 million of goodwill in connection with the acquisition of
VitalStream in February 2007 described in note 3 and we recorded $36.3
million of goodwill from acquisitions in previous years. All of the VitalStream
goodwill has been allocated to the CDN services segment and all remaining
goodwill from previous acquisitions is included in our IP services segment. A
total of $17.1 million of goodwill is deductible for tax purposes.
We test
goodwill for impairment at least annually. We perform our annual goodwill
impairment test as of August 1 of each calendar year, following our annual
strategic planning cycle. Our assessment of goodwill for impairment
includes comparing the fair value to the net book value of our reporting
units. We estimate fair value using a combination of discounted cash flow
models and market approaches. If the fair value of a reporting unit exceeds
its net book value, goodwill is not impaired and no further testing is
necessary. If the net book value of a reporting unit exceeds its fair
value, we perform a second test to measure the amount of impairment loss, if
any. To measure the amount of any impairment loss, we determine the implied
fair value of goodwill in the same manner as if the affected reporting unit were
being acquired in a business combination. Specifically, we allocate the fair
value of the affected reporting unit to all of the assets and liabilities of
that unit, including any unrecognized intangible assets, in a hypothetical
calculation that would yield the implied fair value of goodwill. If the implied
fair value of goodwill is less than the goodwill recorded on our balance sheet,
we record an impairment charge for the difference.
As a
result of our August 1, 2008 assessment, we recorded a
$99.7 million goodwill impairment charge to adjust goodwill in our CDN
services segment to an implied fair value of $54.7 million. We present
the goodwill impairment charge separately in the accompanying statement of
operations for the year ended December 31, 2008. The goodwill impairment is
primarily due to declines in our CDN services revenues and operating results as
compared to our projections and unfavorable changes in market factors used to
estimate fair values. The declines in CDN services revenues and operating
results compared to projections are attributable to integration and reliability
issues in the acquired network and have now been resolved, a strategic shift to
larger, higher credit quality customers and more recently, a highly-competitive
market environment for CDN services that is driving lower pricing. Changes
in market factors include lower market multiples across the CDN services
industry from when we completed the acquisition of VitalStream and our own
now-lower market capitalization. The culmination of these factors leading
to our impairment of goodwill did not occur until the three months ended
September 30, 2008. The impairment charge does not have any impact on
our current cash balance or result in violation of any covenants of our debt
instruments.
INTERNAP
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The
changes in the carrying amount of goodwill for the years ended December 31, 2008
and 2007 are as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Data
|
|
|
|
|
|
|
|
|
|
IP
|
|
|
Center
|
|
|
CDN
|
|
|
|
|
|
|
Services
|
|
|
Services
|
|
|
Services
|
|
|
Total
|
|
Balance,
January 1, 2007
|
|
$
|
36,314
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
36,314
|
|
Goodwill
acquired
|
|
|
—
|
|
|
|
—
|
|
|
|
154,653
|
|
|
|
154,653
|
|
Adjustments
to pre-acquisition assets and liabilities
|
|
|
—
|
|
|
|
—
|
|
|
|
133
|
|
|
|
133
|
|
Utilization
of a portion of net operating losses
|
|
|
—
|
|
|
|
—
|
|
|
|
(423
|
)
|
|
|
(423
|
)
|
Balance,
December 31, 2007
|
|
|
36,314
|
|
|
|
—
|
|
|
|
154,363
|
|
|
|
190,677
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance,
January 1, 2008
|
|
|
36,314
|
|
|
|
—
|
|
|
|
154,363
|
|
|
|
190,677
|
|
Impairment
|
|
|
—
|
|
|
|
—
|
|
|
|
(99,700
|
)
|
|
|
(99,700
|
)
|
Balance,
December 31, 2008
|
|
$
|
36,314
|
|
|
$
|
—
|
|
|
$
|
54,663
|
|
|
$
|
90,977
|
|
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. These estimates and
assumptions primarily include, but are not limited to, the discount rate,
terminal growth rate, earnings before interest, taxes, depreciation and
amortization, or EBITDA, and capital expenditures forecasts. The use of
different assumptions, inputs and judgments, or changes in circumstances, could
materially affect the results of the valuation. Due to the inherent
uncertainty involved in making these estimates, actual results could differ from
our estimates and could result in an additional non-cash impairment charge in
the future. The following is a description of the valuation methodologies
we used to derive the fair value the CDN services segment:
|
|
|
|
●
|
Income Approach
: To
determine fair value, we discounted the expected cash flows of the CDN
services reporting unit. We calculated expected cash flows using a
compounded annual revenue growth rate of approximately 20%, forecasting
existing cost structures and considering capital reinvestment
requirements. We used a discount rate of 20%, representing the
estimated weighted average cost of capital, which reflects the overall
level of inherent risk involved in our CDN services operations and the
rate of return an outside investor would expect to earn. To estimate cash
flows beyond the final year of our model, we used a terminal value and
incorporated the present value of the resulting terminal value into our
estimate of fair value.
|
|
|
|
|
●
|
Market-Based Approach
:
To corroborate the results of the income approach described above, we
estimated the fair value of our CDN services reporting unit using several
market-based approaches, including the enterprise value that we derive
based on our stock price. We also used the guideline company method, which
focuses on comparing our risk profile and growth prospects, to select
reasonably similar/guideline publicly traded companies. Using the
guideline company method, we selected revenue and EBITDA multiples below
the median for our comparable
companies.
|
We used
similar valuation methodologies to derive the fair values of our two IP services
reporting units: services and products. Our data center services operating
segment does not include any goodwill, but was valued using an income approach
as part of our determination of enterprise value. 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. We assessed the likelihood of
triggering events and concluded that no such triggering events have
occurred that would cause us to re-assess goodwill for impairment subsequent to
August 1, 2008.
The
impairment also caused us to reverse a deferred tax liability and create an
income tax benefit of $0.6 million associated with the CDN services
goodwill.
