Overview
We were
incorporated as a Washington corporation in 1996 and reincorporated in Delaware
in 2001. Our principal executive offices are located at 250 Williams Street,
Suite E-100, Atlanta, Georgia 30303, and our telephone number is (404) 302-9700.
Our common stock trades on the NASDAQ Global Market under the symbol “INAP.” Our
website address is
www.internap.com
.
We are an
Internet solutions and data center company providing a suite of network
optimization and delivery services and products that manage, deliver and
distribute applications and content with a 100% availability service level
agreement, as well as a global provider of secure and reliable data center
services. We help our customers innovate their business, improve service levels
and lower the cost of information technology operations. Our services and
products, combined with progressive and proactive technical support, enable our
customers to migrate business-critical applications from private to public
networks.
We
provide services through 73 Internet Protocol, or IP, service points, which
include 20 content delivery network, or CDN, points of presences, or POPs, and
47 data centers across North America, Europe and the Asia-Pacific region. We
also have two additional international standalone CDN POPs and two additional
domestic standalone data center locations through which we provide IP services
by extension. However, through December 31, 2009, neither revenues generated nor
long-lived assets located outside the United States were significant (all less
than 10%).
Our
Private Network Access Points, or P-NAPs, feature multiple direct high-speed
connections to major Internet backbones, also referred to as network service
providers, or NSPs, such as Verizon Communications Inc.; Global Crossing
Limited; Level 3 Communications, Inc.; XO Holdings Inc.; and Cogent
Communications Group, Inc. We operate in two business segments: IP services and
data center services. These segments reflect a change from our historical
segments, which also included CDN services as a separate segment. We now operate
our IP services and the majority of our CDN services on a combined basis while
we operate the managed hosting portion of our CDN services as part of our data
center services. We discuss the determination of and changes in our business
segments below in “Segments” and in notes 2 and 4 to the accompanying
consolidated financial statements.
Our
intelligent routing technology facilitates traffic over multiple carriers, as
opposed to just one carrier’s network, to ensure highly-reliable performance
over the Internet. Our data center, or colocation, services allow us to expand
the reach of our high performance IP services to customers who wish to take
advantage of locating their network and application assets in secure,
high-performance facilities. We believe that our unique managed multi-network
approach provides better performance, control and reliability compared to
conventional Internet connectivity alternatives. Our service level agreements,
or SLAs, guarantee performance across multiple networks and a broader segment of
the Internet in the United States, excluding local connections, than providers
of conventional Internet connectivity which typically only guarantee performance
on their own network.
On
February 20, 2007, we closed the acquisition of VitalStream in an all-stock
transaction accounted for using the purchase method of accounting for business
combinations. Our results of operations include the activities of VitalStream
from February 21, 2007 through December 31, 2009.
We
currently have approximately 2,900 customers across more than 25 metropolitan
markets, serving a variety of industries, including entertainment and media,
financial services, healthcare, travel, e-commerce, retail and
technology.
Industry
Background
The
Emergence of Multiple Internet Networks
The
Internet originated as a restricted network designed to provide efficient and
reliable long distance data communications among the disparate computer systems
used by government-funded researchers and organizations. As the Internet
evolved, businesses began to use the Internet for functions critical to their
core business and communications. Telecommunications companies established
additional networks to supplement the original public infrastructure and satisfy
increasing demand. Currently, the Internet is a global collection of
interconnected computer networks, forming a network of networks. These networks
were developed at great expense but are nonetheless constrained by the
fundamental limitations of the Internet’s architecture and routing protocols.
Each network must connect to one another to permit its users to communicate with
each other. Consequently, many Internet network service providers, or ISPs, have
agreed to exchange large volumes of data traffic through a limited number of
public and private network access points.
The
Problem of Inefficient Routing of Data Traffic on the Internet
An
individual ISP only controls the routing of data within its network and its
routing practices tend to compound the inefficiencies of the Internet. When an
ISP receives a packet that is not destined for one of its own customers, it must
route that packet to another ISP to complete the delivery of the packet over the
Internet. An ISP will often route the data from private connections, or peered
data, to the nearest point of traffic exchange, in an effort to get the packet
off its network and onto a competitor’s network as quickly as possible to reduce
capacity and management burdens on its own transport network. Once the
origination traffic leaves the network of an ISP, SLAs with that ISP typically
do not apply since that carrier cannot control the quality of service on the
network of another ISP. Consequently, to complete a communication, data
ordinarily passes through multiple networks and peering points without
consideration for congestion or other factors that inhibit performance. For
customers of conventional Internet connectivity providers, this transfer can
result in lost data, slower and more erratic transmission speeds and an overall
lower quality of service, especially where the ISP is not familiar with the
performance of the destination network. The quality of service can be further
degraded by basic routing protocols that make assumptions about the “best” path
or network to route traffic to, without consideration of the performance of that
network. Equally important, customers have no control over the transmission
arrangements and have no single point of contact that they can hold accountable
for degradation in service levels, such as poor data transmission performance or
service failures. As a result, it is virtually impossible for a single ISP to
offer a high quality of service across disparate networks.
The
Problem of Poor Application Performance over Distant Network Paths
The major
application protocols often utilized over data networks perform poorly under
congestion when network latency is high or network paths are subject to packet
and data loss. These applications may timeout, reset or cause user frustration
and abandonment of an activity or session. Network latency, a measure of time it
takes data to travel between two network points, is a significant factor when
communicating over vast distances such as the global network paths between two
continents. The more distant the communicating parties are from each other, the
higher the network latency will be, potentially resulting in lower effective
throughput. Additionally, longer distances typically result in more network
hops, or data transition points, and may increase the likelihood of encountering
congestion. As a result, business application performance and resultant user
experience may degrade.
The
Growing Importance of the Internet for Business-Critical Internet-Based
Applications
The
Internet is used as a communications platform for an increasing number of
business-critical Web- and Internet-based applications, such as those relating
to electronic commerce, Voice over IP, or VoIP, supply chain management,
customer relationship management, project coordination, streaming media and
video conferencing and collaboration. Businesses are redesigning their
information technology operations models to take advantage of new, more
cost-effective application delivery models, such as software-as-a-service,
hosting and cloud computing. In all cases, these new delivery models rely on the
Internet as the primary means of communicating with customers and users, and
result in enhanced expectations of performance, availability and transparent
delivery for the business application to work as expected.
Businesses
often are unable to benefit from the full potential of the Internet primarily
because of performance issues discussed above. The emergence of technologies and
applications that rely on network quality and require consistent, high-speed
data transfer, such as VoIP, video conferencing and streaming, multimedia
document distribution and streaming and audio and video conferencing and
collaboration, are hindered by inconsistent performance. We believe that
companies who provide a consistently high quality of service that enables
businesses to successfully and cost effectively execute their business-critical
Internet-based applications over the public network infrastructure through
superior performance Internet routing services will lead the market for Internet
services. We believe that our patented route optimization technologies
facilitate such superior performance by mitigating the factors that inhibit
efficient movement of traffic as described above.
The
Growing Demand for Secure and Reliable Data Center Environments
Businesses
and organizations continue to move more data, applications and operations
online, creating a demand for secure and reliable data center environments. Many
companies do not have the capital dollars or the time to manage ongoing data
center space and power requirements for their business. As a result, we provide
companies secure, offsite environments for their equipment or an outsourced
hosting service for their applications and business-critical websites. Our data
centers improve a company’s ability to directly connect to NSPs, which avoids
local loops and mitigates online risk. As our customers’ business models evolve
to leverage rich media content, we help them stream it globally, and as their
media library grows we provide scalable, secure storage for their
content.
The
Growing Demand for Delivery of Rich Media Content over the Internet
The
proliferation of Internet-connected devices and broadband Internet connections
coupled with increased consumption of media over the Internet including
personalized media content have created a demand for delivery of rich media
content. Increasingly, as the volume and quality of dynamic content progresses,
viewers of all ages are spending more and more time using the
Internet. Viewers now expect to be able to watch a movie or television show
online, view the latest news clips, take a virtual walk-through of a home, hear
a podcast, watch a live sporting event or concert or participate in an
educational course, just to name a few examples. Companies that need to
deliver rich media content can either deliver the content using basic Internet
connectivity or utilize a content delivery network, or CDN. Because of the
inherent weaknesses of the Internet, delivery of rich media content is not
reliable. To overcome this problem, companies can either invest substantial
capital to build the infrastructure to bypass the public Internet or utilize a
third party’s CDN.
Our
Market Opportunity
Historically,
ISPs have maintained at-will agreements to deliver Internet traffic on a “best
efforts” basis without guaranteeing various levels of quality of service on
other networks. This best efforts delivery is sub-optimal for time-sensitive and
real-time applications that require uninterrupted streams of data such as voice
and video. For companies that rely on the Internet as a medium for commerce or
relationship management, this unpredictable performance often translates into
lost revenue, decreased productivity and dissatisfied customers.
We
believe we are well positioned through our patented and patent-pending network
route optimization technologies and data center services to help businesses
overcome the inherent limitations and unpredictable performance of the Internet.
This is especially relevant for companies that use the Internet as a core
component of their business operations such as direct sales, supply chain and
collaboration strategies or rely on the Internet to reach global partners,
suppliers and customers. This changing landscape, combined with an increasingly
dispersed workforce and the adoption of emerging technologies, including VoIP
and streaming media, has increased the need for fast, reliable connectivity and
delivery of content-rich media. Additionally, the emergence of
bandwidth-intensive video and the general and rapid increase of digital
information creation and delivery will further drive the need for
highly-available and performance-optimized network transport
service.
Our suite
of technology services and products increase reliability, decrease network
latency and optimize routing to enable customers to effectively leverage the
Internet to promote productivity, decrease transactional costs and generate new
revenue streams.
Segments
During
the year ended December 31, 2009, we changed how we view and manage our
business. We now operate our IP services and the majority of our CDN services on
a combined basis while we operate the managed hosting portion of our CDN
services as part of our data center services. The change from our historical
segments reflects management’s views of the business and aligns our segments
with our operational and organizational structure. We have integrated the
primary components of our CDN services with our IP services in the IP services
segment. This includes integration of our CDN POPs into our P-NAPs along with
combining engineering and operations teams and internal financial reporting.
In addition, a
single manager reports directly to our chief executive officer for the
integrated IP services. Historically, CDN services also included managed
hosting, or maintaining network equipment on behalf of customers. Since these
CDN services are a hosting activity, they are more similar to our data center
services, and therefore we have included these services in our data center
services segment. We have reclassified financial information for prior periods
to conform to the current period presentation.
We
discuss the determination of and changes in our business segments below in
“Management’s Discussion and Analysis of Financial Condition and Results of
Operations—Results of Operations—Segment Information.”
IP
Services
IP
services represent our IP transit activities and include our high-performance
Internet connectivity, CDN services and flow control platform, or FCP,
products.
Our
patented and patent-pending network route optimization technologies address the
inherent weaknesses of the Internet, allowing businesses to take advantage of
the convenience, flexibility and reach of the Internet to connect to customers,
suppliers and partners, and to adopt new information technology delivery models,
in a reliable and predictable manner. Our services and products take into
account the unique performance requirements of each business application to
ensure performance as designed, without unnecessary cost. When recommending an
appropriate network solution for our customers’ applications, we consider key
performance objectives such as bandwidth capacity needed, expected bandwidth
usage, location of services and cost objectives. Our fees for IP services are
based on a fixed-fee, usage or a combination of both.
Our CDN
services enable our customers to quickly and securely stream and distribute rich
media and content, such as video, audio software and applications to audiences
across the globe through strategically located data POPs. Providing
capacity-on-demand to handle large events and unanticipated traffic spikes, we
deliver high-quality content regardless of audience size or geographic location
and the analytic tool to allow our customers to refine their marketing
programs.
Our FCP
products are a premise-based intelligent routing hardware product for
customers who run their own multiple network architectures, known as
multi-homing. The FCP functions similarly to our P-NAP. We offer FCP as either a
one-time hardware purchase or as a monthly subscription service. Sales of FCP
also generate annual maintenance fees and professional service fees for
installation.
Data
Center Services
Data
center, or colocation, 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
and the managed hosting portion of CDN services. Throughout this Annual Report
on Form 10-K, we refer to data center services and colocation services
interchangeably.
Our data
center services allow us to expand the reach of our high performance IP services
to customers who wish to take advantage of locating their network and
application assets in secure, high-performance facilities. We operate data
centers where customers can host their applications directly on our network to
eliminate issues associated with the quality of local connections. Data center
services also enable us to have a more flexible product offering, such as
bundling our high performance IP connectivity and content delivery, along with
hosting customers’ applications. Our data center services provide a single
source for network infrastructure, IP connectivity and security, all of
which are designed to maximize solution performance while providing a more
stable, dependable infrastructure, and are backed by guaranteed service levels
and our team of dedicated support professionals. We also provide a managed
hosting solution that leverages our IP services. With this service, our
customers own and manage the software applications and content, while we provide
and maintain the hardware, operating system, colocation and
bandwidth.
We use a
combination of facilities operated by us and by third parties, referred to as
company-controlled facilities and partner sites, respectively. We offer a
comprehensive solution at 49 service points, consisting of nine
company-controlled facilities and 40 partner sites, summarized below. We charge
monthly fees for data center services based on the amount of square footage and
power that the customers use. We also have relationships with various data
center providers to extend our P-NAP model into markets with high
demand.
During
2009, we established Statement on Auditing Standards No. 70, or SAS 70, Type II
compliance over controls and processes in our company-controlled data centers.
SAS 70 Type II compliance provides assurances that controls and processes around
our data center security and environmental protection have been suitably
designed and are operating effectively to protect and safeguard customers’
equipment and data. The underlying providers for several of our partner data
centers also maintain SAS 70 Type II compliance.
Other
Other
revenues and direct costs of network, sales and services during the year ended
December 31, 2007 consisted of third-party CDN services. Throughout 2007, other
revenues and direct costs of network, sales and services decreased steadily as
the revenue streams from our acquisition of VitalStream replaced the activity of
the former third-party CDN service provider.
Network
Access Points, Points of Presence and Data Centers
We
provide our services through our network access points across North America,
Europe and the Asia-Pacific region. Our P-NAPs and data centers feature multiple
direct high-speed connections to major Internet backbones, also referred to as
network service providers or NSPs, such as Verizon Communications Inc.; Global
Crossing Limited; Level 3 Communications, Inc.; XO Holdings Inc.; and Cogent
Communications Group, Inc. We provide access to the Internet for our CDN
customers through our CDN POPs. As of December 31, 2009, we provided services
worldwide through 73 IP service points, which includes 20 CDN POPs and 47 data
centers. We also have two additional international standalone CDN POPs and two
additional domestic standalone data center locations through which we provide IP
services by extension. We directly operate nine of these data center sites and
have operating agreements with third parties for the remaining locations. We
have P-NAPs, CDN POPs and/or data centers in the following markets, some of
which have multiple sites:
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Internap
operated
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Domestic
sites operated
under
third party agreements
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International
sites operated
under
third party agreements
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Atlanta
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Atlanta
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Oakland
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Amsterdam
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Paris
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Boston
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Boston
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Orange
County/
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Frankfurt
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Singapore
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Houston
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Chicago
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San
Diego
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Hong
Kong
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Sydney
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New
York
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Dallas
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Philadelphia
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London
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Tokyo
(1)
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Seattle
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Denver
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Phoenix
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Mumbai
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Toronto
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Los
Angeles
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San
Francisco
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Osaka
(1)
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Miami
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San
Jose
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New
York
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Washington
DC
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(1)
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Through
our joint venture in Internap Japan Co., Ltd. with NTT-ME Corporation and
Nippon Telegraph and Telephone
Corporation.
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We are
dependent upon the NSPs noted above as well as other ISPs, telecommunications
carriers and vendors in the United States, Europe and Asia-Pacific
region.
Financial
Information about Geographic Areas
For each
of the three years in the period ended December 31, 2009, we derived less than
10% of our total revenues from operations outside the United
States.
Sales
and Marketing
Our sales
and marketing objective is to achieve market penetration and increase brand
recognition among business customers in key industries that use the Internet for
strategic and business-critical operations. We employ a direct sales team with
extensive and relevant sales experience with our target market. Our sales
offices are located in key cities across North America, as well as an office in
the United Kingdom, or U.K.
Our sales
and service organization includes approximately 82 employees in direct and
channel sales, professional services, account management and technical
consulting. As of December 31, 2009, we had approximately 48 direct sales
representatives whose performance is measured on the basis of achievement of
quota objectives.
To
support our sales efforts and promote the Internap brand, we conduct
comprehensive marketing programs. Our marketing strategies include
advertising, participation at trade shows, direct response programs, new service
point launch events, an active public relations campaign and continuing customer
communications. As of December 31, 2009, we had four employees in our
marketing department.
Research
and Development
Research
and development costs, which we include in general and administrative 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. Acceleration technologies improve the performance
(throughput) of applications that depend upon IP for network transport. Cloud
technologies enable the delivery of on-demand, scalable service consumption with
self-service and automated subscription, management, provisioning and billing
capabilities. Product development costs, which we also include in general and
administrative cost and expense as incurred, are primarily related to
network engineering costs associated with changes to the functionality of our
proprietary services and network architecture. Research and development costs
were $3.8 million, $5.0 million and $3.1 million during the years ended December
31, 2009, 2008 and 2007, respectively. These costs do not include $0.9 million,
$1.4 million and $1.6 million in internal software development costs capitalized
during the years ended December 31, 2009, 2008 and 2007, respectively. We
also expense as incurred those costs that do not qualify for capitalization
as software development costs.
Customers
As of
December 31, 2009, we had approximately 2,900 customers. We provide
services to customers in multiple vertical industry segments including
entertainment and media, financial services, healthcare, travel, e-commerce,
retail and technology; however, our customer base is not concentrated in any
particular industry. In each of the past three years, no single customer
accounted for 10% or more of our net revenues. Similarly, in each of the
past three years, we did not derive any significant amounts of revenue from
contracts or subcontracts terminable or renegotiable at the election of the
federal government, and we do not expect such contracts to be a significant
percentage of our total revenue in 2010.
Competition
The
market for our services is intensely competitive and is characterized by
technological change, the introduction of new products and services and price
erosion. We believe that the principal factors of competition for service
providers in our target markets include: speed and reliability of connectivity,
quality of facilities, level of customer service and technical support, price
and brand recognition. We believe that we compete favorably on the basis of
these factors.
Our
current and potential competition primarily consists of:
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NSPs
that provide connectivity services, including AT&T Inc.; Sprint Nextel
Corporation; Verizon Communications Inc.; Level 3 Communications, Inc.;
Global Crossing Limited; and Verio, an NTT Communications
Company;
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global,
national and regional ISPs such as Orange Business Services, BT Infonet,
and Savvis, Inc.;
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providers
of specific applications or services, such as content delivery, security
or storage such as Akamai Technologies, Inc.; Limelight Networks, Inc.; CD
Networks Co., Ltd.; Mirror Image Internet, Inc.; Symantec Corporation;
Network Appliance, Inc. and Virtela Communications,
Inc.;
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software-based,
Internet infrastructure companies focused on IP route control and wide
area network optimization products such as Riverbed Technology, Inc.; F5
Networks, Inc. and Radware Ltd.;
and
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colocation
and data center providers, including Equinix, Inc.; Terremark Worldwide,
Inc.; Navisite, Inc.; 365 Main Inc.; Quality Technology Services and
Savvis, Inc.
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Competition
has resulted, and will likely continue to result, in price pressure on our
services.
