Internap Corporation
INTERNAP NETWORK SERVICES CORP (Form: 10-Q, Received: 11/04/2010 17:10:17)
 
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
 
 
FORM 10-Q
 
 
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended September 30, 2010
OR
 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from _______ to ______
 
Commission File Number: 000-27265
 
 
INTERNAP NETWORK SERVICES CORPORATION
(Exact Name of Registrant as Specified in Its Charter)

DELAWARE
91-2145721
(State or Other Jurisdiction of
(I.R.S. Employer
Incorporation or Organization)
Identification No.)
   
 
250 Williams Street
Atlanta, Georgia 30303
(Address of Principal Executive Offices, Including Zip Code)
 
(404) 302-9700
(Registrant’s Telephone Number, Including Area Code)
 
 
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
o
Accelerated filer
x
Non-accelerated filer
o
Smaller reporting company
o
(Do not check if a smaller reporting company)
   
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
 
As of October 29, 2010, 51,907,929 shares of the registrant’s outstanding common stock, $0.001 par value per share, were outstanding.
 
 
 
 

 
INTERNAP NETWORK SERVICES CORPORATION
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2010
TABLE OF CONTENTS
         
       
Pages
         
   
PART I. FINANCIAL INFORMATION
   
         
ITEM 1.
 
FINANCIAL STATEMENTS
   
         
   
Unaudited Condensed Consolidated Statements of Operations
 
2
         
   
Unaudited Condensed Consolidated Balance Sheets
 
3
         
   
Unaudited Condensed Consolidated Statements of Cash Flows
 
4
         
   
Unaudited Condensed Consolidated Statements of Stockholders’ Equity and Comprehensive Loss
 
5
         
   
Unaudited Condensed Notes to Consolidated Financial Statements
 
6
         
ITEM 2.
 
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
    14
         
ITEM 3.
 
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
    23
         
ITEM 4.
 
CONTROLS AND PROCEDURES
    23
         
   
PART II. OTHER INFORMATION
   
         
ITEM 1.
 
LEGAL PROCEEDINGS
    24
         
ITEM 1A.
 
RISK FACTORS
    25
         
ITEM 2.
 
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
    25
         
ITEM 6.
 
EXHIBITS
    26
         
   
SIGNATURES
    27
 
 
 

 
PART I. FINANCIAL INFORMATION
 
ITEM 1. FINANCIAL STATEMENTS
 
INTERNAP NETWORK SERVICES CORPORATION
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
                         
   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2010
   
2009
   
2010
   
2009
 
Revenues:
                       
Data center services
  $ 31,550     $ 33,547     $ 96,468     $ 97,535  
Internet protocol (IP) services
    28,765       30,867       87,736       95,175  
Total revenues
    60,315       64,414       184,204       192,710  
                                 
Operating costs and expenses:
                               
Direct costs of network, sales and services, exclusive of depreciation and amortization, shown below:
                               
Data center services
    20,405       24,450       63,232       71,896  
IP services
    11,162       12,047       33,683       36,844  
Direct costs of customer support
    5,438       4,767       15,793       13,608  
Direct costs of amortization of acquired technologies
    979       979       2,937       7,370  
Sales and marketing
    7,451       5,955       21,577       20,701  
General and administrative
    7,828       10,626       24,521       35,062  
Depreciation and amortization
    7,601       7,313       22,388       20,895  
Loss (gain) on disposal of property and equipment
    (13 )     20       7       20  
Impairments and restructuring
                1,201       54,608  
Total operating costs and expenses
    60,851       66,157       185,339       261,004  
Loss from operations
    (536 )     (1,743 )     (1,135 )     (68,294 )
                                 
Non-operating expense (income):
                               
Interest income
    (2 )     (8 )     (64 )     (131 )
Interest expense
    618       189       1,439       557  
Other, net
    4       (11 )     40       (125 )
Total non-operating expense
    620       170       1,415       301  
                                 
Loss before income taxes and equity in loss (earnings) of equity method investment
    (1,156 )     (1,913 )     (2,550 )     (68,595 )
Provision for income taxes
    634       93       919       575  
Equity in loss (earnings) of equity-method investment, net of taxes
    (128 )     (31 )     (277 )     57  
                                 
Net loss
  $ (1,662 )   $ (1,975 )   $ (3,192 )   $ (69,227 )
                                 
Basic and diluted net loss per share
  $ (0.03 )   $ (0.04 )   $ (0.06 )   $ (1.41 )
                                 
Weighted average shares outstanding used in computing basic and diluted net loss per share
    50,026       49,638       50,391       49,058  
 
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 
2

 
INTERNAP NETWORK SERVICES CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except par value amounts)
             
   
September 30,
2010
   
December 31,
2009
 
   
(Unaudited)
       
ASSETS
           
Current assets:
           
Cash and cash equivalents
  $ 68,311     $ 73,926  
Short-term investments in marketable securities
          7,000  
Accounts receivable, net of allowance for doubtful accounts of $2,010 and $1,953, respectively
    19,886       18,685  
Inventory
    213       375  
Prepaid expenses and other assets
    10,361       8,768  
Total current assets
    98,771       108,754  
                 