Other
Intangible Assets
In
conjunction with our review of our long-term financial outlook, we also
performed an analysis of the potential impairment and re-assessed the remaining
asset lives of other identifiable intangible assets acquired in the VitalStream
acquisition. The analysis and re-assessment of other identifiable
intangible assets recorded in the VitalStream acquisition resulted
in:
|
|
|
|
●
|
an
impairment charge of $1.9 million in developed advertising technology due
to a strategic change in market focus,
|
|
●
|
an
impairment charge of $0.8 million in trade names as a result of
discontinuing use of the VitalStream trade name,
and
|
INTERNAP
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
|
●
|
a
change in our estimates that resulted in an acceleration of amortization
expense of our customer relationships intangible asset over a shorter
estimated useful life (four remaining years instead of an original
estimated nine years) due to customer churn resulting in higher than
expected attrition as of the acquisition
date.
|
The impairment
charge of $1.9 million for developed advertising technology is included in the
caption “Direct costs of amortization of acquired technologies” in the
accompanying consolidated statements of operations. The impairment charge of
$0.8 million for the trade name is included in the caption “Restructuring and
other impairments” in the accompanying consolidated statements of
operations. The impairment charge for trade name is presented in the
accompanying statement of operations net of a non-cash increase of approximately
$1.0 million to our restructuring liability, as discussed in note 9. None
of the impairment charges have any impact on our current cash balance
or result in violation of any covenants of our debt instruments. The
change in accounting estimate for our customer relationship intangible asset
resulted in an increase to our net loss of $0.4 million, or less than $0.01 per
basic and diluted share for the year ended December 31, 2008.
The
components of our amortizing intangible assets are as follows (in
thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December
31, 2008
|
|
December
31, 2007
|
|
|
|
Gross
|
|
|
|
Gross
|
|
|
|
|
|
Carrying
|
|
Accumulated
|
|
Carrying
|
|
Accumulated
|
|
|
|
Amount
|
|
Amortization
|
|
Amount
|
|
Amortization
|
|
Technology
based
|
|
$
|
40,061
|
|
$
|
(13,317
|
)
|
$
|
41,911
|
|
$
|
(8,518
|
)
|
Contract
based
|
|
|
24,232
|
|
|
(17,034
|
)
|
|
25,018
|
|
|
(15,403
|
)
|
|
|
$
|
64,293
|
|
$
|
(30,351
|
)
|
$
|
66,929
|
|
$
|
(23,921
|
)
|
Amortization
expense for identifiable intangible assets during 2008, 2007 and 2006 was $6.4
million, $5.3 million and $0.5 million, respectively. This amortization expense
does not include impairment charges of $2.7 million in 2008. As of December 31,
2008, estimated amortization expense for the next five years is as follows (in
thousands):
|
|
|
|
|
|
|
2009
|
|
$
|
6,696
|
|
|
2010
|
|
|
6,509
|
|
|
2011
|
|
|
6,181
|
|
|
2012
|
|
|
5,356
|
|
|
2013
|
|
|
4,246
|
|
|
Thereafter
|
|
|
4,954
|
|
|
|
|
$
|
33,942
|
|
|
|
9.
|
RESTRUCTURING
AND OTHER IMPAIRMENTS
|
In
conjunction with the preparation of our financial statements as of and for the
year ended December 31, 2008 and in light of the recent and significant
deterioration in the real estate market, we completed an analysis of our
remaining accrued restructuring liability for leased facilities. After reviewing
the analysis, and specifically the underlying assumptions related to anticipated
sublease recoveries, we concluded that certain of the facilities remaining in
the restructuring accrual were taking longer than expected to sublease or were
otherwise not generating the expected levels of sublease income. The analyses
were based on discounted cash flows using the same credit-adjusted risk-free
rate that we used to measure the initial restructuring liability for leases that
were part of the 2007 restructuring plan and undiscounted cash flows for leases
that were part of the 2001 restructuring plan. The cumulative effect of these
changes was $1.1 million which we recorded as additional restructuring expense
and an increase to the liability. We also recorded a non-cash benefit of $0.1
million in the three months ended September 30, 2008 to reduce our restructuring
liability for employee separations. This non-cash adjustment removes the
liability for employee separations since we have paid all amounts.
During
the year ended December, 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 VitalStream acquisition and our plan to finalize
the overall integration and implementation of the acquisition. 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.
After considering the adjustments for anticipated changes in sublease income
described above, we estimated net related expenditures for the 2007
restructuring plan to be $12.2 million, of which we paid $4.2 million through
December 31, 2008, and the balance continuing through December 2016, the last
date of the longest lease term. We expect to pay these expenditures from
operating cash flows. The $1.4 million impairment charge consisted of $1.3
million for restructured leases and less than $0.1 million for other assets. We
estimated cost savings from the restructuring to be approximately $0.8 million
per year through 2016, primarily for rent.
INTERNAP
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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.
All of
these adjustments to the restructuring liability are reported in “Restructuring
and other impairments” in the accompanying consolidated statement of operations.
The following table displays the activity and balances for the restructuring and
asset impairment activity for the years ended December 31, 2008 and 2007 (in
thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December
31,
|
|
|
Restructuring
|
|
|
|
|
|
|
|
|
|
|
|
December
31,
|
|
|
|
|
|
|
|
|
December
31,
|
|
|
|
2006
|
|
|
and
|
|
|
|
|
|
Non-Cash
|
|
|
Non-Cash
|
|
|
2007
|
|
|
|
|
|
Non-Cash
|
|
|
2008
|
|
|
|
Restructuring
|
|
|
Impairment
|
|
|
Cash
|
|
|
Write-
|
|
|
Plan
|
|
|
Restructuring
|
|
|
Cash
|
|
|
Plan
|
|
|
Restructuring
|
|
|
|
Liability
|
|
|
Charges
|
|
|
Payments
|
|
|
Downs
|
|
|
Adjustments
|
|
|
Liability
|
|
|
Payments
|
|
|
Adjustments
|
|
|
Liability
|
|
Activity
for 2007 restructuring charge:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Real
estate obligations
|
|
$
|
—
|
|
|
$
|
7,755
|
|
|
$
|
(2,248
|
)
|
|
$
|
—
|
|
|
$
|
805
|
|
|
$
|
6,312
|
|
|
$
|
(1,120
|
)
|
|
$
|
1,084
|
|
|
$
|
6.276
|
|
Employee
separations
|
|
|
—
|
|
|
|
1,140
|
|
|
|
(615
|
)
|
|
|
—
|
|
|
|
(119
|
)
|
|
|
406
|
|
|
|
(260
|
)
|
|
|
(146
|
)
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
restructuring costs
|
|
|
—
|
|
|
|
8,895
|
|
|
|
(2,863
|
)
|
|
|
—
|
|
|
|
686
|
|
|
|
6,718
|
|
|
|
(1,380
|
)
|
|
|
938
|
|
|
|
6,276
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Activity
for 2007 impairment charge:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Leasehold
improvements
|
|
|
—
|
|
|
|
897
|
|
|
|
—
|
|
|
|
(897
|
)
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Other
|
|
|
—
|
|
|
|
471
|
|
|
|
—
|
|
|
|
(471
|
)
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
asset impairments
|
|
|
—
|
|
|
|
1,368
|
|
|
|
—
|
|
|
|
(1,368
|
)
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Activity
for 2001 restructuring charge:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Real
estate obligations
|
|
|
4,784
|
|
|
|
—
|
|
|
|
(1,199
|
)
|
|
|
—
|
|
|
|
(211
|
)
|
|
|
3,374
|
|
|
|
(647
|
)
|
|
|
19
|
|
|
|
2,746
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
4,784
|
|
|
$
|
10,263
|
|
|
$
|
(4,062
|
)
|
|
$
|
(1,368
|
)
|
|
$
|
475
|
|
|
$
|
10,092
|
|
|
$
|
(2,027
|
)
|
|
$
|
957
|
|
|
$
|
9,022
|
|
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. 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. 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.