Many of
our competitors have longer operating histories and presence in key markets,
greater name recognition, larger customer bases and significantly greater
financial, sales and marketing, distribution, technical and other resources than
we have. As a result, these competitors may be able to introduce emerging
technologies on a broader scale and adapt to changes in customer requirements or
to devote greater resources to the promotion and sale of their products. In all
of our target markets, we also may face competition from newly established
competitors, suppliers of services or products based on new or emerging
technologies and customers that choose to develop their own network services or
products. We also may encounter further consolidation in the markets in which we
compete. In addition, competitors may develop technologies that more effectively
address our markets with services that offer enhanced features or lower costs.
Increased competition could result in pricing pressures, decreased gross margins
and loss of market share, which may materially and adversely affect our
business, consolidated financial condition, results of operations and cash
flows.
Intellectual
Property
We rely
on a combination of copyright, patent, trademark, trade secret and other
intellectual property law, nondisclosure agreements and other protective
measures to protect our proprietary rights. We also utilize unpatented,
proprietary know-how and trade secrets and employ various methods to protect
such intellectual property. As of December 31, 2009, we had 19 patents (14
issued in the United States and five issued internationally) that extend to
various dates between 2017 and 2026, and 14 registered trademarks in the United
States. We believe our intellectual property rights are significant and
that the loss of all or a substantial portion of such rights could have a
material adverse impact on our results of operations. We can offer no assurance
that our intellectual property protection measures will be sufficient to prevent
misappropriation of our technology. In addition, the laws of many foreign
countries do not protect our intellectual property rights to the same extent as
the laws of the United States. From time-to-time, third parties have or may
assert infringement claims against us or against our customers in connection
with their use of our products or services. In addition, we may desire or be
required to renew or to obtain licenses from others to further develop and
market commercially viable products or services effectively. We can offer no
assurances that any necessary licenses will be available on reasonable
terms.
Employees
As of
December 31, 2009, we had approximately 390 employees, substantially all of whom
are full-time employees. None of our employees are represented by a labor union,
and we have not experienced any work stoppages to date. We consider the
relationships with our employees to be good. Competition for technical personnel
in the industries in which we compete is intense. We believe that our future
success depends in part on our continued ability to hire, assimilate and retain
qualified personnel. We can offer no assurances that we will be successful in
recruiting and retaining qualified employees in the future.
We operate in a changing environment
that involves numerous known and unknown risks and uncertainties that could have
a materially adverse impact on our operations. The risks described below
highlight some of the factors that have affected, and in the future could
affect, our operations. You should carefully consider these risks. These risks
are not the only ones we may face. Additional risks and uncertainties of which
we are unaware or that we currently deem immaterial also may become important
factors that affect us. If any of the events or circumstances described in the
followings risks occurs, our business,
consolidated financial
condition, results of operations, cash flows, or any combination of the
foregoing, could be materially and adversely affected.
Our risks
are described in detail below; however, the more significant risks we face can
be summarized into several broad categories, including:
The
future evolution of the technology industry in which we operate is difficult to
predict, highly competitive and requires continual innovation, strategic
planning, capital investment, demand planning and space utilization management
to remain viable. We face on-going challenges to develop new services and
products to maintain current customers and obtain new ones, whether in a
cost-effective manner or at all. In addition, technological advantages typically
devalue rapidly creating constant pressure on pricing and cost structures and
hinder our ability to maintain or increase margins.
We are
dependent on numerous suppliers, vendors and other third-party providers across
a wide spectrum of products and services to operate our business. These include
real-estate, network capacity and access points, network equipment and supplies,
power and other vendors. In many cases the suppliers of these products and
services are not only vendors, they are also competitors. While we maintain
contractual agreements with these suppliers, we have limited ability to
guarantee they will meet their obligations, or that we will be able to continue
to obtain the products and services necessary to operate our business in
sufficient supply, or at an acceptable cost.
Our
business model involves designing, deploying, and maintaining a complex set of
network infrastructures at considerable capital expense. We invest significant
resources to help maintain the integrity of our infrastructure and support our
customers; however, we face constant challenges related to our
network infrastructure, including capital forecasting, demand planning,
space utilization management, physical failures, obsolesce,
maintaining redundancies, security breaches, power demand, and other
risks.
Our
financial results have fluctuated over time and we have a history of losses,
including in each of the past three years. We have also incurred significant
charges related to impairments and restructuring efforts, which, along with
other factors, may contribute to volatility in our stock price.
Risks
Related to our Industry
We
cannot predict with certainty the future evolution of the market for technology
and products, and may be unable to respond effectively and on a timely basis to
rapid technological change.
Our
industry is characterized by rapidly changing technology, industry standards and
customer needs, as well as by frequent new product and service introductions.
New technologies and industry standards have the potential to replace or provide
lower cost alternatives to our services. The adoption of such new technologies
or industry standards could render our existing services or products obsolete
and unmarketable to a sufficiently large number of customers. Our failure to
anticipate the prevailing standard, to adapt our technology to any changes in
the prevailing standard or the failure of a common standard to emerge could
materially and adversely affect our business. Our pursuit of necessary
technological advances may require substantial time and expense, and we may be
unable to successfully adapt our network and services to alternative access
devices and technologies. If the Internet becomes subject to a form of central
management, or if NSPs establish an economic settlement arrangement regarding
the exchange of traffic between Internet networks, the demand for our IP
services could be materially and adversely affected. Likewise, technological
advances in computer processing, storage, capacity, component size or advances
in power management could change which could result in a decreased demand for
our data center services.
If
we are unable to develop new and enhanced services and products that achieve
widespread market acceptance, or if we are unable to improve the performance and
features of our existing services and products or adapt our business model to
keep pace with industry trends, our business and operating results could be
adversely affected.
Our
industry is constantly evolving. The process of expending research and
development to create new services and products, and the technologies that
support them, is expensive, time and labor intensive and uncertain. We may
fail to understand the market demand for new services and products or not be
able to overcome technical problems with new services. The demand for top
research and development talent is high, and there is significant competition
for these scarce resources.
Our
future success may depend on our ability to respond to the rapidly changing
needs of our customers by expending research and development in a cost-effective
manner to acquire talent, develop and introduce new services, products and
product upgrades on a timely basis. New product development and introduction
involves a significant commitment of time and resources and is subject to a
number of risks and challenges, including:
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sourcing,
identifying, obtaining, and maintaining qualified R&D staff with the
appropriate skill and expertise;
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managing
the length of the development cycle for new products and product
enhancements, which historically has been longer than
expected;
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adapting
to emerging and evolving industry standards and to technological
developments by our competitors and customers services and
products
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entering
into new or unproven markets where we have limited
experience;
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managing
new product and service strategies and integrating those with our existing
services and products;
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incorporating
acquired products and technologies;
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trade
compliance issues affecting our ability to ship new products to
international markets;
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developing
or expanding efficient sales channels;
and
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obtaining
required technology licenses and technical access from operating system
software vendors on reasonable terms to enable the development and
deployment of interoperable
products.
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In
addition, if we cannot adapt our business models to keep pace with industry
trends, our revenue could be negatively impacted. If we are not successful in
managing these risks and challenges, or if our new services, products and
product upgrades are not technologically competitive or do not achieve market
acceptance, we may lose market share, resulting in a decrease in our revenues
and earnings.
Our
capital investment strategy for data center expansion may contain erroneous
assumptions causing our return on invested capital to be materially lower than
expected.
Our
strategic decision to invest capital in expanding our data center space in 2010
and beyond is based on significant assumptions relative to expected growth of
this market, our competitor’s plans, current and expected occupancy rates and
similar factors. We have no way of ensuring the data or models used to deploy
capital into existing markets, or to create new markets, will be accurate.
Errors or imprecision in these estimates, especially those related to customer
demand, could cause actual results to differ materially from expected results
and have a material negative impact on revenue in future periods.
Our
management of existing data center space or estimation of future data center
space needs may be inaccurate, leading to lost revenue through missed sales
opportunities or additional expenses through unnecessary carrying costs for our
data center space.
Adding
data center space involves significant capital outlays well ahead of planned
usage. We strive to maintain accurate records related to data center space by
classification; however, we may not be able to ensure accuracy of existing data
center space nor be able to accurately project future space needs due to
significant estimates and assumptions required for these projections. Errors or
imprecision in these estimates could cause actual results to differ materially
for expected results and correspondingly have a material negative impact on
revenue in future periods.
We
may not be able to compete successfully against current and future
competitors.
The IP
services and data center services markets are highly competitive, as evidenced
by recent declines in pricing for Internet connectivity services and the
significant capital invested in data center expansions by our competitors. We
expect competition to continue to intensify in the future, and we may not have
the financial resources, technical expertise, sales and marketing abilities,
capital or support capabilities to compete successfully. Our competitors
currently include: NSPs that offer Internet access; global, national and
regional NSPs and ISPs; providers of specific applications or service offerings
such as content delivery, security or storage; software-based and other Internet
infrastructure providers and manufacturers; and colocation and data center
providers. In addition, NSPs and ISPs may make technological advancements, such
as the introduction of improved routing protocols to enhance the quality of
their services, which could negatively impact the demand for our services and
products.
In
addition, we expect that we will face additional competition as we expand our
product offerings, including competition from technology and telecommunications
companies. A number of telecommunications companies, NSPs and ISPs have offered
or expanded their network services. Further, the ability of some of these
potential competitors to bundle other services and products with their network
services could place us at a competitive disadvantage. Various companies also
are exploring the possibility of providing, or are currently providing,
high-speed, intelligent data services that use connections to more than one
network or use alternative delivery methods, including the cable television
infrastructure, direct broadcast satellites and wireless local loop. Many of our
existing and future competitors may have greater market presence, engineering
and marketing capabilities and financial, technological and personnel resources
than we have. As a result, our competitors may have significant advantages over
us and may be able to respond more quickly to emerging technologies and ensuing
customer demands. Increased competition and technological advancements by our
competitors could materially and adversely affect our business, consolidated
financial condition, results of operations and cash flows.
Failure
to retain existing customers or add new customers may cause declines in
revenue.
In
addition to adding new customers, we must sell additional services to existing
customers as well as encourage them to increase their usage levels to increase
our revenue. If our existing and prospective customers do not perceive our
services to be of sufficiently high value and quality, we may not be able to
retain our current customers or attract new customers. Our customers have no
obligation to renew their contracts for our services after the expiration of
their initial commitment, and these service agreements may not be renewed at the
same or higher price or level of service, if at all. Moreover, under some
circumstances, some of our customers have the right to cancel their service
agreements prior to the expiration of the terms of their agreements. Due to the
significant upfront costs of managing data centers, if our customers fail to
renew or cancel their service agreements, we may not be able to recover the
initial costs associated with the expansion of our facilities.
Our
customers’ renewal rates may decline or fluctuate as a result of a number of
factors, including:
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their
satisfaction or dissatisfaction with our
services;
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our
ability to provide features and functionality demanded by our
customers;
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the
prices of our services and products as compared with those of our
competitors;
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mergers
and acquisitions affecting our customer base;
and
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reduction
in our customers’ spending levels.
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If our
customers do not renew their service agreements with us or if they renew on less
favorable terms, our revenue may decline and our business may suffer. Similarly,
our customer agreements often provide for minimum commitments that may be
significantly below our customers’ historical usage levels. Consequently, even
if we have agreements with our customers to use our services, these customers
could significantly curtail their usage without incurring any incremental fees
under our agreements. In this event, our revenue would be lower than expected
and our operating results could suffer.
We
have a long sales cycle for our services and products and the implementation
efforts required by customers to activate our services and products can be
substantial.
Our
services and products are complex and require substantial sales efforts and
technical consultation to implement. A customer’s decision to use datacenter
space or acquire IP services typically involves a significant commitment of
resources. Some customers may be reluctant to enter into an agreement with us
due to their inability to accurately forecast future demand, delay in
decision-making or inability to obtain necessary internal approvals to commit
resources. We may expend time and resources pursuing a particular sale or
customer that does not result in revenue. Delays due to the length of our sales
cycle may harm our ability to meet our forecasts and materially and adversely
affect our revenues and operating results.
We
may lose customers if they elect to develop IP or content delivery services or
products internally.
Our
customers and potential customers may decide to develop their own IP or content
delivery services or products rather than outsource to services providers like
us. These in-house services or products could be perceived to be superior to our
services and products. In addition, our customers could decide to host their
Internet applications internally, bypassing outside vendors like us. This is
particularly true as our customers increase their operations and expend greater
resources on delivering their content using third-party services. If we fail to
offer IP, data center or CDN services that compete favorably with in-sourced
services, if we fail to differentiate our services and products or if
competitors introduce new products or services that compete with or surpass the
quality or the price/performance of our services, we may lose customers or fail
to attract customers that may consider pursuing this in-sourced approach, and
our business and financial results would suffer as a result.
In
addition, our customers’ business models may change in ways that we do not
anticipate and these changes could reduce or eliminate our customers’ needs for
our services or products. If this occurred, we could lose customers or potential
customers, and our business and financial results would suffer. As a result of
these or similar potential developments, in the future it is possible that
competitive dynamics in our market may require us to reduce our prices, which
could harm our revenue, gross margin and operating results.
Pricing
pressure may continue to decrease our revenue and threaten the attractiveness of
our premium-priced IP services.
Pricing
for Internet connectivity services has declined significantly in recent years
and may continue to decline. We currently charge, and expect to continue to
charge, premium prices for our high-performance IP services compared to the
prices charged by our competitors for their connectivity services. By bundling
their services and reducing the overall cost of their service offerings, certain
of our competitors may be able to provide customers with reduced communications
costs in connection with their Internet connectivity services or private network
services, thereby significantly increasing the pressure on us to decrease our
prices. Increased price competition, significant price deflation and other
related competitive pressures has eroded, and could continue to erode, our
revenue and could materially and adversely affect our results of operations if
we are unable to control or reduce our costs. Because we rely on NSPs to deliver
our services and have agreed with some of these providers to purchase minimum
amounts of service at predetermined prices, our profitability could be adversely
affected by competitive price reductions to our customers even if accompanied
with an increased number of customers.
In light
of economic factors and technological advances, companies that require Internet
connectivity have evaluated and will continue to evaluate the cost of such
services, particularly high performance connectivity services such as those we
currently offer. Consequently, existing and potential customers may be less
willing to pay premium prices for high performance Internet connectivity
services and may choose to purchase lower-quality services at lower prices,
which could materially and adversely affect our business, consolidated financial
condition, results of operations and cash flows.
In
addition, prices for content delivery services have similarly fallen in recent
years from technological improvements and intensified competition and may
continue to fall in the future. If the price that we are able to charge
customers to deliver their content falls to a greater extent than we anticipate,
if we overestimate future demand for our services or if our costs to deliver our
services do not fall commensurate with any future price declines, we may not be
able to achieve acceptable rates of return on our infrastructure investments,
and our gross profit and results of operations may suffer
dramatically.
We
may acquire other businesses, and these acquisitions involve integration and
other risks that could harm our business.
We may
pursue acquisitions of complementary businesses, products, services and
technologies to expand our geographic footprint, enhance our existing services,
expand our service offerings or enlarge our customer base. If we complete future
acquisitions, we may be required to incur or assume additional debt, make
capital expenditures or issue additional shares of our common stock or
securities convertible into our common stock as consideration, which would
dilute our existing stockholders’ ownership interest and may adversely affect
our results of operations.
If we
fail to identify and acquire needed companies or assets, if we acquire the wrong
companies or assets or if we fail to address the risks associated with
integrating an acquired company, we would not be able to effectively manage our
growth through acquisitions which could adversely affect our
results.
If
governments modify or increase regulation of the Internet, or goods or services
necessary to operate the Internet or our data centers, our services could become
more costly.
International
bodies and federal, state and local governments have adopted a number of laws
and regulations that affect the Internet and are likely to continue to seek to
implement additional laws and regulations. In addition, federal and state
agencies are actively considering regulation of various aspects of the Internet,
including taxation of transactions, imposition of access fees for VoIP, enhanced
data privacy and retention legislation and various energy regulations. In
addition, laws relating to the liability of private network operators and
information carried on or disseminated through their networks are unsettled,
both in the United States and abroad.
The
adoption of any future laws or regulations might decrease the growth of the
Internet, decrease demand for our services, impose taxes or other costly
technical requirements, regulate the Internet or otherwise increase the cost of
doing business on the Internet. Any of these actions could significantly harm
our customers or us. Moreover, the nature of any new laws and regulations and
the interpretation of applicability to the Internet of existing laws governing
intellectual property ownership and infringement, copyright, trademark, trade
secret, obscenity, libel, employment, personal privacy and other issues are
uncertain and developing. Additionally, potential laws and regulations not
specifically directed at the Internet, but targeted at goods or services
necessary to operate the Internet, could have a negative impact on us. Of
specific concern are the legal, political and scientific developments regarding
climate change. These factors may impact the delivery of our services or
products by driving up the cost of power, which is a significant cost of
operating our data centers and other service points.
We cannot
predict the impact, if any, that future regulation or regulatory changes may
have on our business.
Risks
Related to our Business
We
depend on third-party suppliers for key elements of our network infrastructure.
If we are unable to obtain these items on a cost-effective basis, or at all, or
if such services are interrupted, limited or terminated, our growth prospects
and business operations may be adversely affected.
In
delivering our services, we rely on a number of Internet networks, many of which
are built and operated by third parties. To provide high performance
connectivity services to our customers through our network access points, we
purchase connections from several NSPs. We can offer no assurances that these
NSPs will continue to provide service to us on a cost-effective basis or on
otherwise competitive terms, if at all, or that these providers will provide us
with additional capacity to adequately meet customer demand or to expand our
business. Consolidation among NSPs limits the number of vendors from which we
obtain service, possibly resulting in higher network costs to us. We may be
unable to establish and maintain relationships with other NSPs that may emerge
or that are significant in geographic areas, such as Asia, India and Europe, in
which we may locate our future network access points. Any of these situations
could limit our growth prospects and materially and adversely affect our
business.
We also
depend on other companies to supply various key elements of our infrastructure,
including the network access loops between our network access points and our
NSP, local loops between our network access points and our customers’ networks
and certain end-user access networks. Pricing for such network access loops and
local loops has risen significantly over time and operators of these networks
may take measures, such as the deployment of a variety of filters, that could
degrade, disrupt or increase the cost of our or our customers’ access to certain
of these end-user access networks by restricting or prohibiting the use of their
networks to support or facilitate our services, or by charging increased fees to
us, our customers or end-users in connection with our services. Some of our
competitors have their own network access loops and local loops and are,
therefore, not subject to the same or similar availability and pricing
issues.
In
addition, we currently purchase routers and switches from a limited number of
vendors. We do not carry significant inventories of the products we purchase,
and we have no guaranteed supply arrangements with our vendors. A loss of a
significant vendor could delay any 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
materially and adversely affect our results.
We
depend on third-party suppliers for key elements of our data center
infrastructure. If we are unable to obtain datacenter facilities on a
cost-effective basis, or at all, our growth prospects and business operations
may be adversely affected.
In
establishing data center facilities, we rely on a number of vendors to provide
physical space, convert or build space to data center specifications, provide
power, internal cabling and wiring, climate control and system redundancy.
Physical space is typically obtained through long-term lease arrangements, while
multiple other vendors are utilized to perform leasehold improvements necessary
to make the physical space available for occupancy. The demand for premium data
center space in several key markets has outpaced supply over recent years and
the imbalance is projected to continue over the near term. This has increased,
and will continue to increase, our costs to add data center space. If we are not
able to contain data center expansion costs, or are not able to pass these costs
on to our customers, our results will be adversely affected.
Our
business operations depend on contracts with vendors and suppliers who may not
meet their contractual obligations.