Property and equipment, net
    131,087       91,151  
Investments and other related assets
    2,140       1,804  
Intangible assets, net
    15,587       20,782  
Goodwill
    39,464       39,464  
Deposits and other assets
    2,903       2,637  
Deferred tax asset, non-current, net
    2,448       2,910  
Total assets
  $ 292,400     $ 267,502  
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
Current liabilities:
               
Revolving credit facility, current portion
  $ 20,000     $  
Accounts payable
    24,288       17,237  
Accrued liabilities
    8,878       10,192  
Deferred revenues, current portion
    3,154       3,817  
Capital lease obligations, current portion
    1,020       25  
Restructuring liability, current portion
    2,738       2,819  
Other current liabilities
    133       125  
Total current liabilities
    60,211       34,215  
                 
Revolving credit facility, due after one year
          20,000  
Deferred revenues, less current portion
    2,251       2,492  
Capital lease obligations, less current portion
    19,404       3,217  
Restructuring liability, less current portion
    5,645       6,123  
Deferred rent
    16,617       16,417  
Other long-term liabilities
    535       636  
Total liabilities
    104,663       83,100  
Commitments and contingencies
               
Stockholders’ equity:
               
Preferred stock, $0.001 par value; 20,000 shares authorized; no shares issued or outstanding
           
Common stock, $0.001 par value; 120,000 shares authorized and 51,924 shares outstanding at September 30, 2010; 60,000 shares authorized and 50,763 shares outstanding at December 31, 2009
    52       51  
Additional paid-in capital
    1,228,291       1,221,456  
Treasury stock, at cost; 107 and 42 shares at September 30, 2010 and December 31, 2009, respectively
    (477 )     (127 )
Accumulated deficit
    (1,039,740 )     (1,036,548 )
Accumulated items of other comprehensive loss
    (389 )     (430 )
Total stockholders’ equity
    187,737       184,402  
Total liabilities and stockholders’ equity
  $ 292,400     $ 267,502  
 
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
 
 
 
3

 
INTERNAP NETWORK SERVICES CORPORATION
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
             
   
Nine Months Ended
September 30,
 
   
2010
   
2009
 
Cash Flows From Operating Activities:
           
Net loss
  $ (3,192 )   $ (69,227 )
Adjustments to reconcile net loss to net cash provided by operating activities:
               
Goodwill and other intangible asset impairments
          55,647  
Depreciation and amortization
    25,325       24,131  
Loss on disposal of property and equipment
    7       20  
Provision for doubtful accounts
    1,088       2,081  
Equity in loss (earnings) from equity-method investment
    (277 )     57  
Non-cash changes in deferred rent
    200       1,282  
Stock-based compensation expense
    3,551       4,434  
Deferred income taxes
    462       (293 )
Other, net
    619       151  
Changes in operating assets and liabilities:
               
Accounts receivable
    (2,289 )     2,489  
Inventory
    162       (11 )
Prepaid expenses, deposits and other assets
    (1,749 )     2,897  
Accounts payable
    7,051       1,486  
Accrued and other liabilities
    (1,314 )     657  
Deferred revenues
    (904 )     990  
Accrued restructuring liability
    (559 )     418  
Net cash flows provided by operating activities
    28,181       27,209  
                 
Cash Flows From Investing Activities:
               
Purchases of property and equipment
    (43,234 )     (12,950 )
Maturities of investments in marketable securities
    7,000       7,224  
Proceeds from disposal of property and equipment
    12        
Net cash flows used in investing activities
    (36,222 )     (5,726 )
                 
Cash Flows From Financing Activities:
               
Proceeds from notes payable
    58,500       59,000  
Principal payments on notes payable
    (58,500 )     (59,000 )
Payments on capital lease obligations
    (204 )     (246 )
Stock-based compensation plans
    2,837       (252 )
Other, net
    (218 )     (87 )
Net cash flows provided by (used in) financing activities
    2,415       (585 )
Effect of exchange rates on cash and cash equivalents
    11       30  
Net (decrease) increase in cash and cash equivalents
    (5,615 )     20,928  
Cash and cash equivalents at beginning of period
    73,926       46,870  
Cash and cash equivalents at end of period
  $ 68,311     $ 67,798  
                 
Supplemental disclosure of cash flow information:
               
Cash paid for interest
  $ 1,436     $ 615  
Cash paid for income taxes
    294       668  
Non-cash acquisition of property and equipment under capital leases
    16,757        
Capitalized stock-based compensation
    98       14  
 
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
 
 
 
4

 
INTERNAP NETWORK SERVICES CORPORATION
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF
STOCKHOLDERS’ EQUITY AND COMPREHENSIVE LOSS
(In thousands)

 
   
Common Stock
                               
   
Shares
   
Par
Value
   
Additional
Paid-In
Capital
   
Treasury
Stock
   
Accumulated
Deficit
   
Accumulated
Other
Comprehensive
Loss
   
Total
Stockholders’
Equity
 
                                           
NINE MONTHS ENDED SEPTEMBER 30, 2010:
                                         