Accrued
liabilities consist of the following (in thousands):
|
|
December
31,
|
|
|
|
2008
|
|
2007
|
|
Compensation
and benefits payable
|
|
$
|
2,918
|
|
$
|
5,390
|
|
Telecommunications,
sales, use and other taxes
|
|
|
1,902
|
|
|
2,317
|
|
Other
|
|
|
3,936
|
|
|
2,452
|
|
|
|
$
|
8,756
|
|
$
|
10,159
|
|
|
|
11.
|
REVOLVING
CREDIT FACILITY AND NOTE PAYABLE
|
On
September 14, 2007, we entered into a $35.0 million credit agreement with Bank
of America, N.A., as the administrative agent, and other lenders who may become
a party to the credit agreement from time-to-time, or the Credit
Agreement. Four of our subsidiaries, VitalStream Holdings, Inc.,
VitalStream, Inc., PlayStream, Inc., and VitalStream Advertising Services, Inc.,
were guarantors of the Credit Agreement.
The
Credit Agreement replaced our prior credit agreement between us 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.
INTERNAP
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The
Credit Agreement originally provided for a four-year Revolving Credit Facility
in the aggregate amount of up to $5.0 million, which included a $5.0 million
sub-limit for letters of credit. With the prior approval of the
administrative agent, we had the option to 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 was 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. We had no amounts outstanding on the Revolving
Credit Facility as of December 31, 2007.
The
Credit Agreement also originally provided for a term loan, in the amount of
$30.0 million, or the Term Loan. 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 was a tiered
LIBOR-based rate that depended on our 12-month trailing EBITDA. As of December
31, 2007, the interest rate was 7.075%.
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 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.
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 “Interest expense”
within the Non-operating (income) expense section of the accompanying
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, as discussed in note 3.
We
subsequently amended the Credit Agreement on May 14, 2008 and September 30,
2008, or the Amendment (the Credit Agreement along with the Amendment are
referred to as the Amended Credit Agreement). The Amendment modified the
original Credit Amendment as follows:
|
|
|
|
●
|
converted
the Term Loan balance of $20.0 million as of September 30, 2008 into a
loan under the Revolving Credit Facility under the Credit
Agreement;
|
|
●
|
terminated
the Term Loan under the Credit Agreement;
|
|
●
|
increased
the total Revolving Credit Commitment (as defined in the Amended Credit
Agreement) from $5.0 million to $35.0 million;
|
|
●
|
increased
the Letter of Credit Sublimit (as defined in the Amended Credit Agreement)
from $5.0 million to $7.0 million;
|
|
●
|
provided
us and Bank of America with an option to enter into a lease financing
agreement not to exceed $10.0 million; and
|
|
●
|
modified
certain covenants and definitions.
|
Because
the Amendment caused the Revolving Credit Facility to have substantially
different terms than the Term Loan, it is considered an extinguishment of debt.
We recorded a loss on extinguishment of debt in the amount of $0.2 million
during the year ended December 31, 2008. The loss on extinguishment of debt
is included in the caption “Interest expense” within the non-operating (income)
expense section of the accompanying consolidated statements of operations. We
also incurred other costs of less than $0.1 million in connection with the
Amendment, which we recorded as debt issue costs and will amortize over the
remaining term of the Amended Credit Agreement.
The
interest rate on the Revolving Credit Facility as of December 31, 2008 was 3.0%
and is based on Bank of America’s prime rate less a 0.25% margin. The principal
amount of $20.0 million is due September 14, 2011. As of December 31, 2008, we
had a total of $4.2 million of letters of credit issued and $10.8 million in
borrowing capacity on the Revolving Credit Facility.
The
Amended Credit Agreement includes customary representations, warranties,
negative and affirmative covenants (including certain financial covenants
relating to a net funded debt to EBITDA ratio, a debt service coverage ratio and
a minimum liquidity requirement, as well as a prohibition against paying
dividends, limitations on unfunded capital expenditures of $55.0 million for
2008 and $25.0 million or an amount to be mutually agreed upon for 2009 through
2011), customary events of default and certain default provisions that could
result in acceleration of the Credit Agreement.
Our
obligations under the Amended 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.
INTERNAP
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The fair
value of our debt approximates the carrying value due to the nature of our
credit facility.
We record
capital lease obligations and the leased property and equipment at the time of
acquisition at the lesser of the present value of future lease payments based
upon the terms of the related lease agreement or the fair value of the assets
held under capital leases. As of December 31, 2008, our capital leases have
expiration dates ranging from May 2009 to April 2023.
Historically
our capital leases relate to equipment; however, in May 2008 we entered into a
capital lease agreement for one of our data center locations which expires in
April 2023.