We
maintain contracts with third-party vendors that govern our IP capacity, P-NAPs,
data center space and various other services and products. Tracking, monitoring
and managing these contract and vendor relationships is critical to our business
operations; however, we have limited control over the performance of these
contracts by the vendors related to the terms, conditions or contractual
obligations contained therein. Even if these contracts contain terms favorable
to us in the event of a breach, there is no guarantee the damages due us under
the contract would cover the losses suffered or would even be paid. Also, each
contract contains specific terms and conditions that may change over time based
on contract expiration, assignment, assumption or renegotiation. There is no
guarantee that these changes would be favorable to us, and to the event they
were not, our operations could be materially impacted.
In
addition, these contracts may contain clauses, provisions, triggers, rights,
options or obligations that result in favorable or non-favorable impacts on us
depending on actions taken, or not taken. While we intend to pursue all
contractual provisions favorable to our business, the appropriate actions under
a particular contract may require estimates, judgments and assumptions to be
made concerning future events for which we have limited basis for estimation. We
cannot guarantee that we will take the appropriate action under a particular
contract to maximize the benefit to us, which could have a material, adverse
impact on operations.
Our
inability to renew our data center leases on favorable terms could negatively
impact our financial results.
Our
leased data centers have lease terms that expire between 2010 and 2023. The
majority of these leases provide us with the opportunity to renew the lease at
our option for periods generally ranging from five to 10 years. Many of these
options however, if renewed, provide that rent for the renewal period will be
equal to the fair market rental rate at the time of renewal. If the fair market
rental rates are significantly higher than our current rental rates, we may be
unable to offset these costs by charging more for our services, which could have
a negative impact on our financial results. Conversely, if rental rates drop
significantly in the near term, we would not be able to take advantage of the
drop in rates until the expiration of the lease as we would be bound by the
terms of the existing lease agreement.
If
we are unable to deploy new service points (network access points and/or data
center space) or do not adequately control expenses associated with the
deployment of new service points, our results of operations could be adversely
affected.
As part
of our strategy, we may continue to expand our network access points and/or data
center space, particularly into new geographic markets. We face various risks
associated with identifying, obtaining and integrating new service points,
negotiating leases for data centers on competitive terms, cost estimation errors
or overruns, delays in connecting with local exchanges, equipment and material
delays or shortages, the inability to obtain necessary permits on a timely
basis, if at all, and other factors, many of which are beyond our control and
all of which could delay the deployment of new service points. We can offer no
assurance that we will be able to open and operate new service points on a
timely or profitable basis. Deployment of new service points will increase
operating expenses, including expenses associated with hiring, training,
retaining and managing new employees, provisioning capacity from NSPs,
purchasing new equipment, implementing new systems, leasing additional real
estate and incurring additional depreciation expense. In addition,
delays in opening and operating new service points could have a material,
negative impact on our financial results.
Any
failure of the physical infrastructure in our data service centers could lead to
significant costs and disruptions that could harm our business reputation,
consolidated financial condition, results of operations and cash
flows.
Our
business depends on providing customers with highly-reliable service. We must
protect our infrastructure and our customers’ data and their equipment located
in our data centers. The services we provide in each of our data centers are
subject to failure resulting from numerous factors, including:
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physical
or electronic security breaches;
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fire,
earthquake, hurricane, flood, tornado and other natural
disasters;
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improper
building maintenance by the landlords of the buildings in which our data
centers are located;
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water
damage, extreme temperatures, fiber
cuts;
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power
loss or equipment failure;
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sabotage
and vandalism; and
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failures
experienced by underlying service providers upon which our business
relies.
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Problems
at one or more of the data centers operated by us or any of our colocation
providers, whether or not within our control, could result in service
interruptions or significant equipment damage. Most of our customers have
service level agreements that require us to meet minimum performance
obligations. As a result, service interruptions or equipment damage in our data
centers could impact our ability to maintain performance obligations in our
service level agreements to these customers and we could face claims related to
such failures. We have in the past given credits to our customers as a result of
service interruptions due to equipment failures. Because our data centers are
critical to many of our customers’ businesses, service interruptions or
significant equipment damage in our data centers also could result in lost
profits or other indirect or consequential damages to our customers. We cannot
guarantee that a court would enforce any contractual limitations on our
liability in the event that a customer brings a lawsuit against us as the result
of a problem at one of our data centers.
Any loss
of services, equipment damage or inability to meet performance obligations in
our service level agreements could reduce the confidence of our customers and
could result in lost customers or an inability to attract new customers, which
would adversely affect both our ability to generate revenues and our operating
results.
Furthermore,
we are dependent upon NSPs and telecommunications carriers in the United States,
Europe and Asia-Pacific region, some of whom have experienced significant system
failures and electrical outages in the past. Users of our services may
experience difficulties due to system failures unrelated to our systems and
services. If, for any reason, these providers fail to provide the required
services, our business, consolidated financial condition, results of operations
and cash flows could be materially adversely impacted.
A
failure in the redundancies in our network operations centers, network access
points or computer systems could cause a significant disruption in our IP
services which could impact our ability to service our customers.
While we
maintain multiple layers of redundancy in or operating facilities, if we
experience a problem at our network operations centers, including the failure of
redundant systems, we may be unable to provide IP services to our customers,
provide customer service and support or monitor our network infrastructure or
network access points, any of which would seriously harm our business and
operating results. Also, because we provide continuous Internet availability
under our SLAs, we may be required to issue a significant amount of customer
credits as a result of such interruptions in service. These credits could
negatively affect our revenues and results of operations. In addition,
interruptions in service to our customers could potentially harm our customer
relations, require us to issue credits, expose us to potential lawsuits or
necessitate additional capital expenditures.
A
significant number of our network access points are located in facilities owned
and operated by third parties. In many of those arrangements, we do not have
property rights similar to those customarily possessed by a lessee or subtenant
but instead have lesser rights of occupancy. In certain situations, the
financial condition of those parties providing occupancy to us could have an
adverse impact on the continued occupancy arrangement or the level of service
delivered to us under such arrangements.
Our
network and software are subject to potential security breaches and similar
threats that could result in liability and harm our reputation.
A number
of widespread and disabling attacks on public and private networks have
occurred. The number and severity of these attacks may increase in the future as
network assailants take advantage of outdated software, security breaches or
incompatibility between or among networks. Computer viruses, intrusions and
similar disruptive problems could cause us to be liable for damages under
agreements with our customers, and our reputation could suffer, thereby
deterring potential customers from working with us. Security problems or other
attacks caused by third parties could lead to interruptions and delays or to the
cessation of service to our customers. Furthermore, inappropriate use of the
network by third parties could also jeopardize the security of confidential
information stored in our computer systems and in those of our customers and
could expose us to liability under unsolicited commercial e-mail, or “spam,”
regulations. In the past, third parties have occasionally circumvented some of
these industry-standard measures. We can offer no assurance that the measures we
implement will not be circumvented. Our efforts to eliminate computer viruses
and alleviate other security problems, or any circumvention of those efforts,
may result in increased costs, interruptions, delays or cessation of service to
our customers, and negatively impact hosted customers’ on-line business
transactions. Affected customers might file claims against us under such
circumstances, and our insurance may not be adequate to cover these
claims.
The
increased use of high-power density equipment may limit our ability to fully
utilize our data centers.
Customers
continue to increase their use of high-power density equipment, which has
significantly increased the demand for power. The current demand for electrical
power may exceed our designed capacity in these facilities. As electrical power,
rather than space, is typically the primary factor limiting capacity in our data
centers, our ability to fully utilize our data centers may be limited in these
facilities. If we are unable to adequately utilize our data centers, our
ability to grow our business cost-effectively could be materially and adversely
affected.
Our
business could be harmed by prolonged electrical power outages or shortages,
increased costs of energy or general availability of electrical
resources.
Our data
centers and P-NAPs are susceptible to regional costs and supply of power,
electrical power shortages, planned or unplanned power outages and availability
of adequate power resources. Power outages could harm our customers and our
business. While we attempt to limit exposure to system downtime by using backup
generators, uninterruptible power systems and other redundancies, we may not be
able to limit our exposure entirely. Even with these protections in place we
have experienced power outages in the past and may in the future. In addition,
our energy costs have increased and may continue to increase for a variety of
reasons including increased pressure on legislators to pass green legislation.
As energy costs increase, we may not be able to pass on to our customers the
increased cost of energy, which could harm our business and operating
results.
In each
of our markets, we rely on utility companies to provide a sufficient amount of
power for current and future customers. Because we rely on third parties to
provide power, we cannot ensure that these third parties will deliver such power
in adequate quantities or on a consistent basis. At the same time, power and
cooling requirements are growing on a per-unit basis. As a result, some
customers are consuming an increasing amount of power per cabinet. We do not
have long-term power agreements in all our markets for long-term guarantees of
provisioned amounts and may face power limitations in our centers. This
limitation could have a negative impact on the effective available capacity of a
given data center and limit our ability to grow our business, which could have a
negative impact on our relationships with our customers as well as our
consolidated financial condition, results of operations and cash
flows.
Risks
Related to our Capital Stock and Other Business Risks
We
have a history of losses and may not sustain profitability.
We have a
history of quarterly and annual period net losses, including for each of three
years in the period ended December 31, 2009. At December 31, 2009, our
accumulated deficit was $1,036.5 million. Considering the competitive and
evolving nature of the industry in which we operate, we may not be able to
achieve or sustain profitability on a quarterly or annual basis, and our failure
to do so could materially and adversely affect our business, including our
ability to raise additional funds.
We
may incur additional goodwill and other intangible asset impairment charges,
restructuring charges or both.
As more
fully described in notes 8 and 9 to the accompanying consolidated financial
statements, we have recently recorded significant impairment and restructuring
charges and made changes in estimates that resulted in acceleration of
amortization expense related to certain intangible assets.
The
assumptions, inputs and judgments used in performing the valuation analysis and
assessments are inherently subjective and reflect estimates based on known facts
and circumstances at the time the valuation is performed. The use of different
assumptions, inputs and judgments or changes in circumstances could materially
affect the results of the valuation and assessments. Due to the inherent
uncertainty involved in making these estimates, actual results could differ from
our estimates.
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 impairment and restructuring charges
include probabilities of future events, such as expected operating results,
future economic conditions, the 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. Adverse changes in any of these factors could result in an
additional impairment and restructuring charges in the future.
Our
results of operations have fluctuated in the past and likely will continue to
fluctuate, which could negatively impact the price of our common
stock.
We have
experienced fluctuations in our results of operations on a quarterly and annual
basis. Fluctuation in our operating results may cause the market price of our
common stock to decline. We expect to experience continued fluctuations in our
operating results in the foreseeable future due to a variety of factors,
including:
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competition
and the introduction of new services by our
competitors;
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continued
pricing pressures resulting from competitors’ strategies or excess
bandwidth supply;
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fluctuations
in the demand and sales cycle for our
services;
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fluctuations
in the market for qualified sales and other
personnel;
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the
cost and availability of adequate public utilities, including
power;
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our
ability to obtain local loop connections to our network access points at
favorable prices;
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general
economic conditions; and
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any
impairments or restructurings charges that we may incur in the
future.
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In
addition, fluctuations in our results of operations may arise from strategic
decisions we have made or may make with respect to the timing and magnitude of
capital expenditures such as those associated with the expansion of our data
center facilities, the deployment of additional network access points and the
terms of our network connectivity purchase agreements. A relatively large
portion of our expenses are fixed in the short-term, particularly with respect
to lease and personnel expense, depreciation and amortization and interest
expense. Our results of operations, therefore, are particularly sensitive to
fluctuations in revenue. We can offer no assurance that the results of any
particular period are an indication of future performance in our business
operations. Fluctuations in our results of operations could have a negative
impact on our ability to raise additional capital and execute our business plan.
Our operating results in one or more future quarters may fail to meet the
expectations of securities analysts or investors, which could cause an immediate
and significant decline in the trading price of our stock.
Failure
to sustain or increase our revenues may cause our business and financial results
to suffer.
We have
considerable fixed expenses, and we expect to continue to incur significant
expenses, particularly with the expansion of our data center facilities. We
incur a substantial portion of these expenditures upfront, and are only able to
recover these costs over time. We must, therefore, at least sustain or
generate higher revenues to maintain profitability. Although revenue from
our data center services segment is growing, this segment has lower margins than
our IP services segment. If we are unable to increase our margins in the data
center services segment, our business may suffer.
Numerous
factors could affect our ability to increase revenue, either alone or in
combination with other factors, including:
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failure
to increase sales of our services and
products;
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significant
increases in bandwidth and data center costs or other operating
expenses;
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failure
of our services or products to operate as
expected;
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loss
of customers or inability to attract new customers or loss of existing
customers at a rate greater than our increase in new
customers;
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inability
of customers to pay for services and products on a timely basis or at all
or failure to continue to purchase our services and products in accordance
with their contractual commitments;
or
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network
failures and any breach or unauthorized access to our
network.
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Our
common stockholders may experience significant dilution, which could depress the
market price of our common stock.
Holders
of our stock options may exercise those options to purchase our common stock,
which would increase the number of shares of our common stock that are
outstanding in the future. As of December 31, 2009, options to purchase an
aggregate of 4.3 million shares of our common stock at a weighted average
exercise price of $7.16 were outstanding. Also, the vesting of 1.1 million
outstanding shares of restricted stock will increase the weighted average number
of shares used for calculating diluted net loss per share. Greater than expected
capital requirements could require us to obtain additional financing through the
issuance of securities, which could be in the form of common stock or preferred
stock or other securities having greater rights than our common stock. The
issuance of our common stock or other securities, whether upon the exercise of
options, the future vesting and issuance of stock awards to our executives and
employees or in financing transactions, could depress the market price of our
common stock by increasing the number of shares of common stock or other
securities outstanding on an absolute basis or as a result of the timing of
additional shares of common stock becoming available on the market.
Any
failure to meet our debt obligations and other long-term commitments would
damage our business.
As of
December 31, 2009, our total long-term debt, including capital leases, was $23.2
million. If we use more cash than we generate in the future, our level of
indebtedness could adversely affect our future operations by increasing our
vulnerability to adverse changes in general economic and industry conditions and
by limiting or prohibiting our ability to obtain additional financing for future
capital expenditures, acquisitions and general corporate and other purposes. In
addition, if we are unable to make interest or principal payments when due, we
would be in default under the terms of our long-term debt obligations, which
would result in all principal and interest becoming due and payable which, in
turn, would seriously harm our business.
We also
have other long-term commitments for operating leases and service contracts
totaling $226.7 million over the next 15 years with a minimum of $36.2 million
payable in 2010. If we are unable to make payments when due, we would be in
breach of contractual terms of the agreements, which may result in disruptions
of our services which, in turn, would seriously harm our business.
Our
existing credit agreement puts limitations upon us.
Our
existing credit agreement, which expires in September 2011, puts operating and
financial limitations on us and requires us to meet certain financial covenants.
These limitations may negatively impact our business, consolidated financial
condition, results of operations and cash flows by limiting or prohibiting us
from engaging in certain transactions. Our credit agreement contains certain
covenants, including those that limit our ability to incur further indebtedness,
make acquisitions or investments, make certain capital expenditures and create
liens on our assets, in addition to covenants that require us to maintain
minimum liquidity levels.
If we do
not satisfy these covenants, we would be in default under the credit agreement.
Any defaults, if not waived, could result in our lender ceasing to make loans or
extending credit to us, accelerating or declaring all or any obligations
immediately due or taking possession of or liquidating collateral. If any of
these events occur, we may not be able to borrow sufficient funds to refinance
the credit agreement on terms that are acceptable to us, which could materially
and adversely impact our business, consolidated financial condition, results of
operations and cash flows.
Finally,
our ability to access the capital markets may be limited at a time when we would
like or need to do so, which could have an impact on our flexibility to pursue
expansion opportunities and maintain our desired level of revenue growth in the
future.
Our ability to use U.S. net operating
loss carryforwards might be limited.
As of
December 31, 2009, we had net operating loss carryforwards of
$179.5 million for U.S. federal tax purposes. These loss carryforwards
expire between 2020 and 2026. To the extent these net operating loss
carryforwards are available, we intend to use them to reduce the corporate
income tax liability associated with our operations. Section 382 of the
U.S. Internal Revenue Code generally imposes an annual limitation on the
amount of net operating loss carryforwards that might be used to offset taxable
income when a corporation has undergone significant changes in stock ownership.
To the extent our use of net operating loss carryforwards is significantly
limited, our income could be subject to corporate income tax earlier than it
would if we were able to use net operating loss carryforwards, which could
result in lower profits.
Our
stock price may be volatile.
The
market for our equity securities has been extremely volatile. Our stock price
could suffer in the future as a result of any failure to meet the expectations
of public market analysts and investors about our results of operations from
quarter to quarter. The following factors could cause the price of our common
stock in the public market to fluctuate significantly:
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actual
or anticipated variations in our quarterly and annual results of
operations;
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changes
in market valuations of companies in the Internet connectivity and
services industry;
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changes in expectations of future financial performance or changes in estimates
of securities analysts;
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fluctuations
in stock market prices and volumes;
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future
issuances of common stock or other
securities;
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the
addition or departure of key
personnel; and
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announcements by us or our competitors of acquisitions, investments or strategic
alliances.
We
previously identified a material weakness in our internal control over financial
reporting. Although we have remediated this weakness, any additional control
deficiencies could cause us to fail to meet our financial reporting obligations
or prevent us from providing reliable and accurate financial reports or avoiding
or detecting fraud.
We must
maintain effective internal controls to provide reliable and accurate financial
reports and prevent fraud. These controls are designed and implemented to
help ensure reliable financial statement reporting, including accurate reserves,
estimates, judgments and disclosures. In connection with our evaluation of
internal control over financial reporting for the year ended December 31, 2007,
we identified a material weakness related to effective controls over the
analysis of requests for sales credits and billing adjustments. We remediated
this weakness during the year ended December 31, 2008; however, any additional
control deficiencies, significant deficiencies or material weaknesses that we
may identify in the future could require us to incur significant costs, expend
significant time and management resources or make other changes. Any delay or
failure to design and implement new or improved controls, or difficulties
encountered in their implementation or operation may cause us to fail to meet
our financial reporting obligations or prevent us from providing reliable and
accurate financial reports or avoiding or detecting fraud.
Our
business requires the continued development of effective and efficient business
support systems to support our customer growth and related
services.
The
growth of our business depends on our ability to continue to develop effective,
efficient business support policies, processes and systems. This is a
complicated undertaking requiring significant resources and expertise. Business
support systems are needed for:
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sourcing,
evaluating and targeting potential customers and managing existing
customers;
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implementing
customer orders for services;
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delivering
these services;
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timely
billing for these services;
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budgeting,
forecasting, tracking and reporting our results of operations;
and
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providing
technical and operational support to customers and tracking the resolution
of customer issues.
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If the
number of customers that we serve or our services portfolio increases, we may
need to develop additional business support systems on a schedule sufficient to
meet proposed service rollout dates. The failure to continue to develop
effective and efficient business support systems could harm our ability to
implement our business plans and meet our financial goals and
objectives.
We
depend upon our key employees and may be unable to attract or retain sufficient
numbers of qualified personnel.
Our
future performance depends upon the continued contributions of our executive
management team and other key employees. To the extent we are able to expand our
operations and deploy additional network access points, we may need to increase
our workforce. Accordingly, our future success depends on our ability to
attract, hire, train and retain highly skilled management, technical, sales,
research and development, marketing and customer support personnel. Competition
for qualified employees is intense, and we compete for qualified employees with
companies that may have greater financial resources than we have. Our employment
security plan with our executive officers provides that either party may
terminate their employment at any time. Consequently, we may not be successful
in attracting, hiring, training and retaining the people we need, which would
seriously impede our ability to implement our business strategy.