Future
minimum capital lease payments together with the present value of the minimum
lease payments as of December 31, 2008, are as follows (in
thousands):
|
|
|
|
|
2009
|
|
$
|
822
|
|
2010
|
|
|
564
|
|
2011
|
|
|
566
|
|
2012
|
|
|
569
|
|
2013
|
|
|
581
|
|
Thereafter
|
|
|
6,339
|
|
Remaining
capital lease payments
|
|
|
9,441
|
|
Less:
amounts representing imputed interest
|
|
|
(5,923
|
)
|
Present
value of minimum lease payments
|
|
|
3,518
|
|
Less:
current portion
|
|
|
(274
|
)
|
|
|
$
|
3,244
|
|
The
current and deferred income tax provision (benefit) for the years ended
December 31, 2008, 2007 and 2006 was as follows (in
thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
|
2008
|
|
2007
|
|
2006
|
|
|
Current:
|
|
|
|
|
|
|
|
|
|
|
|
Federal
|
|
$
|
254
|
|
$
|
15
|
|
$
|
145
|
|
|
State
|
|
|
181
|
|
|
—
|
|
|
—
|
|
|
Foreign
(including change in unrecognized tax benefits)
|
|
|
(668
|
)
|
|
921
|
|
|
—
|
|
|
Total
current provision
|
|
|
(233
|
)
|
|
936
|
|
|
145
|
|
|
Deferred:
|
|
|
|
|
|
|
|
|
|
|
|
Federal
|
|
|
(398
|
)
|
|
356
|
|
|
—
|
|
|
State
|
|
|
(16
|
)
|
|
42
|
|
|
—
|
|
|
Foreign
|
|
|
821
|
|
|
(4,414
|
)
|
|
—
|
|
|
Total
deferred benefit
|
|
|
407
|
|
|
(4,016
|
)
|
|
—
|
|
|
Net
income tax provision (benefit)
|
|
$
|
174
|
|
$
|
(3,080
|
)
|
$
|
145
|
|
We
account for income taxes under the liability method. We determine deferred tax
assets and liabilities based on differences between financial reporting and tax
bases of assets and liabilities, and we measure such assets using the enacted
tax rates and laws that will be in effect when we expect the differences to
reverse. We provide a valuation allowance to reduce our deferred tax assets to
their estimated realizable value.
INTERNAP
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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:
|
|
|
|
|
|
|
|
|
|
|
|
|
Year
Ending December 31,
|
|
|
|
2008
|
|
2007
|
|
2006
|
|
Federal
income tax (benefit) expense at statutory rates
|
|
|
(34
|
)%
|
|
(34
|
)%
|
|
34
|
%
|
Goodwill
impairment
|
|
|
29
|
|
|
—
|
|
|
—
|
|
Foreign
and state income tax (benefit) expense
|
|
|
—
|
|
|
(4
|
)
|
|
4
|
|
Stock-based
compensation expense
|
|
|
1
|
|
|
6
|
|
|
8
|
|
Tax
reserves
|
|
|
—
|
|
|
11
|
|
|
—
|
|
Other
|
|
|
—
|
|
|
—
|
|
|
1
|
|
Change
in valuation allowance
|
|
|
4
|
|
|
(14
|
)
|
|
(43
|
)
|
Effective
tax rate
|
|
|
—
|
%
|
|
(35
|
)%
|
|
4
|
%
|
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,
|
|
|
|
2008
|
|
|
2007
|
|
Current
deferred income tax assets:
|
|
|
|
|
|
|
Provision
for doubtful accounts
|
|
$
|
1,378
|
|
|
$
|
593
|
|
Accrued
compensation
|
|
|
205
|
|
|
|
233
|
|
Other
accrued expenses
|
|
|
213
|
|
|
|
196
|
|
Deferred
revenue
|
|
|
1,298
|
|
|
|
1,648
|
|
Restructuring
costs
|
|
|
973
|
|
|
|
910
|
|
Foreign
net operating loss carryforwards – current portion
|
|
|
—
|
|
|
|
479
|
|
Other
|
|
|
63
|
|
|
|
77
|
|
Current
deferred income tax assets
|
|
|
4,130
|
|
|
|
4,136
|
|
Less:
valuation allowance
|
|
|
(4,129
|
)
|
|
|
(3,625
|
)
|
|
|
|
1
|
|
|
|
511
|
|
|
|
|
|
|
|
|
|
|
Non-current
deferred income tax assets:
|
|
|
|
|
|
|
|
|
Property
and equipment
|
|
|
23,719
|
|
|
|
21,488
|
|
Goodwill
|
|
|
3,897
|
|
|
|
—
|
|
Intangible
assets
|
|
|
2,574
|
|
|
|
—
|
|
Deferred
revenue, less current portion
|
|
|
767
|
|
|
|
717
|
|
Restructuring
costs, less current portion
|
|
|
2,455
|
|
|
|
2,925
|
|
Deferred
rent
|
|
|
5,689
|
|
|
|
4,184
|
|
Stock
compensation
|
|
|
3,378
|
|
|
|
2,620
|
|
U.
S. net operating loss carryforwards
|
|
|
71,616
|
|
|
|
81,766
|
|
Foreign
net operating loss carryforwards, less current portion
|
|
|
5,481
|
|
|
|
13,717
|
|
Capital
loss carryforwards
|
|
|
2,271
|
|
|
|
2,271
|
|
Tax
credit carryforwards
|
|
|
690
|
|
|
|
180
|
|
Other
|
|
|
539
|
|
|
|
502
|
|
Non-current
deferred income tax assets
|
|
|
123,076
|
|
|
|
130,370
|
|
Less:
valuation allowance
|
|
|
(120,626
|
)
|
|
|
(124,936
|
)
|
|
|
|
2,450
|
|
|
|
5,434
|
|
Non-current
deferred income tax liabilities:
|
|
|
|
|
|
|
|
|
Purchased
intangibles
|
|
|
—
|
|
|
|
(1,531
|
)
|
FIN
48 liability related to net operating loss carryforwards
|
|
|
—
|
|
|
|
(921
|
)
|
Goodwill
|
|
|
—
|
|
|
|
(398
|
)
|
Non-current
deferred income tax assets (liabilities), net
|
|
|
2,450
|
|
|
|
2,584
|
|
Net
deferred tax assets
|
|
$
|
2,451
|
|
|
$
|
3,095
|
|
Based
upon a study conducted in 2008, we reduced our net operating loss carryforwards
due to limitations under Section 382 of the Internal Revenue Code with regard to
an ownership change in 2001. As of December 31, 2008, we had U.S. net
operating loss carryforwards for federal tax purposes of approximately $188.5
million that will expire through 2026.
All periods presented have been
revised to reflect these limitations. Of the total U.S. net operating loss
carryforwards, $16.8 million of net operating losses related 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 and state tax credit carryforwards of approximately $0.7 million,
which have an indefinite carryforward period, and foreign net operating loss
carryforwards of approximately $18.4 million that will begin to expire in
2009.
INTERNAP
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
We
determined that through December 31, 2008, no further ownership shifts have
occurred since 2001. Therefore, no additional material limitations exist on the
U.S. net operating losses related to Section 382 of the Internal Revenue Code as
of December 31, 2008. However, if we experience subsequent changes in stock
ownership as defined by Section 382 of the Internal Revenue Code, we may have
additional limitations on the future utilization of our U.S. net operating
losses.
We
periodically evaluate the recoverability of the deferred tax assets and the
appropriateness of the valuation allowance. For U.S. tax purposes, we
established a valuation allowance of approximately $121.4 million 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 we determine that it is
more likely than not that the deferred tax assets will be realized, we will
reduce the valuation allowance accordingly.
Based on
analysis of our projected future U.S. pre-tax income, we may have sufficient
positive evidence within the next 12 months to release the valuation allowance
currently recorded against our U.S. deferred tax assets. Currently,
while we cannot guarantee that our expectations of future positive income
will occur, we may recognize an income tax benefit derived from total U.S.
deferred tax assets upon the release of the valuation allowance. This potential
release of the valuation allowance could be affected by an ownership change as
defined by Section 382 of the Internal Revenue Code which might limit the future
use of our U.S. net operating loss carryovers and thus reduce the potential
benefit of such losses in the future to offset taxable income and reduce cash
outflows for income taxes.
During
the fourth quarter of 2007, we concluded that it was more likely than not that
we will realize our U.K. deferred tax assets in future years. The U.K.
deferred tax assets primarily consist of net operating loss carryforwards. The
total deferred tax asset was $11.6 million as of December 31, 2007. We
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, for a net recognized tax benefit of $3.5
million.
Changes
in our deferred tax asset valuation allowance are summarized as follows (in
thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
|
2008
|
|
2007
|
|
2006
|
|
|
|
|
$
|
128,561
|
|
$
|
117,747
|
|
$
|
130,316
|
|
|
Decrease
(increase) in deferred tax assets
|
|
|
(3,806
|
)
|
|
15,228
|
|
|
(12,569
|
)
|
|
Recognition
of deferred tax assets
|
|
|
|
|
|
(4,414
|
)
|
|
—
|
|
|
|
|
$
|
124,775
|
|
$
|
128,561
|
|
$
|
117,747
|
|
The
impairment of goodwill and other intangible assets in the third quarter of 2008
had a material effect on the income tax provision. While a component of the CDN
services goodwill is deductible for tax purposes, the majority of the goodwill
had no basis for tax purposes. Accordingly, when the “non tax basis” goodwill of
$90.0 million was impaired for financial reporting purposes, it resulted in a
$30.5 million permanent difference that impacted our effective income tax rate.
The portion of goodwill where there was corresponding tax basis at the time of
the acquisition only impacted our effective income tax rate to the extent that
the tax amortization reduced the tax basis of the goodwill below the
corresponding book basis while we have a valuation allowance. In past years,
this resulted in a permanent difference of an aggregate $0.4 million relating to
the tax amortization difference. With the additional impairment of the “tax
basis” goodwill in 2008, we recorded a tax benefit for the reversal of the
previous income tax expense recognized related to the tax amortization of the
CDN services goodwill.
We intend
to reinvest future earnings indefinitely within each country; however, it is not
practicable to determine the amount of the unrecognized deferred income tax
liability related to future foreign earnings. Accordingly, we have not recorded
deferred taxes for the difference between our financial and tax basis
investment in foreign entities.
Effective
January 1, 2007, we adopted the provisions of FASB Interpretation No. 48,
Accounting for Uncertainty in
Income Taxes,
or FIN 48. FIN 48 clarifies the accounting for
uncertainty in income taxes recognized in our financial statements in accordance
with SFAS No. 109. FIN 48 requires us 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, we must measure the tax position to determine the amount to
recognize in the financial statements.
INTERNAP
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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 for the years ending December 31,
2008 and 2007 is as follows (in thousands):
|
|
|
|
|
|
|
|
|
Year
Ending December 31,
|
|
|
|
2008
|
|
|
2007
|
|
Unrecognized
tax benefits balance at January 1,
|
|
$
|
921
|
|
|
$
|
—
|
|
Additions
for tax positions of prior years
|
|
|
—
|
|
|
|
—
|
|
Reductions
for tax positions of prior years settlements
|
|
|
—
|
|
|
|
—
|
|
Additions
for tax positions of current year
|
|
|
—
|
|
|
|
921
|
|
Foreign
exchange (loss)
|
|
|
(253
|
)
|
|
|
—
|
|
Lapse
of statute of limitations
|
|
|
(668
|
)
|
|
|
—
|
|
Unrecognized
tax benefits balance at December 31,
|
|
$
|
—
|
|
|
$
|
921
|
|
The
changes in the FIN 48 liability had no impact on our effective income tax rate
in the respective periods of change due to the offsetting changes in our U.K.
deferred tax asset.
We
classify interest and penalties arising from the underpayment of income taxes in
the accompanying consolidated statement of operations as a component of general
and administrative expenses. As of December 31, 2008 and 2007, we had no accrued
interest or penalties related to uncertain tax positions. Our federal income tax
returns remain open to examination for the tax years 2005 through 2007, however,
tax authorities have the right to adjust the net operating loss carryovers for
years prior to 2005. Returns filed in other jurisdictions are subject to
examination for years prior to 2005.
|
|
14.
|
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 $0.9 million, $0.8 million and $0.7
million for the years ended December 31, 2008, 2007 and 2006,
respectively.
|
|
15.
|
COMMITMENTS,
CONTINGENCIES, CONCENTRATIONS OF RISK AND LITIGATION, INCLUDING SUBSEQUENT
EVENT
|
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 20 years and contain various periods of
free rent and any renewal options. However, we record rent expense on a
straight-line basis over the initial lease term and any 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, 2008 (in
thousands):
|
|
|
|
|
|
|
2009
|
|
$
|
24,808
|
|
|
2010
|
|
|
25,789
|
|
|
2011
|
|
|
26,109
|
|
|
2012
|
|
|
26,875
|
|
|
2013
|
|
|
24,846
|
|
|
Thereafter
|
|
|
86,882
|
|
|
|
|
$
|
215,309
|
|
Rent
expense was $21.5 million, $15.1 million and $18.8 million for the years ended
December 31, 2008, 2007 and 2006, respectively. Sublease income, recorded as a
reduction of rent expense, was $0.3 million, $0.5 million and $0.6 million
during the years ended December 31, 2008, 2007 and 2006,
respectively.