Additionally,
changes in our senior management team during the past several years, both
through voluntary and involuntary separation, have resulted in loss of valuable
company intellectual capital and in paying significant severance and hiring
costs. With reduced staffing, or staffing new to the organization, we may not be
able to maintain an adequate separation of duties in key areas of monitoring,
oversight and review functions and may not have adequate succession plans in
place to mitigate the impact of future personnel losses. If we continue to
experience similar levels of turnover in our senior management team, the
execution of our corporate strategy could be affected and the costs of such
changes could negatively impact our operations.
Our
international operations may not be successful.
We have
limited experience operating internationally and have only recently begun to
achieve some success in our international operations. We currently have network
access points or CDN POPs in Amsterdam, Hong Kong, London, Mumbai, Singapore,
Sydney and Toronto. We also participate in a joint venture with NTT-ME
Corporation and Nippon Telegraph and Telephone Corporation, or NTT Holdings,
that operates network access points in Tokyo and Osaka, Japan. We may develop or
acquire network access points or complementary businesses in additional
international markets. The risks associated with expansion of our international
business operations include:
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challenges
in establishing and maintaining relationships with foreign customers as
well as foreign NSPs and local vendors, including data center and local
network operators;
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challenges
in staffing and managing network operations centers and network access
points across disparate geographic
areas;
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potential
loss of proprietary information due to misappropriation or laws that may
be less protective of our intellectual property rights than the laws in
the United States;
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challenges
in reducing operating expense or other costs required by local laws, and
longer accounts receivable payment cycles and difficulties in collecting
accounts receivable;
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exposure
to fluctuations in foreign currency exchange
rates;
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costs
of customizing network access points for foreign countries and
customers;
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compliance
with requirements of foreign laws, regulations and other governmental
controls, including trade and labor restrictions and related laws that may
reduce the flexibility of our business operations or favor local
competition;
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We may be
unsuccessful in our efforts to address the risks associated with our
international operations, which may limit our international sales growth and
materially and adversely affect our business and results of
operations.
If
we fail to adequately protect our intellectual property, we may lose rights to
some of our most valuable assets.
We rely
on a combination of copyright, patent, trademark, trade secret and other
intellectual property law, nondisclosure agreements and other protective
measures to protect our proprietary rights. We also utilize unpatented
proprietary know-how and trade secrets and employ various methods to protect
such intellectual property. We believe our intellectual property rights are
significant and that the loss of all or a substantial portion of such rights
could have a material adverse impact on our results of operations. We can offer
no assurance that our intellectual property protection measures will be
sufficient to prevent misappropriation of our technology. In addition, the laws
of many foreign countries do not protect our intellectual property to the same
extent as the laws of the United States. From time-to-time, third parties have
or may assert infringement claims against us or against our customers in
connection with their use of our products or services.
In
addition, we rely on the intellectual property of others. We may desire or be
required to renew or to obtain licenses from these other parties to further
develop and market commercially-viable products or services effectively. We can
offer no assurance that any necessary licenses will be available on reasonable
terms, or at all.
We
may face litigation and liability due to claims of infringement of third-party
intellectual property rights.
The
Internet services industry is characterized by the existence of a large number
of patents and frequent litigation based on allegations of patent infringement.
From time-to-time, third parties may assert patent, copyright, trademark, trade
secret and other intellectual property rights to technologies that are important
to our business. Any claims that our services or products infringe or may
infringe proprietary rights of third parties, with or without merit, could be
time-consuming, result in costly litigation, divert the efforts of our technical
and management personnel or require us to enter into royalty or licensing
agreements, any of which could significantly impact our operating results. In
addition, our customer agreements generally provide for us to indemnify our
customers for expenses and liabilities resulting from claimed infringement of
patents or copyrights of third parties, subject to certain limitations. If an
infringement claim against us were to be successful, and we were not able to
obtain a license to the relevant technology or a substitute technology on
acceptable terms or redesign our services or products to avoid infringement, our
ability to compete successfully in our market would be materially
impaired.
We
are currently subject to a securities class action lawsuit and a derivative
action lawsuit, the unfavorable outcomes of which could have a material adverse
impact on our financial condition, results of operations and cash
flows.
In
November 2008, a putative securities class action lawsuit was filed against us
and our former chief executive officer and in November 2009, a putative
derivative lawsuit was filed purportedly on our behalf against certain of our
directors and officers. While we are, and will continue to, vigorously contest
these lawsuits, we cannot determine the final resolution of these lawsuits or
when they 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 discuss these lawsuits
further in “Legal Proceedings” below.
We may become involved in other
litigation that may adversely affect us
.
In the
ordinary course of business, we are or may become involved in litigation,
administrative proceedings and governmental proceedings. Such matters can
be time-consuming, divert management’s attention and resources and cause us to
incur significant expenses. The results of any such actions could have a
material adverse impact on our business, consolidated financial condition,
results of operations and cash flows.
Provisions
of our charter documents and Delaware law may have anti-takeover effects that
could prevent a change in control even if the change in control would be
beneficial to our stockholders.
Provisions
of our Certificate of Incorporation and Bylaws, as well as provisions of
Delaware law, could discourage, delay or prevent a merger, acquisition or other
change in control of our company. These provisions are intended to protect
stockholders’ interests by providing our board of directors a means to attempt
to deny coercive takeover attempts or to negotiate with a potential acquirer in
order to obtain more favorable terms. Such provisions include a board of
directors that is classified so that only one-third of directors stand for
election each year. These provisions could also discourage proxy contests and
make it more difficult for stockholders to elect directors and take other
corporate actions.
None.
Our
principal executive offices are located in Atlanta, Georgia adjacent to our
network operations center, one of our P-NAPs and data center facilities. Our
Atlanta facility, included in the table below, consists of 120,298 square feet
under a lease agreement that expires in 2020. We lease other facilities to
fulfill our real estate requirements in metropolitan areas and specific cities
where our service points are located. We believe our existing facilities are
adequate for our current needs and that suitable additional or alternative space
will be available in the future on commercially reasonable terms as needed. The
following table shows the number and gross square footage of our facilities in
our top markets as of December 31, 2009, and includes both company-controlled
facilities and partner sites:
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Top
Markets
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Number of
our Facilities
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Approximate
Gross Square
Footage
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Atlanta
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1
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120,298
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Boston area
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2
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116,699
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Houston
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1
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36,649
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Los
Angeles
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1
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15,320
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New
York Metro area
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2
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152,848
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Northern
California
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8
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27,586
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Seattle
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3
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70,535
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Top
Markets Total
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18
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539,935
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We have
entered into leases or will expand our presence in 2010 for additional space in
Seattle, Northern California and Houston, which are not included in the table
above.
Securities
Class Action Litigation
On
November 12, 2008, a putative securities fraud class action lawsuit was filed
against us and our former 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 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.
Plaintiffs
allege generally that, during the putative class period, we made misleading
statements and omitted material information regarding (a) integration of
VitalStream, (b) customer issues and related credits due to services outages,
and (c) 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.
On August
12, 2009, the Court granted plaintiffs leave to file an Amended Class Action
Complaint (“Amended Complaint”). The Amended Complaint added a claim for
violation of Section 14(a) of the Exchange Act based on alleged
misrepresentations in our proxy statement in connection with our acquisition of
VitalStream. The Amended Complaint also added our former Chief Financial
Officer, David A. Buckel, as a defendant and lengthened the putative class
period.
On
September 11, 2009, we and the individual defendants filed motions to dismiss.
Those motions are currently pending before the Court. On November 6, 2009,
plaintiffs filed a Corrected Amended Class Action Complaint. On December 7,
2009, plaintiffs filed a motion for leave to file a Second Amended Class Action
Complaint to add allegations regarding,
inter alia
, an alleged
failure to conduct due diligence in connection with the VitalStream acquisition
and additional statements from purported confidential witnesses. We opposed
plaintiffs’ motion for leave to file the Second Amended Class Action Complaint
and that motion is also currently pending before the Court.
Derivative
Action Litigation
On November
12, 2009, stockholder Walter M. Unick filed a putative derivative action
purportedly on behalf of Internap against certain of our directors and officers
in the Superior Court of Fulton County, Georgia, captioned
Unick v. Eidenberg, et
al.
, Case No. 2009cv177627. This action is based upon substantially
the same facts alleged in the securities class action litigation described
above. The complaint seeks to recover damages in an unspecified amount.
On January 28, 2010, the Court entered the parties’
agreed order staying the matter until the motions to dismiss are resolved in the
securities class action litigation.
While we
intend to vigorously contest these lawsuits, we cannot determine the final
resolution of the lawsuits or when they 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
currently, and from time to time, are involved in other litigation incidental to
the conduct of our business. Although the amount of liability that may result
from these matters cannot be ascertained, we do not currently believe that, in
the aggregate, such matters will result in liabilities material to our
consolidated financial condition, results of operations or cash
flows.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
1.
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DESCRIPTION
OF THE COMPANY AND NATURE OF
OPERATIONS
|
Internap
Network Services Corporation (“we,” “us” or “our”) provides services through 73
Internet Protocol, or IP, service points, which includes 20 content delivery
network, or CDN, points of presences, or POPs, and 47 data centers across North
America, Europe and the Asia-Pacific region. We also have two additional
international standalone CDN POPs and two additional domestic standalone data
center locations through which we provide IP services by extension. Our Private
Network Access Points, or P-NAPs, feature multiple direct high-speed connections
to major Internet backbones, also referred to as network service providers, such
as Verizon Communications Inc.; Global Crossing Limited; Level 3
Communications, Inc.; XO Holdings Inc.; and Cogent Communications Group, Inc. As
described in note 4, we operate in two business segments: IP services and data
center services. We now operate our IP services and the majority of our CDN
services on a combined basis while we operate the managed hosting portion of our
CDN services as part of our data center services.
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 Annual Report on 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 including for each of the three years in the period ended December 31,
2009. At December 31, 2009, our accumulated deficit was $1,036.5 million.
However, during the years ended December 31, 2009, 2008 and 2007, we generated
net cash flows from operating activities of $37.5 million, $38.0 million and
$27.5 million, respectively.
2.
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SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES
|
Accounting
Principles
We
prepare our consolidated financial statements and accompanying notes 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. We have eliminated significant
inter-company transactions in consolidation.
Estimates
and Assumptions
The
preparation of these financial statements requires us 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, auction rate securities, goodwill and intangible
assets, accruals, stock-based compensation, income taxes, restructuring charges,
leases, 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.
Investments
in Marketable Securities and Other Related Assets
We
determine the appropriate classification of all marketable securities at the
time of purchase and reevaluate such classification as of each reporting period.
Trading securities are carried at fair value with all changes in fair value
reported in “Non-operating expense (income)” in our consolidated statements of
operations. Available-for-sale securities are carried at fair value, with the
unrealized gains and losses reported in “Accumulated items of other
comprehensive income,” a component of stockholders’ equity in our 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 expense (income)” in our consolidated
statements of operations. The cost of securities sold is based on the specific
identification method. As of December 31, 2009, our investments in marketable
securities and other related assets were comprised of auction rate securities
and corresponding rights recorded at fair value equal to $7.0 million and
classified as trading securities. We classify the auction rate securities and
corresponding rights as current in our consolidated balance sheets because we
intend to liquidate our holdings in the auction rate securities at par value
within the next 12 months through redemption by the issuers, sales to third
parties or exercise of our corresponding rights in the auction rate securities.
At December 31, 2008, the fair value of our short-term investments in marketable
securities was $7.2 million, comprised of corporate debt securities and U.S.
Treasury bills, all designated as available for sale. The fair value of our
non-current investments in marketable securities and other related assets were
comprised of auction rate securities and corresponding rights recorded at fair
value equal to $6.4 million, all designated as trading. See note 5 for further
discussion of our investments in marketable securities and other related
assets.
INTERNAP
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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 we consider other factors, such as minority interest
protections, in determining whether the equity method of accounting is
appropriate. As of December 31, 2009, Internap Japan Co. Ltd., or Internap
Japan, a joint venture with NTT-ME Corporation and Nippon Telegraph
and Telephone Corporation, or NTT Holdings, qualified for equity method
accounting. We record our proportional share of the income and losses of
Internap Japan one month in arrears on the accompanying 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
accompanying consolidated statements of operations.
We
incurred a charge during the year ended December 31, 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 new accounting guidance which
defined fair value and provided direction for using fair value to measure assets
and liabilities. In accordance with the accounting guidance, we adopted the new
provisions with regard to all financial assets and liabilities in our financial
statements in the first quarter of 2008 and all nonfinancial assets and
nonfinancial liabilities in the first quarter of 2009. The major categories of
nonfinancial assets and liabilities that we measure at fair value include
reporting units measured at fair value in the first step of a goodwill
impairment test. Our adoption for measuring nonfinancial assets and liabilities
beginning in 2009 did not have a material impact on our consolidated
financial statements. The new guidance 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, we
continue to value the carrying amounts of certain of our financial instruments,
including cash equivalents and marketable securities, at fair value on a
recurring basis.
The new
guidance also 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, 2009. We adopted the optional provisions of an
accounting standard to record certain financial assets and financial liabilities
at fair value. The accounting standard permitted us to choose to measure, on an
instrument-by-instrument basis, many financial instruments and certain other
assets and liabilities at fair value that we are not currently required to
measure at fair value. We applied the optional provisions of this accounting
standard to rights, or the ARS Rights, from one of our investment providers to
sell at par value our auction rate securities originally purchased from the
investment provider at anytime during a two-year period beginning June 30, 2010.
Recording the ARS Rights at fair value enabled us to match changes in the fair
value of the ARS Rights to changes in the fair value of the associated auction
rate securities. See note 5 for further discussion of the ARS Rights and
note 6 for further discussion of the fair value of our financial
instruments.
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. Due to the
nature of our credit facility and variable interest rate, the fair value of our
debt approximates the carrying value.
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
and other related assets also include auction rate securities whose underlying
assets are state-issued student and educational loans which are substantially
backed by the federal government. Although auction rate securities are not
eligible investments under our current investment policy, we intend to exercise
the ARS Rights within the next 12 months if they are not redeemed by the issuers
or sold to third parties. Accordingly, we now classify the auction rate
securities and ARS Rights as current assets. As of December 31, 2009, our
investments in auction rate securities having a par value of $7.0 million had a
carrying value of $6.5 million and as of December 31, 2008, the investments had
par and carrying values of $7.2 million and $6.4 million,
respectively. During 2009, $0.2 million of the securities were called by
the issuer at par value. We recorded the ARS Rights at fair value of
$0.5 million and $0.6 million as of December 31, 2009 and 2008, respectively. We
further discuss auction rate securities and ARS Rights in note 5.
INTERNAP
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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, products.
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 estimated useful lives of the assets. 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 and none over 20 years. 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, we record the assets held under capital lease
and related obligations at the lesser of the present value of aggregate future
minimum lease payments or the fair value of the assets held under capital lease.
We amortize the assets over seven years or over the lease term, depending on the
nature of the improvement, but in no event beyond the expected lease term and
none over 20 years. The duration of lease obligations and commitments ranges
from two years for office equipment to 25 years for facilities. For leases
determined to be operating leases, we record lease expense 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 we control the leased property, which is typically before
lease payments begin under the terms of the lease. The difference between the
expense recorded in our consolidated statements of operations and the amount
paid is recorded as deferred rent and is included in our consolidated balance
sheets.
Costs
of Computer Software Development
We
capitalize certain direct costs incurred developing internal use software. We
capitalized $0.9 million, $1.4 million and $1.6 million in internal software
development costs during the years ended December 31, 2009, 2008 and 2007,
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 (a) the
developer of our financial software purchased the developer of our legacy
billing system, and (b) the legacy billing system would be more flexible in
integrating the VitalStream business. Amortization expense on internally
developed software commences when the software project is ready for its intended
use.
As of
December 31, 2009 and 2008, the balance of unamortized software costs was $4.0
million and $3.8 million, respectively, and during the years ended December 31,
2009 and 2008, amortization expense was $0.7 million and $0.4 million,
respectively.
Valuation
of Long-Lived Assets
We
periodically evaluate the carrying value of our long-lived assets, including,
but not limited to, property and equipment. We consider the carrying value of a
long-lived asset impaired when the undiscounted cash flows from such asset are
separately identifiable and we estimate them 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. We determine fair
value based on either market quotes, if available, or discounted cash flows
using a discount rate commensurate with the risk inherent in our current
business model for the specific asset being valued. We would determine losses on
long-lived assets to be disposed of in a similar manner, except that we would
reduce fair values by the cost of disposal. We charge losses due to impairment
of long-lived assets to operations during the period in which we identify the
impairment.
Goodwill
and Other Intangible Assets
Goodwill
is not amortized. Instead, we assess goodwill for impairment at a reporting unit
level on an annual basis. As discussed in note 4, we changed how we view and
manage our business beginning June 1, 2009. We now operate our IP services and
the majority of our CDN services on a combined basis while we operate the
managed hosting portion of our CDN services as part of our data center services.
Our decision to consolidate segments as of June 1, 2009 required us to assess
goodwill for impairment as of that date, which was earlier than the date of our
annual assessment (August 1). Our newly-combined IP services operating segment
continues to be comprised of two reporting units: services and products.
Similarly, our data center services operating segment continues to be a single
reporting unit; however, it does not have any recorded goodwill.
INTERNAP
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
As a
result of this assessment, we recorded an aggregate impairment charge of $55.6
million for goodwill and other intangible assets during the year ended December
31, 2009. This charge included $48.0 million for goodwill related to our
former CDN services segment, $3.5 million to adjust goodwill in our IP services
segment related to our FCP products and $4.1 million for acquired CDN
advertising technology. The impairments in 2009 are in addition to impairments
of $99.7 million for goodwill and $2.7 million for other intangible assets in
2008 related to our former CDN services segment. We present the impairment
charges for goodwill and trade names in “Impairments and restructuring” while we
present the impairment charges for acquired CDN advertising technologies in
“Direct costs of amortization of acquired technologies” in our consolidated
statements of operations.
Our
assessment of goodwill for impairment includes comparing the fair value of our
reporting units to the carrying value. 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 carrying value, goodwill is not
impaired and no further testing is necessary. If the carrying value of a
reporting unit exceeds its fair value, we perform a second test to measure the
amount of impairment to goodwill, if any. To measure the amount of any
impairment, we determine the implied fair value of goodwill in the same manner
as if we were acquiring the affected reporting unit 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 consolidated balance sheet, we record an impairment
charge for the difference.
We base
the impairment analysis of goodwill on estimated fair values. 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, discount rates; terminal
growth rates; projected revenues and costs; earnings before interest, taxes,
depreciation and amortization, or EBITDA, for expected cash flows; market
comparables 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.
We
perform our annual goodwill impairment test as of August 1 of each calendar year
absent any impairment indicators or other changes that may cause more frequent
analysis. We did not identify an impairment as a result of our annual August 1,
2009 impairment test. We also assess on a quarterly basis whether any events
have occurred or circumstances have changed that would indicate an impairment
could exist. We have considered the likelihood of triggering events that might
cause us to re-assess goodwill on an interim basis and concluded that none had
occurred subsequent to August 1, 2009.
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 eight years for developed
technologies and 15 years for patents. We assess other intangible assets for
impairment in conjunction with our assessment of goodwill or whenever events or
changes in circumstances indicate that the carrying amounts may not be
recoverable. Our assessment for other intangible assets is based on estimated
future cash flows directly associated with the asset or asset group. If we
determine that the carrying value is not recoverable, we may record an
impairment charge, reduce the estimated remaining useful life, or
both.
In
addition to impairment of other intangible assets during the years ended
December 31, 2009 and 2008, we also made changes in estimates that resulted in
acceleration of amortization expense related to certain acquired CDN intangible
assets. These acquired CDN intangible assets either have a remaining estimated
economic useful life of less than one year at December 31, 2009 or were fully
amortized during 2009. Additional information is included in note 8. Similar to
goodwill as noted above, adverse changes in expected operating results and/or
unfavorable changes in other economic factors used to estimate fair values could
result in additional non-cash impairment charges or acceleration of amortization
in the future. We believe that our remaining intangible assets are not
impaired.