INTERNAP
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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, 2008 (in thousands):
|
|
|
|
|
|
|
2009
|
|
$
|
7,163
|
|
|
2010
|
|
|
4,941
|
|
|
2011
|
|
|
1,278
|
|
|
|
|
$
|
13,382
|
|
Subsequent
Event
On
January 29, 2009, we announced the resignation of James P. DeBlasio from
his positions as President and Chief Executive Officer effective as of March 16,
2009, or the Separation Date. Mr. DeBlasio also has resigned as our
director effective March 15, 2009. Pursuant to the terms of a separation
agreement, Mr. DeBlasio will receive (1) a cash payment of $0.9 million, (2)
full vesting of all equity awards previously granted to him as of the Separation
Date and (3) if he so elects, continued health, dental and vision insurance
coverage under our group health plan for 18 months from the Separation Date at
no cost to him. Mr. DeBlasio has 12 months following the Separation Date in
which to exercise any stock options held by him that were vested as of the
Separation Date. We will record the associated severance and stock-based
compensation expense in general and administrative costs during the three months
ended March 31, 2009. Also on January 29, 2009, we announced the
appointment of J. Eric Cooney as our President and Chief Executive Officer and
director, effective March 16, 2009.
Vendor
Disputes
In
delivering our services, we rely on a number of Internet network,
telecommunication and other vendors. We work directly with these vendors to
provision services such as establishing, modifying or 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. We
research disputed costs, both in the vendors’ favor and our favor, and discuss
our analysis with vendors on an ongoing basis until ultimately resolved. We
record the cost and a liability based on our estimate of the most likely outcome
of the dispute. We periodically review these estimates and modify the estimates
in light of new information or developments, if any. Because estimates regarding
disputed costs include assessments of uncertain outcomes, such estimates are
inherently vulnerable to changes due to unforeseen circumstances that could
materially and adversely affect our results of operations and cash
flows.
Concentrations
of Risk
We
participate in 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
On
November 12, 2008, a putative securities fraud class action lawsuit was filed
against us and our Chief Executive Officer, James P. DeBlasio, in the United
States District Court for the Northern District of Georgia, captioned
Catherine Anastasio and Stephen
Anastasio v. Internap Network Services Corp. and James P. DeBlasio
, Civil
Action No. 1:08-CV-3462-JOF. The complaint alleges that we and the individual
defendant violated Section 10(b) of the Securities Exchange Act of 1934, or the
Exchange Act and that the individual defendant also violated Section 20(a) of
the Exchange Act as a “control person” of Internap. Plaintiffs purport to bring
these claims on behalf of a class of our investors who purchased our stock
between March 28, 2007 and March 18, 2008.
INTERNAP
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Plaintiffs
allege generally that, during the putative class period, we made misleading
statements and omitted material information regarding (1) integration of
VitalStream, (2) customer issues and related credits due to services outages,
and (3) our previously reported 2007 revenue that we subsequently reduced in
2008 as announced on March 18, 2008. Plaintiffs assert that we and the
individual defendant made these misstatements and omissions in order to keep our
stock price high. Plaintiffs seek unspecified damages and other
relief.
While we
intend to vigorously contest this lawsuit, we cannot determine the final
resolution of this lawsuit or when it might be resolved. In addition to the
expenses incurred in defending this litigation and any damages that may be
awarded in the event of an adverse ruling, our management’s efforts and
attention may be diverted from the ordinary business operations to address these
claims. Regardless of the outcome, this litigation may have a material adverse
impact on our results because of defense costs, including costs related to our
indemnification obligations, diversion of resources and other
factors.
We are subject
to other 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.
|
|
16.
|
PREFERRED
STOCK AND STOCKHOLDERS’ EQUITY
|
Preferred
Stock
Effective
July 11, 2006, we implemented a one-for-10 reverse stock split for our common
stock. At the time, the authorized number of shares of preferred stock was not
accordingly reduced and remained at 200 million shares. We intended the reverse
stock split to reduce the authorized number of shares of preferred
stock. Accordingly, effective June 19, 2008, we reduced the number of
authorized shares of preferred stock from 200 million shares to 20 million
shares. Of the resulting 20 million authorized shares of preferred stock,
19.5 million shares are blank check preferred stock, the terms and conditions of
which our board of directors may designate. Our board of directors
previously designated the remaining 0.5 million shares of preferred stock as
series B preferred stock pursuant to a certificate of designation of rights,
preferences and privileges on April 11, 2007. We have no shares of preferred
stock outstanding.
Rights
Agreement
On March
15, 2007, our board of directors declared a dividend of one preferred share
purchase right, or a Right, for each outstanding share of our common stock, par
value $0.001 per share. 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 us 1/1000 of a share of our Series B Preferred Stock, 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 us and American
Stock Transfer & Trust Company, as Rights Agent, dated April 11,
2007.
Common
Stock
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-10 reverse stock split of our common stock.
Stockholders approved the stock split on June 21, 2006. 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.
Treasury
Stock
During
2006 and 2008, we acquired shares of treasury stock as payment of taxes on
stock-based compensation from employees. These shares will be 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 expired on August 22,
2008.
INTERNAP
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
|
|
17.
|
STOCK-BASED
COMPENSATION PLANS
|
We
measure stock-based compensation cost at the grant date based on the calculated
fair value of the award. We recognize the expense over the employees’ requisite
service period, generally the vesting period of the award.
For
performance-based awards, we periodically assess whether the performance
conditions are probable of being met and record compensation expense based on
this assessment of probability. We estimate the fair value of stock options at
the grant date 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.
When we
elect to pay certain bonuses in shares of stock, the total amount to be paid is
determined similarly to cash bonuses and the number of shares to be granted is
determined based on the fair value of our stock at the date of
grant.
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 years ended December
31, 2008, 2007 and 2006 (in thousands):
|
|
Year
ended December 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
Direct
costs of customer support
|
|
$
|
1,369
|
|
|
$
|
1,892
|
|
|
$
|
1,102
|
|
Product
development
|
|
|
688
|
|
|
|
856
|
|
|
|
628
|
|
Sales
and marketing
|
|
|
1,782
|
|
|
|
2,135
|
|
|
|
2,145
|
|
General
and administrative
|
|
|
3,660
|
|
|
|
3,798
|
|
|
|
2,067
|
|
Total
stock-based compensation expense included in net income
|
|
$
|
7,499
|
|
|
$
|
8,681
|
|
|
$
|
5,942
|
|
We have
not recognized any tax benefits associated with stock-based compensation due to
our tax net operating losses. We capitalized less than $0.1 million of
stock-based compensation during each of the years ended December 31, 2008, 2007
and 2006.
We
estimated the fair values of stock options 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, 2008, 2007 and 2006, were expected terms of
4.0, 6.2 and 5.7, respectively; historical volatilities of 72%, 114% and 123%
respectively; risk free interest rates of 2.61%, 4.44% and 4.63%, respectively
and no dividend yield. The weighted average estimated fair value per share of
our employee stock options at grant date was $3.79, $13.71 and $7.75 for the
years ended December 31, 2008, 2007 and 2006, 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 term of the options.
We have also used historical data to estimate option exercises, employee
termination and forfeiture rates.
In June
2006, our stockholders approved the repricing of 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. We
implemented the repricing 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 one-for-two;
and
|
|
|
|
|
●
|
Each
new option has a 10-year term and 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.
|
INTERNAP
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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. 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
Compensation and Option Plans
On June
23, 2005, we adopted the Internap Network Services Corporation 2005 Incentive
Stock Plan, or the 2005 Plan, which we amended and restated on March 15, 2006.
Under the 2005 Plan, we may issue stock options, stock appreciation rights,
stock grants and stock unit grants to eligible employees and directors. The 2005
Plan is administered by the compensation committee of our board of directors. On
October 1, 2008, we filed a registration statement on Form S-8 to register 4.0
million additional shares of our common stock for issuance under the 2005 Plan.
We have reserved a total of 10.8 million shares of stock for issuance under the
2005 Plan, comprised of 6.0 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, 2008, 2.6 million options
were outstanding, 0.8 million shares of non-vested restricted stock awards were
outstanding and 6.6 million shares of stock were available for issuance
under the 2005 Plan.
Under the
2005 Plan, we may not grant in any calendar year an option to any employee or
director 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. Similarly, we may not make in any calendar year a stock
grant or stock unit grant to any employee or director where the fair market
value of the stock subject to such grant on the grant date exceeds $3.0
million. Furthermore, we may not issue more than 0.7 million non-forfeitable
shares of stock 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 our 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 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 five 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.
In 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
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, each
non-employee director receives a fully vested and exercisable option for 5,000
shares, provided such person has been a non-employee director for at least the
prior six months. The options have an exercise price equal to 100% of the fair
market value of our common stock on the grant date and are fully vested and
exercisable as of the grant date. Each director also receives an annual grant of
2,500 restricted stock awards, which vest ratably over three years, 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 three years, 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, 2008, 0.2 million options were
outstanding and 0.2 million shares were available for grant pursuant to the
Director Plan.
INTERNAP
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The
option price for each share of stock subject to an option generally may not be
less than the fair market value of a share of stock on the grant date. Stock
options generally have a maximum term of 10 years from the grant date. Incentive
stock options, or ISOs, may be granted only to eligible employees and if granted
to a 10% stockholder, the terms of the grant will be more restrictive than for
other eligible employees. Terms for stock appreciation rights are similar to
those of options. Upon exercise of a stock appreciation right, the compensation
committee of our board of directors determines 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 grant date by our board of directors or the
compensation committee of our board of directors, as applicable. Stock options
generally vest 25% after one year and monthly or quarterly over the following
three years, except for non-employee directors who usually receive immediately
exercisable options. 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 grant date 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 grant date. We have reserved common stock
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
On March
20, 2008, we granted 0.2 million shares of restricted common stock with
performance-based vesting. The awards will vest in increments of one-third
beginning on the first anniversary of the grant date if we achieve revenue and
adjusted earnings levels established by our board of directors. ”Adjusted
earnings” is defined in the 2005 Plan. We will either meet or not meet both
goals in a given year. With respect to all shares of performance-based
restricted stock that do not vest during any of the three years, 50% of such
shares will vest on the fourth anniversary of the date of grant. For the
performance-based restricted stock awards, we recognize compensation expense
based on our assessment of the probability that the performance conditions will
be achieved. We must use our judgment to make the probability assessment and, as
of December 31, 2008, we believed the performance conditions would not be
met.
Option
activity for the year ended December 31, 2008 under all of our stock option
plans is as follows (shares in thousands):
|
|
|
|
|
|
|
|
|
|
|
Shares
|
|
|
Weighted
Average
Exercise
Price
|
|
|
Balance,
January 1, 2008
|
|
|
3,173
|
|
|
$
|
13.29
|
|
|
Granted
|
|
|
660
|
|
|
|
6.90
|
|
|
Exercised
|
|
|
(78
|
)
|
|
|
4.08
|
|
|
Forfeitures
and post-vesting cancellations
|
|
|
(974
|
)
|
|
|
13.62
|
|
|
Balance,
December 31, 2008
|
|
|
2,781
|
|
|
$
|
11.91
|
|
|
Exercisable,
December 31, 2008
|
|
|
1,738
|
|
|
$
|
13.37
|
|
Fully
vested and exercisable stock options and stock options expected to vest as of
December 31, 2008 are further summarized as follows (shares in
thousands):
|
|
|
|
|
|
|
|
|
|
|
Fully
Vested
and
Exercisable
|
|
|
Expected
to
Vest
|
|
|
Total
shares
|
|
|
1,738
|
|
|
|
2,616
|
|
|
Weighted-average
exercise price
|
|
$
|
13.37
|
|
|
$
|
12.07
|
|
|
Aggregate
intrinsic value
|
|
$
|
2,925
|
|
|
$
|
2,925
|
|
|
Weighted-average
remaining contractual term, in years
|
|
|
5.8
|
|
|
|
6.6
|
|
The total
intrinsic value of options exercised was $0.2 million, $11.8 million and $2.6
million for the years ended December 31, 2008, 2007 and 2006, respectively. None
of our stock options or the underlying shares is subject to any right to
repurchase by us.
INTERNAP
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Restricted
stock activity for the year ended December 31, 2008 is as follows (shares in
thousands):
|
|
|
|
|
|
|
|
|
|
|
Shares
|
|
|
Weighted-Average
Grant
Date Fair
Value
|
|
|
Non-vested
balance, January 1, 2008
|
|
|
679
|
|
|
$
|
13.19
|
|
|
Granted
|
|
|
724
|
|
|
|
4.07
|
|
|
Vested
|
|
|
(256
|
)
|
|
|
10.84
|
|
|
Forfeited
|
|
|
(302
|
)
|
|
|
9.22
|
|
|
Non-vested
balance, December 31, 2008
|
|
|
845
|
|
|
$
|
7.76
|
|
The total
fair value of restricted stock awards vested during the years ended December 31,
2008, 2007 and 2006 was $1.1 million, $2.3 million and $2.1 million,
respectively. The cumulative effect of the change in the forfeiture rate for
non-vested restricted stock upon our adoption of SFAS No. 123R on January 1,
2006 was immaterial and recorded as part of operating expense. The total
intrinsic value at December 31, 2008 of all non-vested restricted stock awards
was $2.1 million.