None of
the impairment charges or changes in estimated remaining asset lives had
any impact on our cash balances or covenants in our credit
agreement.
Restructuring
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 charges 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. 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.
INTERNAP
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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
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 if and when we estimate them to be realizable, such as
establishing our expected continuing profitability or that of certain of our
foreign subsidiaries.
We
evaluate liabilities for uncertain tax positions and, as of December 31, 2009
and 2008, we did not recognize any associated liabilities. We have recorded
nominal interest and penalties arising from the underpayment of income taxes in
“General and administrative” expenses in our consolidated statements of
operations. As of December 31, 2009 and 2008, we had no accrued interest or
penalties related to uncertain tax positions, given our 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” in our consolidated statements of
operations.
Stock-Based
Compensation
We
measure stock-based compensation at the grant date based on the calculated fair
value of the award. We recognize the expense over the employee’s requisite
service period, generally the vesting period of the award. 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.
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-based 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, from time-to-time we acquire
shares of treasury stock as payment of statutory minimum payroll taxes due from
employees for stock-based compensation. In 2009, we reissued a portion of the
shares of treasury stock acquired in 2008 and 2009 as part of our stock-based
compensation plans. We also expect to reissue the remaining shares 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.
Revenue
Recognition
We
generate revenues primarily from the sale of IP services and data center
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
recognize IP services revenues on a fixed- or usage-based pricing. 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. We determine data center
revenues by occupied square feet and both allocated and variable-based
usage. We recognize the monthly minimum as revenue each month provided that
we have entered into 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 installation fees as deferred revenue and recognize the revenue ratably
over the estimated life of the customer arrangement.
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 generally accepted accounting principles for software. FCP
product and other hardware sales were $0.9 million, $2.4 million and $2.6
million and FCP-related services and subscription revenues were $0.9 million,
$1.0 million and $0.9 million during the years ended December 31, 2009, 2008 and
2007, respectively.
We also
enter into multiple-element arrangements or bundled services, such as combining
IP services with data center services. When we enter into such
arrangements, we account for each element separately over its respective service
period provided that we have 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, on average, approximately three years for each
of the last three years. 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 ratably
over the contract period, which is generally one year.
INTERNAP
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
We record
an amount for service level agreements and other sales adjustments, which
reduces net revenues and accounts receivable. We identify adjustments for
service level agreements within the billing period and reduce revenues
accordingly. We base the amount for sales adjustments upon specific
customer information, including 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.
We
routinely review the collectability of our accounts receivable and payment
status of our customers. If we determine that collection of revenue is
uncertain, we do not recognize revenue until collection is reasonably assured.
Additionally, we maintain an allowance 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 general customer information,
which primarily includes our historical cash collection experience and the aging
of our accounts receivable. We assess the payment status of customers by
reference to the terms under which we provide services or goods, 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 routinely perform credit checks
for new and existing customers and require deposits or prepayments for customers
that we perceive as being a credit risk.
Research
and Development Costs
Research
and development costs, which we include in general and administrative 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 $3.8 million, $5.0 million and
$3.1 million during the years ended December 31, 2009, 2008 and 2007,
respectively. Product development costs, which we also include in general and
administrative cost and expense as incurred, are primarily related to network
engineering costs associated with changes to the functionality of our
proprietary services and network architecture. 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 during the years
ended December 31, 2009, 2008 and 2007 were $1.3 million, $1.3 million and $1.2
million, respectively.
Net
Loss Per Share
We
compute basic net loss per share by dividing net loss attributable to our common
stockholders by the weighted average number of shares of common stock
outstanding during the period. We have excluded all outstanding options and
unvested restricted stock as such securities are anti-dilutive for all periods
presented.
On
January 1, 2009, we adopted a recently-issued accounting standard related
to whether instruments granted in share-based payment transactions are
participating securities for calculating earnings per share. This new accounting
standard causes all unvested share-based payment awards that contain
non-forfeitable rights to dividends or dividend equivalents (whether paid or
unpaid) to be participating securities. The new accounting standard further
requires participating securities to be included in the computation of earnings
per share pursuant to the two-class method. Under the two-class method, earnings
(after any dividends) are allocated to common stock and participating securities
to the extent that each security may share in earnings. While our unvested
restricted stock participate in any dividends equally with common stock, no
losses are attributed to the awards. Upon adoption, we adjusted all prior-period
earnings per share data presented retrospectively. The adoption of this new
accounting standard did not have any impact on our basic or diluted net loss per
share for any year in the three year period ended December 31,
2009.
Basic and
diluted net loss per share during the years ended December 31, 2009, 2008 and
2007 is calculated as follows (in thousands, except per share
amounts):
|
|
Year
Ended December 31,
|
|
|
|
2009
|
|
|
2008
|
|
|
2007
|
|
Net
loss and net loss available to common stockholders
|
|
$
|
(69,725
|
)
|
|
$
|
(104,813
|
)
|
|
$
|
(5,555
|
)
|
Weighted
average shares outstanding, basic and diluted
|
|
|
49,577
|
|
|
|
49,238
|
|
|
|
46,942
|
|
Net
loss per share, basic and diluted
|
|
$
|
(1.41
|
)
|
|
$
|
(2.13
|
)
|
|
$
|
(0.12
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Anti-dilutive
securities excluded from diluted net loss per share calculation for
stock-based compensation plans
|
|
|
5,356
|
|
|
|
3,651
|
|
|
|
3,894
|
|
INTERNAP
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Segment
Information
We use
the management approach for determining which, if any, of our services and
products, locations, customers or management tructures 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 described in note 4, we
operate in two business segments: IP services and data center services. These
segments reflect a change from our historical segments, which also included CDN
services as a separate segment. We have reclassified financial information for
prior periods to conform to the current period presentation.
Reclassifications
In
addition to reclassifications for changes in our segments, discussed in note 4,
we also have reclassified other prior period amounts to conform to the current
period presentation.
Recent
Accounting Pronouncements
Recently
Issued Accounting Pronouncements That We Have Adopted
In June
2009, the Financial Accounting Standards Board, or FASB, issued authoritative
guidance codifying GAAP. While the guidance was not intended to change GAAP, it
did change the way we reference these accounting principles in the notes to our
consolidated financial statements. This guidance was effective for interim and
annual reporting periods ending after September 15, 2009. Our adoption of
this authoritative guidance as of September 30, 2009 changed how we
reference GAAP in our disclosures.
On January 1, 2009, we adopted new
accounting guidance for business combinations as issued by the FASB. The new
accounting guidance establishes principles and requirements for how an acquirer
in a business combination recognizes and measures in its financial statements
the identifiable assets acquired, liabilities assumed and any noncontrolling
interests in the acquiree, as well as the goodwill acquired and determination of
the useful life of intangible assets. The new guidance also amends provisions
related to the initial recognition and measurement, subsequent measurement and
accounting and disclosures for assets and liabilities arising from contingencies
in business combinations. In addition, the new guidance amends the factors that
an acquirer should consider in developing the renewal or extension assumptions
used to determine the useful life of a recognized intangible asset. Significant
changes from previous guidance resulting from this new guidance include expanded
definitions of “business” and “business combination,” expanded disclosure
regarding the determination of intangible asset useful lives and the elimination
of the distinction between contractual and non-contractual contingencies,
including initial recognition and measurement. For all business combinations
(whether partial, full or step acquisitions): (a) the acquirer must record 100%
of all assets and liabilities of the acquired business, including goodwill,
generally at their fair values; (b) the acquirer must recognize contingent
consideration at its fair value on the acquisition date; (c) for certain
arrangements, the acquirer must recognize changes in fair value in earnings
until settlement; and (d) the acquirer must expense acquisition-related
transaction and restructuring charges rather than treat them as part of the cost
of the acquisition. The new accounting guidance also establishes disclosure
requirements to enable users to evaluate the nature and financial effects of the
business combination. Our adoption of this accounting guidance did not have a
material impact on our consolidated financial statements, although it could have
a material impact on any business combinations we enter into in future
periods.
On
January 1, 2009, we adopted new accounting guidance as issued by the FASB for
the determination of whether instruments granted in share-based payment
transactions are participating securities. As discussed above in “—Net Loss Per
Share,” our adoption of this accounting guidance did not have an impact on net
loss per share for any periods presented.
On
January 1, 2009, we adopted new accounting guidance as issued by the FASB which
clarifies the accounting for certain transactions and impairment considerations
involving equity method investments. Our adoption of this accounting guidance
did not have a material impact on our consolidated financial
statements.
On
January 1, 2009, we adopted new accounting guidance as issued by the FASB
which previously delayed the effective date by one year for nonfinancial assets
and liabilities that we recognize or disclose at fair value in the financial
statements on a non-recurring basis. The major categories of nonfinancial assets
and liabilities that we measure at fair value include reporting units in the
first step of a goodwill impairment test. Our adoption of this accounting
guidance did not have a material impact on our consolidated financial
statements. See note 8 for additional information.
On July
1, 2009, we adopted three related sets of accounting guidance as issued by the
FASB. The accounting guidance sets forth rules related to determining the fair
value of financial assets and financial liabilities when the activity levels
have significantly decreased in relation to the normal market, guidance related
to the determination of other-than-temporary impairments to include the intent
and ability of the holder as an indicator in the determination of whether an
other-than-temporary impairment exists and interim disclosure requirements for
the fair value of financial instruments. Our adoption of the three sets of
accounting guidance did not have a material impact on our consolidated financial
statements.
INTERNAP
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Recently
Issued Accounting Pronouncements That We Have Not Yet Adopted
In June
2009, the FASB issued new accounting guidance which amends the evaluation
criteria to identify the primary beneficiary of a variable interest entity, or
VIE, and requires ongoing reassessment of whether an enterprise is the primary
beneficiary of the VIE. The new guidance significantly changes the consolidation
rules for VIEs including the consolidation of common structures, such as joint
ventures, equity method investments and collaboration arrangements. The guidance
is applicable to all new and existing VIEs. This accounting guidance
is effective for us beginning in the first quarter of 2010. We have concluded
that our joint venture in Internap Japan Co., Ltd. is an equity-method
investment under the voting-interest model, not a VIE and, accordingly, this new
accounting guidance will not impact our consolidated financial
statements.
In
September 2009, the FASB issued new accounting guidance related to revenue
recognition of multiple element arrangements. The new guidance states that if
vendor specific objective evidence or third party evidence for deliverables in
an arrangement cannot be determined, companies will be required to develop a
best estimate of the selling price to separate deliverables and allocate
arrangement consideration using the relative selling price method. The
accounting guidance will be applied prospectively and will become effective
during the first quarter of 2011. Early adoption is allowed. We are currently
evaluating the impact of this accounting guidance on our consolidated financial
statements, but do not expect adoption will materially impact our consolidated
financial statements.
In
September 2009, the FASB issued new accounting guidance related to certain
revenue arrangements that include software elements. Previously, companies that
sold tangible products with “more than incidental” software were required to
apply software revenue recognition guidance. This guidance often delayed revenue
recognition for the delivery of the tangible product. Under the new guidance,
tangible products that have software components that are “essential to the
functionality” of the tangible product will be excluded from the software
revenue recognition guidance. The new guidance includes factors to help
companies determine what is “essential to the functionality.” Software-enabled
products will not be subject to other revenue recognition guidance and will
likely follow the guidance for multiple deliverable arrangements issued by the
FASB in September 2009, noted above. The new guidance is to be applied on a
prospective basis for revenue arrangements entered into or materially modified
in fiscal years beginning on or after June 15, 2010, with early application
permitted. If a company elects earlier application and the first reporting
period of adoption is not the first reporting period in the company’s fiscal
year, the guidance must be applied through retrospective application from the
beginning of the company’s fiscal year and the company must disclose the impact
of the change to those previously reported periods. We are currently evaluating
the impact of this accounting guidance on our consolidated financial statements,
but do not expect adoption will materially impact our consolidated financial
statements.
In
addition to the accounting pronouncements described above, we have adopted and
considered other recent accounting pronouncements that either did not have a
material impact on our consolidated financial statements or are not relevant to
our business. We do not expect other recently issued accounting pronouncements
that are not yet effective will have a material impact on our consolidated
financial statements.
3. BUSINESS
COMBINATION
On
February 20, 2007, we completed the acquisition of VitalStream Holdings, Inc.,
or VitalStream, for $214.0 million, whereby VitalStream became our wholly-owned
subsidiary. The acquisition enabled us to provide services and products for
storing and delivering digital media to large audiences over the Internet and
provide complementary service offerings in the content delivery market. We
accounted for the transaction using the purchase method of accounting. 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
|
|
|
|
$
|
214,022
|
|
As a
result of the acquisition, we issued 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 those stock options in accordance with the terms of the
applicable VitalStream stock-based compensation plan and terms of the stock
option agreement. Based on VitalStream’s stock options outstanding at February
20, 2007, we converted options to purchase 3.0 million shares of VitalStream
common stock into options to purchase 1.5 million shares of our common
stock.
INTERNAP
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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. We
charged the amount allocated to in-process research and development of $0.5
million to the consolidated statements of operations as of the date of
acquisition.
Pro
Forma Results (Unaudited)
The
following unaudited pro forma consolidated financial information reflects the
results of our operations for the year ended December 31, 2007, as if the
acquisition of VitalStream had occurred at the beginning of the period. Prior to
the acquisition, VitalStream was a customer of ours, and during the year ended
December 31, 2007, we recognized revenues of $0.4 million from VitalStream which
we exclude 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 the period (in thousands,
except per share amounts):
|
|
Year
Ended
December
31, 2007
|
|
Pro
forma revenues
|
|
$
|
236,418
|
|
Pro
forma net loss
|
|
|
(14,269
|
)
|
Pro
forma net loss per share, basic and diluted
|
|
|
(0.25
|
)
|
We
operate in two business segments: IP services and data center services. IP
services represent our IP transit activities and include our high performance
Internet connectivity, CDN services and 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.
During
the year ended December 31, 2009, we changed how we view and manage our
business. We now operate our IP services and the majority of our CDN services on
a combined basis while we operate the managed hosting portion of our CDN
services as part of our data center services. The change from our historical
segments reflects our view of the business and aligns our segments with our
operational and organizational structure. We have integrated the primary
components of our CDN services with our IP services in the IP services segment.
This includes integration of our CDN POPs into our P-NAPs, along with
combining engineering and operations teams and internal financial reporting.
In addition, a
single manager reports directly to our chief executive officer for the
integrated IP services. Historically, CDN services also included managed
hosting, or maintaining network equipment on behalf of customers. Since these
CDN services are a hosting activity, they are more similar to our data center
services and therefore we have included these services in our data center
services segment. We have reclassified financial information during the years
ended December 31, 2008 and 2007 to conform to the current period
presentation.
The
following tables show operating results for our reportable segments, along with
reconciliations from segment gross profit to loss before income taxes and equity
in earnings of equity-method investment (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
Year
Ended December 31,
|
|
|
|
2009
|
|
|
2008
|
|
|
2007
|
|
Revenues:
|
|
|
|
|
|
|
|
|
|
IP
services
|
|
$
|
125,548
|
|
|
$
|
139,737
|
|
|
$
|
139,072
|
|
Data
center services
|
|
|
130,711
|
|
|
|
114,252
|
|
|
|
84,590
|
|
Other
|
|
|
—
|
|
|
|
—
|
|
|
|
10,428
|
|
Total
revenues:
|
|
|
256,259
|
|
|
|
253,989
|
|
|
|
234,090
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Direct
costs of network, sales and services, exclusive of depreciation and
amortization:
|
|
|
|
|
|
|
|
|
|
|
|
|
IP
services
|
|
|
48,055
|
|
|
|
51,885
|
|
|
|
50,518
|
|
Data
center services
|
|
|
94,961
|
|
|
|
83,992
|
|
|
|
59,440
|
|
Other
|
|
|
—
|
|
|
|
—
|
|
|
|
8,436
|
|
Total
direct costs of network, sales and services, exclusive of depreciation and
amortization
|
|
|
143,016
|
|
|
|
135,877
|
|
|
|
118,394
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Segment
profit:
|
|
|
|
|
|
|
|
|
|
|
|
|
IP
services
|
|
|
77,493
|
|
|
|
87,852
|
|
|
|
88,554
|
|
Data
center services
|
|
|
35,750
|
|
|
|
30,260
|
|
|
|
25,150
|
|
Other
|
|
|
—
|
|
|
|
—
|
|
|
|
1,992
|
|
Total
segment profit
|
|
|
113,243
|
|
|
|
118,112
|
|
|
|
115,696
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Impairments
and restructuring
|
|
|
54,698
|
|
|
|
101,441
|
|
|
|
11,349
|
|
Other
operating expenses, including direct costs of customer support,
depreciation
and amortization
|
|
|
127,467
|
|
|
|
121,838
|
|
|
|
114,058
|
|
Loss
from operations
|
|
|
(68,922
|
)
|
|
|
(105,167
|
)
|
|
|
(9,711
|
)
|
Non-operating
expense (income)
|
|
|
461
|
|
|
|
(245
|
)
|
|
|
(937
|
)
|
Loss
before income taxes and equity in (earnings) of equity-method
investment
|
|
$
|
(69,383
|
)
|
|
|
(104,922
|
)
|
|
$
|
(8,774
|
)
|
INTERNAP
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
As
discussed in note 8, we recorded the following impairment charges by segment
during the years ended December 31, 2009 and 2008 (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
IP
Services
|
|
|
Data
Center
Services
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year
Ended December 31, 2009:
|
|
|
|
|
|
|
|
|
|
|
Goodwill
|
|
$
|
37,848
|
|
|
$
|
13,665
|
|
|
$
|
51,513
|
|
|
Other
intangible assets
|
|
|
4,134
|
|
|
|
—
|
|
|
|
4,134
|
|
|
|
|
$
|
41,982
|
|
|
$
|
13,665
|
|
|
$
|
55,647
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year
Ended December 31, 2008:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Goodwill
|
|
$
|
74,775
|
|
|
$
|
24,925
|
|
|
$
|
99,700
|
|
|
Other
intangible assets
|
|
|
2,440
|
|
|
|
196
|
|
|
|
2,636
|
|
|
|
|
$
|
77,215
|
|
|
$
|
25,121
|
|
|
$
|
102,336
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
We
present goodwill by segment in note 8. We present total assets by segment as of
December 31, 2009 and 2008 in the following table (in thousands):
|
|
|
|
December
31,
|
|
|
|
|
|
2009
|
|
|
2008
|
|
|
Total
assets:
|
|
|
|
|
|
|
|
|
IP
services
|
|
|
$
|
191,743
|
|
|
$
|
233,268
|
|
|
Data
center services
|
|
|
|
75,759
|
|
|
|
96,815
|
|
|
|
|
|
$
|
267,502
|
|
|
$
|
330,083
|
|
Through
December 31, 2009, neither revenues generated nor long-lived assets located
outside the United States were significant (all less than 10%).
Investments
in Marketable Securities and Other Related Assets
We invest
excess funds are invested pursuant to a formal investment policy. At December
31, 2009, investments in marketable securities and other related assets were
comprised of $7.0 million of auction rate securities and the ARS Rights,
described below, all designated as trading securities. We invested other excess
funds in money market funds classified with cash and cash equivalents at
December 31, 2009. In addition to money market funds, auction rate securities
and the ARS Rights, investments in marketable securities and other related
assets at December 31, 2008 also included high credit quality corporate debt
securities and U.S. Treasury bills having original maturities greater than 90
days but less than one year. At December 31, 2008, we designated all of the
investments as available for sale, except for auction rate securities and the
ARS Rights, which we designated as trading securities.
Auction Rate
Securities.
Auction rate securities are variable rate bonds tied to
short-term interest rates with maturities on the face of the securities in
excess of 90 days and have interest rate resets through a modified Dutch
auction, at predetermined short-term intervals, usually every 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. The underlying assets of our auction rate
securities are state-issued student and educational loans that are substantially
backed by the federal government and carried AAA/Aaa or A3 ratings as of
December 31, 2009 and AAA/Aaa as of December 31, 2008. Although these securities
are issued and rated as long-term bonds, they have historically been priced and
traded as short-term investments because of the liquidity provided through the
interest rate resets.
INTERNAP
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
While we
continue to earn and accrue interest on our auction rate securities at
contractual rates, these investments have not been actively trading since early
2008 when auctions failed to attract sufficient buyers. During 2008, we
reclassified our auction rate securities from current to non-current investments
as presented in our consolidated balance sheet as of December 31, 2008. 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 our auction rate securities from available for sale to trading
securities.
We intend
to exercise the ARS Rights within the next 12 months if they are not redeemed by
the issuers or sold to third parties. Accordingly, we have reclassified both the
underlying securities and the ARS Rights from non-current assets to current
assets as of December 31, 2009. During the years ended December 31, 2009 and
2008, we recorded unrealized gains (losses) on the auction rate securities of
$0.3 million and $(0.8) million, respectively, included in “Non-operating
(income) expense” in the consolidated statements of operations. The unrealized
loss of $0.8 million during the year ended December 31, 2008 represented the
immediate recognition in earnings of the other-than-temporary impairment on our
auction rate securities in connection with our acceptance of the ARS Rights and
transferring our auction rate securities from available for sale to trading
securities. We previously recorded the other-than-temporary impairment on our
auction rate securities in “Accumulated items of other comprehensive income” in
our consolidated balance sheets. The fair values of our auction rate securities
were $6.5 million and $6.4 million, recorded in “Short-term investments in
marketable securities and other related assets” and “Investments and other
related assets” in the consolidated balance sheets as of December 31, 2009 and
2008, respectively. During the year ended December 31, 2009, $0.2 million of our
auction rate securities were called by the issuer at par value. New or
additional auction rate securities are not eligible investments under our
current investment policy.
ARS Rights.
In November 2008, we accepted an offer from one of our investment
providers providing us with the ARS Rights, which gave us the right to sell at
par value auction rate securities originally purchased from the investment
provider at any time during a two-year period beginning June 30, 2010. 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, that is, an agreement with an unrelated
party, binding on both parties and usually legally enforceable, with the
following characteristics: (a) the agreement specifies all significant terms,
including the quantity to be exchanged, the fixed price and the timing of the
transaction, and (b) the agreement includes a disincentive for nonperformance
that is sufficiently large to make performance probable. The enforceability of
the ARS 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 it does not meet the definition of a derivative instrument.
Therefore, we have elected to measure the ARS Rights at fair value in accordance
with applicable accounting standards that permit an entity to elect the fair
value option for selected recognized financial assets. Measuring the ARS Rights
at fair values enables us to match the changes in the fair value of the auction
rate securities. As a result, changes in fair value are and will continue to be
included in earnings in future periods. During the years ended December 31, 2009
and 2008, we recorded unrealized (losses) gains of $(0.1) million and $0.6
million, respectively, on the ARS Rights. The unrealized (losses) gains are
included in “Non-operating (income) expense” in the consolidated statements of
operations and we include the fair values of $0.5 million and $0.6 million in
“Short-term investments in marketable securities and other related assets” and
“Investments and other related assets” in the consolidated balance sheets at
December 2009 and 2008, respectively.
Other Investments
in Marketable Securities.
Summaries of our other investments in
short-term available for sale securities as of December 31, 2008 are as follows
(in thousands):
|
|
Cost
Basis
|
|
|
Unrealized
Gain
(Loss)
|
|
|
Carrying
Value
|
|
Corporate
debt securities
|
|
$
|
5,706
|
|
|
$
|
(7
|
)
|
|
$
|
5,699
|
|
U.S.
Treasury bills
|
|
|
1,500
|
|
|
|
—
|
|
|
|
1,500
|
|
|
|
$
|
7,206
|
|
|
$
|
(7
|
)
|
|
$
|
7,199
|
|
During
the year ended December 31, 2009, we had investment proceeds of $7.4 million,
representing $7.2 million from the maturity of available for sale securities at
par value and $0.2 million from issuer calls of auction rate securities at par
value. Accordingly, we did not recognize any realized gains or losses on the
disposals of these securities. Proceeds from the maturity of short-term
available-for-sale securities, primarily commercial paper, were $3.2 million
during the year ended December 31, 2008 and the related gross realized gains and
losses were less than $0.1 million. As noted above, our investments in
marketable securities and other related assets at December 31, 2009 were
comprised of auction rate securities and ARS Rights, designated as trading
securities.
INTERNAP
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Investment
in Internap Japan
We
invested $4.1 million for 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.
We
include our investment activity in the joint venture in the IP services
operating segment, which is summarized as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
Year
Ended
December 31,
|
|
|
|
2009
|
|
|
2008
|
|
Investment
balance, January 1
|
|
$
|
1,623
|
|
|
$
|
1,138
|
|
Proportional
share of net income
|
|
|
15
|
|
|
|
283
|
|
Unrealized
foreign currency translation gain, net
|
|
|
166
|
|
|
|
202
|
|
Balance,
December 31, 2009
|
|
$
|
1,804
|
|
|
$
|
1,623
|
|
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 year
ended December 31, 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 $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 the provisions of new accounting guidance which
defined fair value and provided director for using fair value to measure assets
and liabilities. In accordance with the accounting guidance, we adopted the new
provisions with regard to all financial assets and liabilities in our financial
statements in the first quarter of 2008 and all nonfinancial assets and
nonfinancial liabilities in the first quarter of 2009. The major categories of
nonfinancial assets and liabilities that we measure at fair value include
reporting units measured at fair value in the first step of a goodwill
impairment test. Our adoption for measuring nonfinancial assets and liabilities
beginning in 2009 did not have a material impact on our consolidated
financial statements.
The new
accounting standard 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.
|
We also
adopted optional provisions of an accounting standard to record certain
financial assets and financial liabilities at fair value. The accounting
standard permitted us to choose to measure, on an instrument-by-instrument
basis, many financial instruments and certain other assets and liabilities at
fair value that we are not currently required to measure at fair value. We
applied the optional provisions of this accounting standard to the ARS Rights as
discussed in note 5.
INTERNAP
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The
following table represents the fair value hierarchy for our financial assets
(cash equivalents, investments in marketable securities and other related
assets) measured at fair value on a recurring basis as of December 31, 2009 and
2008 (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Level
1
|
|
|
Level
2
|
|
|
Level
3
|
|
|
Total
|
|
December
31, 2009:
|
|
|
|
|
|
|
|
|
|
|
|
|
Available for sale
securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Money market funds
(1)
|
|
$
|
26,019
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
26,019
|
|
Trading
securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Auction rate securities
(2)
|
|
|
—
|
|
|
|
—
|
|
|
|
6,503
|
|
|
|
6,503
|
|
ARS Rights
(2)
|
|
|
—
|
|
|
|
—
|
|
|
|
497
|
|
|
|
497
|
|
|
|
$
|
26,019
|
|
|
$
|
—
|
|
|
$
|
7,000
|
|
|
$
|
33,019
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December
31, 2008:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Available for sale
securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Money market funds and other
(1)
|
|
$
|
21,877
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
21,877
|
|
Corporate debt securities
(2)
|
|
|
—
|
|
|
|
5,699
|
|
|
|
—
|
|
|
|
5,699
|
|
U.S. Treasury bills
(2)
|
|
|
—
|
|
|
|
1,500
|
|
|
|
—
|
|
|
|
1,500
|
|
Trading
securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Auction rate securities
(3)
|
|
|
—
|
|
|
|
—
|
|
|
|
6,378
|
|
|
|
6,378
|
|
ARS Rights
(3)
|
|
|
—
|
|
|
|
—
|
|
|
|
649
|
|
|
|
649
|
|
|
|
$
|
21,877
|
|
|
$
|
7,199
|
|
|
$
|
7,027
|
|
|
$
|
36,103
|
|
|
(1)
|
Included
in “Cash and cash equivalents” in the consolidated balance sheets as of
December 31, 2009 and 2008 in addition to $47.9 million and $25.0 million,
respectively, of cash. Unrealized gains and losses on money market funds
were nominal due to the short-term nature of the
investments.
|
|
(2)
|
Included
in “Short-term investments in marketable securities and other related
assets” in the consolidated balance sheets as of December 31, 2009 and
2008, respectively.
|
|
(3)
|
Included
in “Investments and other related assets” in the consolidated balance
sheets as of December 31, 2008 in addition to $1.6 million of
equity-method investment in Internap Japan (note
5).
|
While we
continue to earn and accrue interest on our auction rate securities at
contractual rates, these investments have not been actively trading since early
2008 when auctions failed to attract sufficient buyers, and, as a result, the
auction rate securities lost their liquidity. Our auction rate securities do not
currently have a readily observable market value and their estimated fair value
no longer approximates par value. Given that observable auction rate securities
market information was not sufficiently 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, auction rate securities and ARS Rights, for each of the two
years in the period ended December 31, 2009 (in thousands):
|
|
|
|
|
|
|
|
|
Auction
Rate
Securities
|
|
|
ARS
Rights
|
|
Balance,
December 31, 2007
|
|
$
|
7,150
|
|
|
$
|
—
|
|
Total
losses (realized and unrealized) included in earnings
|
|
|
(772
|
)
|
|
|
—
|
|
Issuance
of ARS Rights
|
|
|
—
|
|
|
|
649
|
|
Balance,
December 31, 2008
|
|
|
6,378
|
|
|
|
649
|
|
Total
gains (losses) (realized and unrealized) included in
earnings
|
|
|
275
|
|
|
|
(152
|
)
|
Settlements
|
|
|
(150
|
)
|
|
|
—
|
|
Balance,
December 31, 2009
|
|
$
|
6,503
|
|
|
$
|
497
|
|
The total
amount of gains or losses included in earnings attributable to the change in
unrealized gains or losses relating to assets still held as of December 31, 2009
and 2008 were $0.1 million and $0.8 million, respectively.
INTERNAP
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The
following table summarizes our nonfinancial assets measured at fair value on a
nonrecurring basis as of December 31, 2009 and 2008 (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Level
1
|
|
|
Level
2
|
|
|
Level
3
|
|
|
Total
|
|
December
31, 2009:
|
|
|
|
|
|
|
|
|
|
|
|
|
Goodwill
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
39,464
|
|
|
$
|
39,464
|
|
Other
intangible assets
|
|
|
—
|
|
|
|
—
|
|
|
|
20,782
|
|
|
|
20,782
|
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
60,246
|
|
|
$
|
60,246
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December
31, 2008:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Goodwill
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
90,977
|
|
|
$
|
90,977
|
|
Other
intangible assets
|
|
|
—
|
|
|
|
—
|
|
|
|
33,942
|
|
|
|
33,942
|
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
124,919
|
|
|
$
|
124,919
|
|
We
further discuss goodwill and other intangibles assets, along with the associated
impairments, in note 8.
Market
risk associated with our variable rate revolving credit facility and fixed rate
other liabilities relates to the potential negative impact to future earnings
and reduction in fair value, respectively, from an increase in interest rates.
The following table presents information about our revolving credit facility and
other liabilities at December 31, 2009 and 2008 (in
thousands):
|
|
December
31,
|
|
|
|
2009
|
|
|
2008
|
|
|
|
Carrying
Amount
|
|
|
Fair
Value
|
|
|
Carrying
Amount
|
|
|
Fair
Value
|
|
Revolving
credit facility
|
|
$
|
20,000
|
|
|
$
|
20,000
|
|
|
$
|
20,000
|
|
|
$
|
20,000
|
|
Other
liabilities
|
|
|
761
|
|
|
|
789
|
|
|
|
878
|
|
|
|
897
|
|
|
|
$
|
20,761
|
|
|
$
|
20,789
|
|
|
$
|
20,878
|
|
|
$
|
20,897
|
|
We
estimate the fair values of our revolving credit facility and other liabilities
based on current market rates of interest.
7.
|
PROPERTY
AND EQUIPMENT
|
Property
and equipment consisted of the following (in thousands):
|
|
|
|
|
|
|
|
|
December
31,
|
|
|
|
2009
|
|
|
2008
|
|
Network
equipment
|
|
$
|
101,705
|
|
|
$
|
96,958
|
|
Network
equipment under capital lease
|
|
|
1,581
|
|
|
|
1,596
|
|
Furniture,
equipment and software
|
|
|
31,637
|
|
|
|
33,853
|
|
Leasehold
improvements
|
|
|
156,252
|
|
|
|
147,835
|
|
Buildings
under capital lease
|
|
|
3,003
|
|
|
|
3,003
|
|
Property
and equipment, gross
|
|
|
294,178
|
|
|
|
283,245
|
|
Less:
Accumulated depreciation and amortization ($1,914 and $1,721 related to
capital leases at December 31, 2009 and 2008,
respectively)
|
|
|
(203,027
|
)
|
|
|
(185,895
|
)
|
|
|
$
|
91,151
|
|
|
$
|
97,350
|
|
We
retired $6.4 million of assets with accumulated depreciation of $6.3 million
during the year ended December 31, 2009, $2.0 million of assets with accumulated
depreciation of $1.9 million during the year ended December 31, 2008 and $2.7
million of fully depreciated assets during the year ended December 31, 2007. The
amount of interest we capitalized was immaterial for each of the three years in
the period ended December 31, 2009.
We
summarize depreciation and amortization of property and equipment associated
with direct costs of network, sales and services and other depreciation expense
as follows (in thousands):
|
|
Year
ended December 31,
|
|
|
|
2009
|
|
|
2008
|
|
|
2007
|
|
Direct
costs of network, sales and services
|
|
$
|
22,134
|
|
|
$
|
20,650
|
|
|
$
|
18,313
|
|
Other
depreciation and amortization
|
|
|
6,148
|
|
|
|
3,215
|
|
|
|
3,929
|
|
Subtotal
|
|
|
28,282
|
|
|
|
23,865
|
|
|
|
22,242
|
|
Amortization
of acquired technologies
(1)
|
|
|
8,349
|
|
|
|
6,649
|
|
|
|
4,165
|
|
Total
depreciation and amortization
|
|
$
|
36,631
|
|
|
$
|
30,514
|
|
|
$
|
26,407
|
|
|
(1)
|
Amortization
of acquired technologies during the years ended December 31, 2009 and 2008
included impairment charges of $4.1 million and $1.9 million,
respectively, for acquired CDN advertising technology. See note 8 for
further details.
|
INTERNAP
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
8.
|
GOODWILL
AND OTHER INTANGIBLE ASSETS
|
Goodwill
We
recorded an aggregate goodwill impairment charge of $51.5 million during the
year ended December 31, 2009. This charge included $48.0 million for
goodwill related to our former CDN services segment and $3.5 million to adjust
goodwill in our IP services segment related to our FCP products. The goodwill
impairments in 2009 are in addition to a goodwill impairment of $99.7 million in
2008 related to our former CDN services segment. We present the goodwill
impairment charges in “Impairments and restructuring” in the consolidated
statements of operations. We reclassified the original goodwill in the former
CDN services segment and the 2008 impairment charge from the former CDN services
segment to IP services and data center services based on the respective
estimated relative fair value of those segments.
The
goodwill impairment in our former CDN services segment was primarily due to
declines in CDN services revenues and operating results compared to our
expectations and declining multiples of our own and comparable
companies. The CDN services goodwill arose from our acquisition of
VitalStream in February 2007. We initially recorded goodwill of $154.7
million in the acquisition, which represented 72% of the $214.0 million purchase
price. These declines in CDN services revenues and operating results were
primarily attributable to continued pricing pressures, which were partially
offset by increased traffic. This was combined with higher costs of sales
related to traffic mix, as well as a weakened economy and steadily increasing
levels of customer churn. Given the declines in CDN services revenues and
operating results, in 2009 we renewed our emphasis on and dedicated our internal
resources within our IP services to strengthen our services offering and
leverage our entire IP backbone and cost structure. Similarly, the goodwill
impairment related to our FCP products in our IP services segment was due to
declines in our FCP products revenues and operating results. The declines in FCP
products revenues were primarily attributable to lower sales associated with a
reduced marketing effort as we reevaluated our equipment sales strategy for FCP
products. The impairment charges did not impact our current cash balance or
result in violation of any covenants in our credit agreement.
The
changes in the carrying amount of goodwill for each of the two years in the
period ended December 31, 2009 are as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
IP
Services
|
|
|
Data
Center
Services
|
|
|
Total
|
|
Balance,
December 31, 2007:
|
|
|
|
|
|
|
|
|
|
Goodwill
|
|
$
|
152,087
|
|
|
$
|
38,590
|
|
|
$
|
190,677
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Impairment
|
|
|
(74,775
|
)
|
|
|
(24,925
|
)
|
|
|
(99,700
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance,
December 31, 2008:
|
|
|
|
|
|
|
|
|
|
|
|
|
Goodwill
|
|
|
152,087
|
|
|
|
38,590
|
|
|
|
190,677
|
|
Accumulated
impairment losses
|
|
|
(74,775
|
)
|
|
|
(24,925
|
)
|
|
|
(99,700
|
)
|
Subtotal
|
|
|
77,312
|
|
|
|
13,665
|
|
|
|
90,977
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Impairment
|
|
|
(37,848
|
)
|
|
|
(13,665
|
)
|
|
|
(51,513
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance,
December 31, 2009:
|
|
|
|
|
|
|
|
|
|
|
|
|
Goodwill
|
|
|
152,087
|
|
|
|
38,590
|
|
|
|
190,677
|
|
Accumulated
impairment losses
|
|
|
(112,623
|
)
|
|
|
(38,590
|
)
|
|
|
(151,213
|
)
|
|
|
$
|
39,464
|
|
|
$
|
—
|
|
|
$
|
39,464
|
|
We base
impairment analysis of goodwill on estimated fair values. 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, discount rates; terminal growth rates;
projected revenues and costs; earnings before interest, taxes, depreciation and
amortization, or EBITDA, for expected cash flows; market comparables 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. Following is a
description of the valuation methodologies we used to derive the fair value the
former CDN services and the FCP products reporting units as of our assessment
date of June 1, 2009:
INTERNAP
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
|
●
|
Income Approach
: To
determine fair value, we discounted the expected cash flows of the CDN
services and the FCP products reporting units. We calculated expected cash
flows using a compounded annual revenue growth rate of approximately 20%
for CDN services and 3% for FCP products, forecasting existing cost
structures and considering capital reinvestment requirements. We used a
discount rate of 16% for CDN services and 18% for FCP products,
representing the estimated weighted average cost of capital, which
reflects the overall level of inherent risk involved in the respective
operations and the rate of return an outside investor could expect to
earn. To estimate cash flows beyond the final year of our models, we used
terminal values and incorporated the present values of the resulting
terminal values into our estimates 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 segment and FCP products
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
multiples below the median for our comparable
companies.
|
We used
similar valuation methodologies to derive the fair value of our other reporting
units. The portion of goodwill from the former CDN services reporting unit
allocated to data center services was immediately impaired so that data center
services continues to not have any recorded goodwill. 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.
We
perform our annual goodwill impairment test as of August 1 each calendar year
absent any impairment indicators or other changes that may cause more frequent
analysis. We did not identify an impairment as a result of our annual August 1,
2009 impairment test. We also assess on a quarterly basis whether any events
have occurred or circumstances have changed that would indicate an impairment
could exist. We have considered the likelihood of triggering events that
might cause us to re-assess goodwill on an interim basis and concluded that none
had occurred subsequent to August 1, 2009.