Total
unrecognized compensation costs related to non-vested stock-based compensation
as of December 31, 2008 is summarized as follows (dollars in
thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December
31, 2008
|
|
|
|
|
Stock
Options
|
|
Restricted
Stock
|
|
Total
|
|
|
Unrecognized
compensation
|
|
$
|
8,367
|
|
$
|
8,253
|
|
$
|
16,620
|
|
|
Weighted-average
remaining recognition period (in years)
|
|
|
2.5
|
|
|
2.6
|
|
|
2.6
|
|
Employee
Stock Purchase Plan
Effective
June 15, 2004, we adopted the 2004 Internap Network Services Corporation
Employee Stock Purchase Plan, or the Purchase Plan. The purpose of the Purchase
Plan is to encourage ownership of our common stock by each of our eligible
employees by permitting eligible employees to purchase our common stock at a
discount. Eligible employees may elect to participate in the Purchase Plan 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 Purchase Plan 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 Purchase Plan 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, we amended the Purchase Plan 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, we did not recognize additional compensation expense
for the Purchase Plan after June 30, 2006. We granted less than 0.1 million
shares under the Purchase Plan during each of the years ended December 31, 2008
and 2007, and we granted approximately 0.1 million shares under the Purchase
Plan during the year ended December 31, 2006. Cash received from participation
in the Purchase Plan was $0.2 million for each of the years ended December 31,
2008 and 2007 and $0.5 million for the year ended December 31, 2006. At December
31, 2008, 0.2 million shares were reserved for future issuance under the
Purchase Plan.
At
December 31, 2008, we had reserved 9.8 million total shares for future awards
under all plans. Cash received from all stock-based compensation arrangements
was $0.5 million, $8.6 million and $3.0 million for the years ended December 31,
2008, 2007 and 2006, respectively.
|
|
18.
|
RELATED
PARTY TRANSACTIONS
|
As
discussed in note 5, 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 2006. As of December 31, 2007, our
outstanding receivable balance with Aventail was less than $0.1 million. 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.
INTERNAP
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
One of
our former executive officers had 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 $0.2 million and $0.1 million during
2008 and 2007, respectively, of which less than $0.1 million was
outstanding as of both December 31, 2008 and 2007. Surfline was not a customer
prior to 2007. This executive officer resigned from the Company in June
2008.
|
|
19.
|
UNAUDITED
QUARTERLY RESULTS
|
The
following table sets forth selected unaudited quarterly data for the years ended
December 31, 2008 and 2007. The quarterly operating results below are not
necessarily indicative of those in future periods (in thousands, except for
share data).
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter
Ended
|
|
2008
|
|
March
31
|
|
|
June
30
|
|
|
September
30
|
|
|
December
31
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
62,053
|
|
|
$
|
62,325
|
|
|
$
|
65,399
|
|
|
$
|
64,212
|
|
Direct
costs of network, sales and services, exclusive of depreciation and
amortization
|
|
|
31,363
|
|
|
|
33,484
|
|
|
|
35,404
|
|
|
|
35,626
|
|
Direct
costs of amortization of acquired technologies
|
|
|
1,229
|
|
|
|
1,229
|
|
|
|
3,049
|
|
|
|
1,142
|
|
Direct
costs of customer support
|
|
|
4,365
|
|
|
|
4,203
|
|
|
|
3,950
|
|
|
|
3,699
|
|
Impairments
and restructuring
|
|
|
—
|
|
|
|
—
|
|
|
|
100,415
|
|
|
|
1,026
|
|
Net
income (loss)
|
|
|
739
|
|
|
|
(3,237
|
)
|
|
|
(101,405
|
)
|
|
|
(910
|
)
|
Basic
net income (loss) per share
|
|
|
0.02
|
|
|
|
(0.07
|
)
|
|
|
(2.06
|
)
|
|
|
(0.02
|
)
|
Diluted
net income (loss) per share
|
|
|
0.01
|
|
|
|
(0.07
|
)
|
|
|
(2.06
|
)
|
|
|
(0.02
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter
Ended
|
|
2007
|
|
March
31
|
|
|
June
30
|
|
|
September
30
|
|
|
December
31
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
53,534
|
|
|
$
|
58,494
|
|
|
$
|
60,426
|
|
|
$
|
61,636
|
|
Direct
costs of network, sales and services, exclusive of depreciation and
amortization
|
|
|
28,
629
|
|
|
|
29,617
|
|
|
|
29,272
|
|
|
|
30,876
|
|
Direct
costs of amortization of acquired technologies
|
|
|
654
|
|
|
|
1,054
|
|
|
|
1,228
|
|
|
|
1,229
|
|
Direct
costs of customer support
|
|
|
3,388
|
|
|
|
4,330
|
|
|
|
4,495
|
|
|
|
4,334
|
|
Impairments
and restructuring
|
|
|
11,349
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Acquired
in-process research and development
|
|
|
450
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Write-off
of investment
|
|
|
—
|
|
|
|
1,178
|
|
|
|
—
|
|
|
|
—
|
|
Net
(loss) income
|
|
|
(10,695
|
)
|
|
|
(1,683
|
)
|
|
|
1,383
|
|
|
|
5,440
|
|
Basic
and diluted net (loss) income per share
|
|
|
(0.26
|
)
|
|
|
(0.03
|
)
|
|
|
0.03
|
|
|
|
0.11
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
INTERNAP
NETWORK SERVICES CORPORATION
FINANCIAL
STATEMENT SCHEDULE
VALUATION
AND QUALIFYING ACCOUNTS AND RESERVES (IN THOUSANDS)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance
at
Beginning
of
Fiscal
Period
|
|
Charges
to
Costs
and
Expense
|
|
Charges
to
Other
Accounts
|
|
Deductions
|
|
Balance
at
End
of
Fiscal
Period
|
|
Year
ended December 31, 2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allowance
for doubtful accounts
|
|
$
|
963
|
|
$
|
548
|
|
$
|
—
|
|
$
|
(1,130
|
)
(1)
|
$
|
381
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year
ended December 31, 2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allowance
for doubtful accounts
|
|
|
381
|
|
|
2,261
|
|
|
928
|
(2)
|
|
(1,219
|
)
(1)
|
|
2,351
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year
ended December 31, 2008:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allowance
for doubtful accounts
|
|
|
2,351
|
|
|
5,322
|
|
|
—
|
|
|
(4,896
|
)
(1)
|
|
2,777
|
|
|
__________________
|
|
(1)
|
Deductions
in the allowance for doubtful accounts represent write-offs of
uncollectible accounts net of recoveries.
|
|
|
|
|
(2)
|
Purchase
price adjustment associated with our acquisition of VitalStream Holdings,
Inc.
|
S -
1