The
goodwill impairment during the year ended December 31, 2008 also caused us to
reverse a deferred tax liability and create an income tax benefit of $0.6
million associated with the former CDN services goodwill. The goodwill
impairment during the year ended December 31, 2009 similarly resulted in a
deferred tax asset of $0.5 million associated with the former CDN services
goodwill that we fully offset by a valuation allowance.
Other
Intangible Assets
In
conjunction with the change in our business segments and the associated review
of our long-term financial outlook during the year-ended December 31, 2009, we
also performed an analysis of the potential impairment and re-assessed the
remaining asset lives of other identifiable intangible assets. The analysis
and re-assessment of other identifiable intangible assets resulted
in:
|
●
|
an
impairment charge of $4.1 million in acquired CDN advertising technology
due to a strategic change in market
focus,
|
|
●
|
a
change in estimates that resulted in an acceleration of amortization
expense of our acquired CDN customer relationships over a shorter
estimated remaining useful life (from 38 months remaining as of June 1,
2009 to 11 months) to reflect our historical churn rate for acquired CDN
customers,
|
|
●
|
a
change in estimates that resulted in an acceleration of amortization
expense of our acquired CDN trade names over a shorter estimated remaining
useful life (from 32 months remaining as of June 1, 2009 to 17 months) to
reflect the decreased value of our acquired CDN trade names to our
business, and
|
|
●
|
a
change in estimates that resulted in acceleration of amortization expense
of our CDN non-compete agreements over a shorter estimated remaining
useful life (from nine months remaining as of June 1, 2009 to one month)
to reflect the decreased value of the non-compete agreements to our
business.
|
Similarly,
the review of our long-term financial outlook during the year-ended December 31,
2008 resulted in:
|
●
|
an
impairment charge of $1.9 million in acquired CDN advertising
technology,
|
|
●
|
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 an acceleration of amortization
expense of our acquired CDN customer relationships over a shorter
estimated useful life (from nine years remaining as of August 1, 2008 to
four years) due to customer churn resulting in higher than expected
attrition as of the acquisition
date.
|
INTERNAP
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The
impairment charges and changes in estimated remaining useful lives of CDN
intangible assets did not impact our cash balances or result in violation of any
covenants in our credit agreement. We continue to believe that our remaining
intangible assets are not impaired.
We
included the impairment charges for acquired CDN advertising technology of $4.1
million and $1.9 million during the years ended December 31, 2009 and 2008,
respectively, in “Direct costs of amortization of acquired technologies” in the
consolidated statements of operations. We include the impairment charge for the
VitalStream trade name of $0.8 million during the year ended December 31, 2008
in “Impairments and restructuring” in the consolidated statements of
operations. The change in estimates of remaining useful lives for the
intangible assets as of June 1, 2009 noted above resulted in an increase to our
net loss of $2.8 million, or $0.06 per basic and diluted share,
during the year ended December 31, 2009. The change in estimate for our customer
relationship intangible asset as of August 1, 2008 noted above resulted in an
increase to our net loss of $0.4 million, or less than $0.01 per basic and
diluted share, during the year ended December 31, 2008.
The
components of our amortizing intangible assets are as follows (in
thousands):
|
|
December
31, 2009
|
|
|
December
31, 2008
|
|
|
|
Gross
Carrying
Amount
|
|
|
Accumulated
Amortization
|
|
|
Gross
Carrying
Amount
|
|
|
Accumulated
Amortization
|
|
Technology
based
|
|
$
|
35,927
|
|
|
$
|
(17,532
|
)
|
|
$
|
40,061
|
|
|
$
|
(13,317
|
)
|
Contract
based
|
|
|
24,232
|
|
|
|
(21,845
|
)
|
|
|
24,232
|
|
|
|
(17,034
|
)
|
|
|
$
|
60,159
|
|
|
$
|
(39,377
|
)
|
|
$
|
64,293
|
|
|
$
|
(30,351
|
)
|
Amortization
expense for intangible assets during the years ended December 31, 2009, 2008 and
2007 was $9.0 million, $6.4 million and $5.3 million, respectively. This
amortization expense does not include impairment charges of $4.1 million and
$2.7 million during the years ended December 31, 2009 and 2008, respectively. As
of December 31, 2009, remaining amortization expense for the next six years is
as follows (in thousands):
|
|
|
|
|
2010
|
|
$
|
6,083
|
|
2011
|
|
|
3,528
|
|
2012
|
|
|
3,528
|
|
2013
|
|
|
3,528
|
|
2014
|
|
|
3,528
|
|
2015
|
|
|
587
|
|
|
|
$
|
20,782
|
|
9.
|
RESTRUCTURING
AND OTHER IMPAIRMENTS
|
During
the year ended December 31, 2009, we made adjustments in sublease income
assumptions for certain properties included in our previously-disclosed 2007 and
2001 restructuring plans, implemented a restructuring plan to reduce our
workforce by 45 employees and ceased use of four smaller facilities which were
office and partner data center facilities.
The
adjustments in sublease income assumptions for certain properties included in
our 2007 and 2001 restructuring plans extended the period during which we do not
anticipate receiving sublease income from those properties given our expectation
that it will take longer to find sublease tenants and the increased availability
of space in each of these markets where we have unused space. The related
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, in accordance with
accounting standards in effect at the time we initiated the restructuring plans.
The new assumptions resulted in an increase to our restructuring accrual of $2.0
million, which we recorded as a restructuring charge and an increase to the
related liability. We made similar adjustments during 2008 resulting in a $1.1
million increase in the restructuring liability and additional restructuring
expense as of and during the year ended December 31, 2008.
The
workforce reduction of 45 employees in March 2009 represented 10% of our total
workforce at that time and was primarily in back-office functions as well as the
elimination of certain senior management positions. All of the $0.9 million of
associated non-recurring severance charges during the year ended December 31,
2009 were cash expenditures. The restructuring charge for the four leased
facilities was $0.2 million and all amounts related to these leases were due
within 12 months of the date we cased use. Due to the short remaining terms of
these leases, we did not expect to earn any sublease income in future
periods.
We also
recorded a non-cash benefit of $0.1 million during the year ended December 31,
2008 to reduce our restructuring liability for employee terminations. This
non-cash adjustment eliminated the remaining liability for employee terminations
since we had paid all amounts.
INTERNAP
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
During
the year ended December 31, 2007, we incurred a restructuring and impairment
charge of $10.3 million, which included $1.4 million for the impairment of
leasehold improvements and other assets. We took this charge following a review
of our business, particularly in light of our acquisition of VitalStream and our
plan to finalize the overall integration and implementation of the acquisition.
In addition to the $1.4 million impairment of leasehold improvements and other
assets, the charge to expense included $7.8 million for leased facilities and
$1.1 million of severance payments for the termination of employees. After
considering the adjustments for anticipated changes in sublease income described
above, we estimated net related expenditures for the 2007 restructuring plan to
be $14.0 million, of which we paid $5.9 million through December 31, 2009, 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 during 2007 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.
In 2001,
we implemented significant restructuring plans that resulted in substantial
charges for real estate and network infrastructure obligations, personnel and
other charges. We subsequently incurred additional related charges as we
continued to evaluate our restructuring reserve.
The
following table displays the activity and balances for the restructuring and
asset impairment activity during the years ended December 31, 2009 and 2008 (in
thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December
31,
2007
Restructuring
Liability
|
|
|
Cash
Payments
|
|
|
Non-Cash
Plan
Adjustments
|
|
|
December
31,
2008
Restructuring
Liability
|
|
|
Initial
Restructuring
Charges
|
|
|
Subsequent
Plan
Adjustments
(1)
|
|
|
Cash
Payments
|
|
|
December
31,
2009
Restructuring
Liability
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Activity
for 2009
restructuring charge:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Employee
terminations
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
877
|
|
|
$
|
31
|
|
|
$
|
(872
|
)
|
|
$
|
36
|
|
Real
estate obligations
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
239
|
|
|
|
5
|
|
|
|
(66
|
)
|
|
|
178
|
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
1,116
|
|
|
|
36
|
|
|
|
(938
|
)
|
|
|
214
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Activity
for 2007
restructuring charge:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Real
estate obligations
|
|
|
6,312
|
|
|
|
(1,120
|
)
|
|
|
1,084
|
|
|
|
6,276
|
|
|
|
—
|
|
|
|
1,694
|
|
|
|
(1,722
|
)
|
|
|
6,248
|
|
Employee
terminations
|
|
|
406
|
|
|
|
(260
|
)
|
|
|
(146
|
)
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
|
6,718
|
|
|
|
(1,380
|
)
|
|
|
938
|
|
|
|
6,276
|
|
|
|
—
|
|
|
|
1,694
|
|
|
|
(1,722
|
)
|
|
|
6,248
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Activity
for 2001
restructuring charge:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Real
estate obligations
|
|
|
3,374
|
|
|
|
(647
|
)
|
|
|
19
|
|
|
|
2,746
|
|
|
|
—
|
|
|
|
309
|
|
|
|
(575
|
)
|
|
|
2,480
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
10,092
|
|
|
$
|
(2,027
|
)
|
|
$
|
957
|
|
|
$
|
9,022
|
|
|
$
|
1,116
|
|
|
$
|
2,039
|
|
|
$
|
(3,235
|
)
|
|
$
|
8,942
|
|
(1)
|
Includes
$0.1 million of reclassifications of accrued liabilities and deferred rent
related to prior restructuring
activities.
|
Accrued
liabilities consist of the following (in thousands):
|
|
December
31,
|
|
|
|
2009
|
|
|
2008
|
|
Compensation
and benefits payable
|
|
$
|
5,818
|
|
|
$
|
2,918
|
|
Telecommunications,
sales, use and other taxes
|
|
|
1,743
|
|
|
|
1,902
|
|
Other
|
|
|
2,631
|
|
|
|
3,936
|
|
|
|
$
|
10,192
|
|
|
$
|
8,756
|
|
11.
|
REVOLVING
CREDIT FACILITY
|
On
September 14, 2007, we entered into a $35.0 million credit agreement, or the
Credit Agreement, with Bank of America, N.A., as the administrative agent. We
amended the Credit Agreement on May 14, 2008 and September 30, 2008, or the
Amendment (we refer to the Credit Agreement along with the Amendment as the
Amended Credit Agreement). The Amended Credit Agreement includes a
revolving credit facility of $35.0 million with a letter of credit sublimit of
$7.0 million and an option to enter into a lease financing agreement not to
exceed $10.0 million. The revolving credit facility is available to finance
working capital, capital expenditures and other general corporate
purposes.
INTERNAP
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
A summary
of the revolving credit facility as of December 31, 2009 and 2008 follows
(dollars in thousands):
|
|
December
31,
|
|
|
|
2009
|
|
|
2008
|
|
Credit
limit
|
|
$
|
35,000
|
|
|
$
|
35,000
|
|
Outstanding
principal balance, due September 14, 2011
|
|
|
20,000
|
|
|
|
20,000
|
|
Letters
of credit issued
|
|
|
3,610
|
|
|
|
4,200
|
|
Borrowing
capacity
|
|
|
11,390
|
|
|
|
10,800
|
|
Interest
rate, based on our bank’s prime rate
|
|
|
3.25
|
%
|
|
|
3.00
|
%
|
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 capital expenditures of $25.0 million, plus prior-year
carryover, or an amount to be mutually agreed upon for 2010 and 2011, customary
events of default and certain default provisions that could result in
acceleration of all outstanding amounts due under the Amended Credit
Agreement).
Our
obligations under the Amended Credit Agreement are pledged by substantially all
of our assets including the capital stock of our domestic subsidiaries and 65%
of the capital stock of our foreign subsidiaries.
The 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, 2009, our capital leases had
expiration dates ranging from 2010 to 2023.
Historically,
our capital leases related to equipment; however, in May 2008 we entered into a
capital lease agreement for one of our data center locations that expires in
2023.
Future
minimum capital lease payments together with the present value of the minimum
lease payments as of December 31, 2009, are as follows (in
thousands):
|
|
|
|
|
2010
|
|
$
|
562
|
|
2011
|
|
|
566
|
|
2012
|
|
|
569
|
|
2013
|
|
|
581
|
|
2014
|
|
|
599
|
|
Thereafter
|
|
|
5,740
|
|
Remaining
capital lease payments
|
|
|
8,617
|
|
Less:
amounts representing imputed interest
|
|
|
(5,375
|
)
|
Present
value of minimum lease payments
|
|
|
3,242
|
|
Less:
current portion
|
|
|
(25
|
)
|
|
|
$
|
3,217
|
|
The
current and deferred income tax provision (benefit) during the years ended
December 31, 2009, 2008 and 2007 was as follows (in
thousands):
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2009
|
|
|
2008
|
|
|
2007
|
|
Current:
|
|
|
|
|
|
|
|
|
|
Federal
|
|
$
|
153
|
|
|
$
|
254
|
|
|
$
|
15
|
|
State
|
|
|
356
|
|
|
|
181
|
|
|
|
—
|
|
Foreign
(including change in unrecognized tax benefits)
|
|
|
—
|
|
|
|
(668
|
)
|
|
|
921
|
|
|
|
|
509
|
|
|
|
(233
|
)
|
|
|
936
|
|
Deferred:
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal
|
|
|
—
|
|
|
|
(398
|
)
|
|
|
356
|
|
State
|
|
|
4
|
|
|
|
(16
|
)
|
|
|
42
|
|
Foreign
|
|
|
(156
|
)
|
|
|
821
|
|
|
|
(4,414
|
)
|
|
|
|
(152
|
)
|
|
|
407
|
|
|
|
(4,016
|
)
|
Net
income tax provision (benefit)
|
|
$
|
357
|
|
|
$
|
174
|
|
|
$
|
(3,080
|
)
|
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
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,
|
|
|
|
2009
|
|
|
2008
|
|
|
2007
|
|
Federal
income tax (benefit) at statutory rates
|
|
|
(34
|
)%
|
|
|
(34
|
)%
|
|
|
(34
|
)%
|
Goodwill
impairment
|
|
|
24
|
|
|
|
29
|
|
|
|
—
|
|
Foreign
and state income tax (benefit)
|
|
|
—
|
|
|
|
—
|
|
|
|
(4
|
)
|
Stock-based
compensation
|
|
|
1
|
|
|
|
1
|
|
|
|
6
|
|
Tax
reserves
|
|
|
—
|
|
|
|
—
|
|
|
|
11
|
|
Change
in valuation allowance
|
|
|
8
|
|
|
|
4
|
|
|
|
(14
|
)
|
Effective
tax rate
|
|
|
(1
|
)%
|
|
|
—
|
%
|
|
|
(35
|
)%
|
Temporary
differences between the financial statement carrying amounts and tax bases of
assets and liabilities that give rise to significant portions of deferred taxes
related to the following (in thousands):
|
|
|
|
|
|
|
|
|
December
31,
|
|
|
|
2009
|
|
|
2008
|
|
Current
deferred income tax assets:
|
|
|
|
|
|
|
Provision
for doubtful accounts
|
|
$
|
2,192
|
|
|
$
|
1,378
|
|
Accrued
compensation
|
|
|
84
|
|
|
|
205
|
|
Other
accrued expenses
|
|
|
304
|
|
|
|
213
|
|
Deferred
revenue
|
|
|
1,347
|
|
|
|
1,298
|
|
Restructuring
liability
|
|
|
1,071
|
|
|
|
973
|
|
Other
|
|
|
66
|
|
|
|
63
|
|
Current
deferred income tax assets
|
|
|
5,064
|
|
|
|
4,130
|
|
Less:
valuation allowance
|
|
|
(5,064
|
)
|
|
|
(4,129
|
)
|
Net
current deferred income tax assets
|
|
|
—
|
|
|
|
1
|
|
|
|
|
|
|
|
|
|
|
Non-current
deferred income tax assets:
|
|
|
|
|
|
|
|
|
Property
and equipment
|
|
|
27,577
|
|
|
|
23,719
|
|
Goodwill
|
|
|
5,724
|
|
|
|
3,897
|
|
Intangible
assets
|
|
|
4,508
|
|
|
|
2,574
|
|
Deferred
revenue, less current portion
|
|
|
933
|
|
|
|
767
|
|
Restructuring
liability, less current portion
|
|
|
2,327
|
|
|
|
2,455
|
|
Deferred
rent
|
|
|
6,513
|
|
|
|
5,689
|
|
Stock-based
compensation
|
|
|
1,647
|
|
|
|
3,378
|
|
U.S.
net operating loss carryforwards
|
|
|
68,221
|
|
|
|
71,616
|
|
Foreign
net operating loss carryforwards, less current portion
|
|
|
5,514
|
|
|
|
5,481
|
|
Capital
loss carryforwards
|
|
|
2,271
|
|
|
|
2,271
|
|
Tax
credit carryforwards
|
|
|
712
|
|
|
|
690
|
|
Other
|
|
|
877
|
|
|
|
539
|
|
Non-current
deferred income tax assets
|
|
|
126,824
|
|
|
|
123,076
|
|
Less:
valuation allowance
|
|
|
(123,914
|
)
|
|
|
(120,626
|
)
|
Non-current
deferred income tax assets , net
|
|
|
2,910
|
|
|
|
2,450
|
|
Net
deferred tax assets
|
|
$
|
2,910
|
|
|
$
|
2,451
|
|
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, 2009, we had U.S. net operating
loss carryforwards for federal tax purposes of $179.5 million that will expire
beginning 2020 through 2026. We have revised all periods presented 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-based
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
research and development tax credit carryforwards of approximately $0.7 million.
Alternative minimum tax credits have an indefinite carryforward period while our
research and development credits will begin to expire in 2026. Finally, we have
foreign net operating loss carryforwards of $18.7 million that will begin to
expire in 2009.
We
determined that through December 31, 2009, no further ownership changes have
occurred since 2001. Therefore, as of December 31, 2009, no additional material
limitations exist on the U.S. net operating losses related to Section 382 of the
Internal Revenue Code. 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.
INTERNAP
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
A
deferred tax asset is also created by accelerated depreciable lives of fixed
assets for income tax purposes. Network equipment and leasehold improvements
comprise the majority of the income tax basis differences. These assets are
deductible over a shorter life for financial reporting than for income tax
purposes. As we retire assets in the future, the income tax basis differences
will reverse and become deductible for income taxes.
We
periodically evaluate the recoverability of the deferred tax assets and the
appropriateness of the valuation allowance. For U.S. income tax purposes, we
established a valuation allowance of $125.4 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.
During
the year ended December 31, 2007, we concluded that it was more likely than not
that we will realize our deferred tax assets generated in the United Kingdom, or
U.K., in future years. The U.K. deferred tax assets primarily consist of
net operating loss carryforwards and were $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
during the year ended December 31, 2007.
Changes
in our deferred tax asset valuation allowance are summarized as follows (in
thousands):
|
|
Year
Ended December 31,
|
|
|
|
2009
|
|
|
2008
|
|
|
2007
|
|
Balance,
January 1,
|
|
$
|
124,755
|
|
|
$
|
128,561
|
|
|
$
|
117,747
|
|
Decrease
(increase) in deferred tax assets
|
|
|
4,223
|
|
|
|
(3,806
|
)
|
|
|
15,228
|
|
Recognition
of deferred tax assets
|
|
|
—
|
|
|
|
—
|
|
|
|
(4,414
|
)
|
Balance,
December 31,
|
|
$
|
128,978
|
|
|
$
|
124,755
|
|
|
$
|
128,561
|
|
The
impairment of goodwill and other intangible assets during the year ended
December 31, 2009 had a material impact on the income tax provision. While we
may deduct a component of the former CDN services goodwill for tax purposes, the
majority of the goodwill associated with both the former CDN services and FCP
products as well as other intangible assets had no basis for tax purposes.
Accordingly, the impairments of goodwill and other intangible assets of $55.6
million during the year ended December 31, 2009 resulted in a $49.6 million
permanent difference that impacted our effective income tax rate. The remainder
of the goodwill impairment resulted in a termporary tax difference. Our
effective income tax rate was not impacted as the tax basis over the book basis
in goodwill created a deferred tax asset for financial reporting basis which was
offset by a valuation allowance.
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. Based on limited cumulative earnings from
foreign operations, we expect the unrecognized deferred assets or liabilities to
be an immaterial component of our consolidated financial
statements.
Our
accounting for uncertainty in income taxes 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.
Changes
in our unrecognized tax benefits are summarized as follows (in
thousands):
|
|
Year
Ended December 31,
|
|
|
|
2009
|
|
|
2008
|
|
|
2007
|
|
Unrecognized
tax benefits balance, January 1,
|
|
$
|
—
|
|
|
$
|
921
|
|
|
$
|
—
|
|
Additions
for tax positions of current year
|
|
|
—
|
|
|
|
—
|
|
|
|
921
|
|
Foreign
exchange (loss)
|
|
|
—
|
|
|
|
(253
|
)
|
|
|
—
|
|
Lapse
of statute of limitations
|
|
|
—
|
|
|
|
(668
|
)
|
|
|
—
|
|
Unrecognized
tax benefits balance, December 31,
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
921
|
|
The
changes in the liability for unrecognized tax benefits 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 for the corresponding
periods.
We
classify interest and penalties arising from the underpayment of income taxes in
the consolidated statements of operations as a component of “General and
administrative expenses.” As of December 31, 2009 and 2008, 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 2006 through 2008; however,
tax authorities have the right to adjust the net operating loss carryovers for
years prior to 2006. Returns filed in other jurisdictions are subject to
examination for years prior to 2006.
INTERNAP
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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 $0.7 million, $0.9 million and $0.8
million during the years ended December 31, 2009, 2008 and 2007,
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 data center, P-NAP
and office space and office equipment that are classified as operating leases.
Initial lease terms range from two to 25 years and contain various periods of
free rent and 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 having terms in excess of one year were as
follows at December 31, 2009 (in thousands):
|
|
|
|
|
|
|
2010
|
|
$
|
29,430
|
|
|
2011
|
|
|
29,515
|
|
|
2012
|
|
|
29,565
|
|
|
2013
|
|
|
26,773
|
|
|
2014
|
|
|
24,647
|
|
|
Thereafter
|
|
|
70,506
|
|
|
|
|
$
|
210,436
|
|
Rent
expense was $26.6 million, $21.5 million and $15.1 million during the years
ended December 31, 2009, 2008 and 2007, respectively. Sublease income, recorded
as a reduction of rent expense, was $0.2 million, $0.3 million and $0.5 million
during the years ended December 31, 2009, 2008 and 2007,
respectively.
Service
Commitments
We have
entered into service commitment contracts with Internet network service
providers to provide interconnection services and data center providers to
provide data center services for our customers. Future minimum payments under
these service commitments having terms in excess of one year were as follows at
December 31, 2009 (in thousands):
|
|
|
|
|
|
|
2010
|
|
$
|
6,772
|
|
|
2011
|
|
|
3,356
|
|
|
2012
|
|
|
6,116
|
|
|
|
|
$
|
16,244
|
|
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
if we are not 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, a limited number of
vendors currently supply the routers and switches used in our network.
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
maintenance or expansion of our infrastructure and increase our costs. If our
limited number of suppliers fail 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
Securities Class
Action Litigation
.
On November 12, 2008, a putative securities fraud class action lawsuit
was filed against us and our former 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 (a) integration of
VitalStream, (b) customer issues and related credits due to services outages,
and (c) 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.
On August
12, 2009, the Court granted plaintiffs leave to file an Amended Class Action
Complaint (“Amended Complaint”). The Amended Complaint added a claim for
violation of Section 14(a) of the Exchange Act based on alleged
misrepresentations in our proxy statement in connection with our acquisition of
VitalStream. The Amended Complaint also added our former Chief Financial
Officer, David A. Buckel, as a defendant and lengthened the putative class
period.
On
September 11, 2009, we and the individual defendants filed motions to dismiss.
Those motions are currently pending before the Court. On November 6, 2009,
plaintiffs filed a Corrected Amended Class Action Complaint. On December 7,
2009, plaintiffs filed a motion for leave to file a Second Amended Class Action
Complaint to add allegations regarding,
inter alia
, an alleged
failure to conduct due diligence in connection with the VitalStream acquisition
and additional statements from purported confidential witnesses. We opposed
plaintiffs’ motion for leave to file the Second Amended Class Action Complaint
and that motion is also currently pending before the Court.
Derivative Action
Litigation
. On November 12, 2009, stockholder Walter M. Unick filed
a putative derivative action purportedly on behalf of Internap against certain
of our directors and officers in the Superior Court of Fulton County, Georgia,
captioned
Unick v. Eidenberg,
et al.
, Case No. 2009cv177627. This action is based upon
substantially the same facts alleged in the securities class action litigation
described above. The complaint seeks to recover damages in an unspecified
amount.
On January 28, 2010, the Court entered the
parties’ agreed order staying the matter until the motions to dismiss are
resolved in the securities class action litigation.
While we
intend to vigorously contest these lawsuits, we cannot determine the final
resolution of the lawsuits or when they 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 impact 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, although we intended the reverse stock split to reduce the
authorized number of shares of preferred stock, we did not amend our certificate
of incorporation to make this change and, therefore, the authorized number of
shares of preferred stock remained at 200.0 million shares. To implement this
change, effective June 19, 2008, we reduced the number of authorized shares of
preferred stock from 200.0 million shares to 20.0 million
shares.
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 entitled 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. The description and terms of
the Rights were set forth in the Preferred Stock Rights Agreement between us and
American Stock Transfer & Trust Company, as Rights Agent, dated April
11, 2007, or the Rights Agreement.
During
2009, of the 20.0 million authorized shares of preferred stock, 19.5 million
shares were designated as blank check preferred stock, the terms and conditions
of which our board of directors could designate, with the remaining 0.5 million
shares of preferred stock designated as series B preferred stock.
On
November 23, 2009, we approved the termination of the Rights Agreement.
Originally scheduled to expire on March 23, 2017, we amended the Rights
Agreement to accelerate its expiration which occurred on the close of business
on December 31, 2009. In connection with the expiration of the Rights Agreement,
we filed a Certificate of Elimination with the Secretary of State of the State
of Delaware on February 26, 2010, to eliminate our series B preferred stock. The
Certificate of Elimination removed the previous designation of 0.5 million
shares of series B preferred stock and caused such shares of series B preferred
stock to resume their status as undesignated shares of our preferred stock.
Accordingly, all 20.0 million authorized shares of preferred stock are now
designated as blank check preferred stock.
We have
no shares of preferred stock outstanding.
INTERNAP
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Treasury
Stock
From time
to time, we acquire shares of treasury stock as payment of statutory minimum
payroll taxes on stock-based compensation from employees. We expect to reissue
shares of treasury stock as part of our stock-based compensation
plans.
17.
|
STOCK-BASED
COMPENSATION PLANS
|
We have
granted employees options to purchase shares of stock and issued unvested stock
awards, commonly referred to as stock options and restricted stock,
respectively. We measure stock-based compensation cost at the grant date based
on the calculated fair value of the option or award. We recognize the expense
over the employees’ requisite service period, generally the vesting period of
the option or award. We estimate the fair value of stock options at the grant
date using the Black-Scholes option pricing model. Stock 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.
Stock-Based
Compensation
The
following table summarizes the amount of stock-based compensation, net of
estimated forfeitures, included in the consolidated statements of operations
during the years ended December 31, 2009, 2008 and 2007 (in
thousands):
|
|
Year
ended December 31,
|
|
|
|
2009
|
|
|
2008
|
|
|
2007
|
|
Direct
costs of customer support
|
|
$
|
1,112
|
|
|
$
|
1,369
|
|
|
$
|
1,892
|
|
Sales
and marketing
|
|
|
1,395
|
|
|
|
1,782
|
|
|
|
2,135
|
|
General
and administrative
|
|
|
3,106
|
|
|
|
4,348
|
|
|
|
4,654
|
|
|
|
$
|
5,613
|
|
|
$
|
7,499
|
|
|
$
|
8,681
|
|
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 three years in the period ended
December 31, 2009.
The
significant weighted average assumptions used for estimating the fair value of
the option grants under our stock-based compensation plans during the years
ended December 31, 2009, 2008 and 2007, were expected terms of 4.3, 4.0 and 6.2,
respectively; historical volatilities of 82%, 72% and 114% respectively; risk
free interest rates of 1.8%, 2.6% and 4.4%, respectively and no dividend yield.
The weighted average estimated fair value per share of our stock options at
grant date was $1.65, $3.79 and $13.71 during the years ended December 31, 2009,
2008 and 2007, respectively. The expected term represents the weighted
average period of time that the stock options are expected to be outstanding,
giving consideration to the vesting schedules and our historical exercise
patterns. Because our stock 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 stock option exercises, employee terminations and
forfeiture rates.
Stock-Based
Compensation and Option Plans
Under the
Internap Network Services Corporation 2005 Incentive Stock Plan, or the 2005
Plan, we may issue stock options, stock appreciation rights, stock grants and
stock unit grants to eligible employees and directors. Our historical practice
has been to grant only stock options and stock grants (i.e., restricted
stock).
The
compensation committee of our board of directors administers 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 stock options and awards
and 3.8 million shares of unexercised stock options under certain pre-existing
plans. We will not make any future grants under these pre-existing plans, but
each of the 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, 2009, 3.2 million stock
options were outstanding, 1.1 million shares of unvested restricted stock were
outstanding and 3.3 million shares of stock were available for issuance
under the 2005 Plan.
Under the
2005 Plan, we may not grant a stock 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 in any calendar year. Similarly, we may not make 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 in
any calendar year. Furthermore, we may not issue more than 0.7 million
non-forfeitable shares of stock pursuant to stock grants.
INTERNAP
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
As a
result of our acquisition of VitalStream as discussed in note 3, we assumed the
VitalStream Stock Option/Stock Issuance Plan, or the VitalStream Plan, and all
of outstanding stock options granted under such plan. 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-based compensation plan and
stock option agreement. We converted 3.0 million stock options to purchase
shares of VitalStream common stock into 1.5 million stock options to purchase
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.
There
were 5.4 million VitalStream shares, or 2.8 million Internap shares on a
post-converted basis, reserved for issuance under the VitalStream 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 grant date 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.
Under the
1999 Non-Employee Directors’ Stock Option Plan, or the Director Plan, we granted
non-qualified stock options to non-employee directors. A total of 0.4 million
shares of our common stock were reserved for issuance under the Director Plan.
Under the Director Plan, non-employee directors received 8,000 stock options on
the date such person is first elected or appointed as a non-employee director.
On the day after each of our annual stockholder meetings, each non-employee
director received 5,000 stock options, provided such person was a non-employee
director for at least the prior six months. The stock options had an exercise
price equal to 100% of the fair market value of our common stock on the grant
date and were fully vested and exercisable as of the grant date. Each director
also received an annual grant of restricted stock, which vested ratably over
three years, subject to the terms of the 2005 Plan, under which these shares of
restricted stock were granted. Beginning in 2009, the actual number of
stock options and shares of restricted stock to be granted was the lesser of
dividing $55,000 by either (a) our closing stock price on the grant date, or (b)
$3.00 per share. In addition, new non-employee directors were to receive a grant
of 12,500 shares of restricted to vest ratably over three years. As of
December 31, 2009, 0.3 million stock options were outstanding and 0.2 million
shares were available for grant pursuant to the Director Plan. The Director Plan
expired by its terms in July 2009. We will make future grants of
stock options and/or restricted stock to non-employee directors from the 2005
Plan.
For all
stock-based compensation plans, the exercise price for each stock option
generally may not be less than the fair market value of a share of our common
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 stock 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.
Stock
options and stock appreciation rights, if any, 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-based compensation plans to satisfy stock
option exercises with newly issued stock. However, we may also use treasury
stock to satisfy stock option exercises.
Stock
option activity during the year ended December 31, 2009 under all of our
stock-based compensation plans is as follows (shares in thousands):
|
|
|
|
|
|
|
|
|
Shares
|
|
|
Weighted
Average
Exercise
Price
|
|
Balance,
December 31, 2008
|
|
|
2,781
|
|
|
$
|
11.91
|
|
Granted
|
|
|
2,224
|
|
|
|
2.66
|
|
Exercised
|
|
|
(5
|
)
|
|
|
2.14
|
|
Forfeitures
and post-vesting cancellations
|
|
|
(747
|
)
|
|
|
10.53
|
|
Balance,
December 31, 2009
|
|
|
4,253
|
|
|
$
|
7.16
|
|
Exercisable,
December 31, 2009
|
|
|
2,084
|
|
|
$
|
10.59
|
|
INTERNAP
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Fully
vested and exercisable stock options and stock options expected to vest as of
December 31, 2009 are further summarized as follows (shares in
thousands):
|
|
|
|
|
|
|
|
|
Fully
Vested
and
Exercisable
|
|
|
Expected
to
Vest
|
|
Total
shares
|
|
|
2,084
|
|
|
|
3,815
|
|
Weighted-average
exercise price
|
|
$
|
10.59
|
|
|
$
|
7.58
|
|
Aggregate
intrinsic value
|
|
$
|
170,194
|
|
|
$
|
3,181,769
|
|
Weighted-average
remaining contractual term, in years
|
|
|
3.8
|
|
|
|
6.1
|
|
The total
intrinsic value of stock options exercised was less than $0.1 million, $0.2
million and $11.8 million during the years ended December 31, 2009, 2008 and
2007, respectively. None of our stock options or the underlying shares is
subject to any right to repurchase by us.
Restricted
stock activity during the year ended December 31, 2009 is as follows (shares in
thousands):
|
|
|
|
|
|
|
|
|
Shares
|
|
|
Weighted-Average
Grant
Date Fair
Value
|
|
Unvested
balance, December 31, 2008
|
|
|
845
|
|
|
$
|
7.76
|
|
Granted
|
|
|
944
|
|
|
|
2.61
|
|
Vested
|
|
|
(384
|
)
|
|
|
7.95
|
|
Forfeited
|
|
|
(317
|
)
|
|
|
5.87
|
|
Unvested
balance, December 31, 2009
|
|
|
1,088
|
|
|
$
|
3.61
|
|
The total
fair value of restricted stock vested during the years ended December 31, 2009,
2008 and 2007 was $1.1 million, $1.1 million and $2.3 million, respectively. The
total intrinsic value at December 31, 2009 of all unvested restricted stock was
$5.1 million.
Total
unrecognized compensation costs related to unvested stock-based compensation as
of December 31, 2009 is summarized as follows (dollars in
thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock
Options
|
|
|
Restricted
Stock
|
|
|
Total
|
|
Unrecognized
compensation
|
|
$
|
5,218
|
|
|
$
|
3,384
|
|
|
$
|
8,602
|
|
Weighted-average
remaining recognition period (in years)
|
|
|
3.1
|
|
|
|
2.9
|
|
|
|
3.0
|
|
Employee
Stock Purchase Plan
Our 2004
Internap Network Services Corporation Employee Stock Purchase Plan, or the
Purchase Plan encourages ownership of our common stock by our 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.
The price
for shares of common stock purchased under the Purchase Plan is 95% of the
closing sale price per share of common our stock on the last day of the purchase
period. The Purchase Plan is intended to be a non-compensatory plan for both tax
and financial reporting purposes. We granted less than 0.1 million shares under
the Purchase Plan during each of the years during the three year period ended
December 31, 2009. Cash received from participation in the Purchase Plan was
$0.1 million during the year ended December 31, 2009 and $0.2 million for each
of the years ended December 31, 2008 and 2007. At December 31, 2009, 0.2 million
shares were reserved for future issuance under the Purchase Plan.
At
December 31, 2009, we had reserved 8.9 million total shares for future awards
under all stock-based compensation plans. Cash received from all stock-based
compensation arrangements was $0.1 million, $0.5 million and $8.6 million during
the years ended December 31, 2009, 2008 and 2007, respectively.
18.
|
RELATED
PARTY TRANSACTIONS
|
As
discussed in note 5, we have a 51% ownership interest in Internap Japan, a joint
venture that we account for using the equity method. Transactions with Internap
Japan are summarized as follows (in thousands):
|
|
Year
Ended December 31,
|
|
|
|
2009
|
|
|
2008
|
|
|
2007
|
|
Revenues
|
|
$
|
390
|
|
|
$
|
366
|
|
|
$
|
357
|
|
Direct
costs of network sales and services
|
|
|
168
|
|
|
|
181
|
|
|
|
139
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
INTERNAP
NETWORK SERVICES CORPORATION AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
|
|
December
31,
|
|
|
|
2009
|
|
|
2008
|
|
Accounts
receivable
|
|
$
|
95
|
|
|
$
|
89
|
|
Accounts
payable
|
|
|
51
|
|
|
|
26
|
|
Also 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. As of December 31, 2007, our outstanding receivable balance with
Aventail was less than $0.1 million. We incurred a charge during the year ended
December 31, 2007, totaling $1.2 million, representing the write-off of the
remaining carrying value of our investment in series D preferred stock of
Aventail.
19. SUPPLEMENTAL
CASH FLOW INFORMATION
Supplemental
cash flow information is as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
Year
Ended December 31,
|
|
|
|
2009
|
|
|
2008
|
|
|
2007
|
|
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
|
|
|
795
|
|
|
|
1,403
|
|
|
|
1,152
|
|
Cash
paid for income taxes
|
|
|
681
|
|
|
|
361
|
|
|
|
103
|
|
Non-cash
acquisition of property and equipment under capital leases
|
|
|
—
|
|
|
|
3,069
|
|
|
|
148
|
|
Capitalized
stock-based compensation
|
|
|
24
|
|
|
|
97
|
|
|
|
25
|
|
20. UNAUDITED
QUARTERLY RESULTS
The
following table sets forth selected unaudited quarterly data during the years
ended December 31, 2009 and 2008. The quarterly operating results below are not
necessarily indicative of those in future periods (in thousands, except for
share data).
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter
Ended
|
|
2009
|
|
March
31
|
|
|
June
30
|
|
|
September
30
|
|
|
December
31
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
63,924
|
|
|
$
|
64,372
|
|
|
$
|
64,414
|
|
|
$
|
63,549
|
|
Direct
costs of network, sales and services, exclusive of depreciation and
amortization
|
|
|
35,665
|
|
|
|
36,579
|
|
|
|
36,497
|
|
|
|
34,275
|
|
Direct
costs of customer support
|
|
|
4,403
|
|
|
|
4,438
|
|
|
|
4,767
|
|
|
|
4,919
|
|
Direct
costs of amortization of acquired technologies
|
|
|
1,158
|
|
|
|
5,233
|
|
|
|
979
|
|
|
|
979
|
|
Impairments
and restructuring
|
|
|
870
|
|
|
|
53,735
|
|
|
|
—
|
|
|
|
93
|
|
Net
loss
|
|
|
(6,608
|
)
|
|
|
(60,645
|
)
|
|
|
(1,975
|
)
|
|
|
(497
|
)
|
Basic
and diluted net loss per share
|
|
|
(0.13
|
)
|
|
|
(1.22
|
)
|
|
|
(0.04
|
)
|
|
|
(0.01
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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 customer support
|
|
|
4,365
|
|
|
|
4,203
|
|
|
|
3,950
|
|
|
|
3,699
|
|
Direct
costs of amortization of acquired technologies
|
|
|
1,229
|
|
|
|
1,229
|
|
|
|
3,049
|
|
|
|
1,142
|
|
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
|
)
|