Balance, December 31, 2009
    50,763     $ 51     $ 1,221,456     $ (127 )   $ (1,036,548 )   $ (430 )   $ 184,402  
Net loss
                            (3,192 )           (3,192 )
Foreign currency translation adjustment
                                  41       41  
Total comprehensive loss
                                                    181,251  
Stock compensation plans activity and stock-based compensation expense
    1,161       1       6,835       (350 )                 6,486  
Balance, September 30, 2010
    51,924     $ 52     $ 1,228,291     $ (477 )   $ (1,039,740 )   $ (389 )   $ 187,737  
                                                         
NINE MONTHS ENDED SEPTEMBER 30, 2009:
                                                       
Balance, December 31, 2008
    50,224     $ 50     $ 1,216,267     $ (370 )   $ (966,823 )   $ (929 )   $ 248,195  
Net loss
                            (69,227 )           (69,227 )
Change in unrealized gains and losses on investments, net of taxes
                                  25       25  
Foreign currency translation adjustment
                                  300       300  
Total comprehensive loss
                                                    (68,902 )
Stock compensation plans activity and stock-based compensation expense
    481       1       3,939       257                   4,197  
Balance, September 30, 2009
    50,705     $ 51     $ 1,220,206     $ (113 )   $ (1,036,050 )   $ (604 )   $ 183,490  
 
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
 
 
 
5

 
INTERNAP NETWORK SERVICES CORPORATION
UNAUDITED CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
Nature of Operations and Basis of Presentation
 
Internap Network Services Corporation (“Internap,” “we,” “us” or “our”) provides secure and reliable data center services and 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. We help our customers innovate their businesses, 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 at 36 data centers across North America, Europe and the Asia-Pacific region and through 74 Internet Protocol (“IP”) service points, which include 21 content delivery network (“CDN”) points of presence (“POPs”). We also have two additional domestic standalone data center locations and one additional international standalone CDN POP through which we provide IP services by extension. For the nine months ended September 30, 2010, revenues generated, and long-lived assets located outside the United States were less than 10% of our total revenues and assets.
 
We have prepared our unaudited condensed consolidated financial statements pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) which include all of our accounts and those of our wholly owned subsidiaries. As permitted by such rules and regulations, we have condensed or omitted certain information and note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The unaudited condensed consolidated financial statements reflect all adjustments, which consist of normal recurring adjustments, necessary for a fair statement of our financial position as of September 30, 2010 and our operating results, cash flows and changes in stockholders’ equity for the interim periods presented. We derived the balance sheet at December 31, 2009 from our audited financial statements as of that date. You should read these financial statements and the related notes in conjunction with our financial statements and notes thereto contained in our Annual Report on Form 10-K for the year ended December 31, 2009 filed with the SEC.
 
The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities and revenues and expenses in the financial statements. Examples of estimates subject to possible revision based upon the outcome of future events include, among others, the provision for doubtful accounts, network cost accruals, income taxes, sales, use and other taxes, recoverability of long-lived assets and goodwill, depreciation of property and equipment, restructuring allowances and stock-based compensation. Actual results could differ from those estimates.
 
The results of operations for the three and nine months ended September 30, 2010 are not necessarily indicative of the results that may be expected for any future periods or for the year ending December 31, 2010 or subsequent years.
 
Operating Segments
 
We operate in two business segments: data center services and IP services. The data center services segment includes physical space for hosting customers’ network and other equipment, managed hosting and services such as redundant power and network connectivity, environmental controls and security. The IP services segment includes our IP transit activities and high performance Internet connectivity, CDN services and flow control platform (“FCP”) products.
 
The following tables show operating results for our business segments, along with reconciliations from segment gross profit to loss before income taxes and equity in (loss) earnings of equity-method investment:

 
6

INTERNAP NETWORK SERVICES CORPORATION
UNAUDITED CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
 
   
Data
Center
Services
   
IP
Services
   
Total
 
Three Months Ended September 30, 2010:
                 
Revenues
  $ 31,550     $ 28,765     $ 60,315  
Direct costs of network, sales and services, exclusive of depreciation and amortization, included below
    20,405       11,162       31,567  
Segment gross profit
  $ 11,145     $ 17,603       28,748  
                         
Other operating costs and expenses, including direct costs of customer support and depreciation and amortization
                    29,284  
Loss from operations
                    (536 )
Non-operating expense
                    620  
Loss before income taxes and equity in loss (earnings) of equity-method investment
                  $ (1,156 )
                         
Three Months Ended September 30, 2009:
                       
Revenues
  $ 33,547     $ 30,867     $ 64,414  
Direct costs of network, sales and services, exclusive of depreciation and amortization, included below
    24,450       12,047       36,497  
Segment gross profit
  $ 9,097     $ 18,820       27,917  
                         
Other operating costs and expenses, including direct costs of customer support and depreciation and amortization
                    29,660  
Loss from operations
                    (1,743 )
Non-operating expense
                    170  
Loss before income taxes and equity in loss (earnings) of equity-method investment
                  $ (1,913 )
                         
Nine Months Ended September 30, 2010:
                       
Revenues
  $ 96,468     $ 87,736     $ 184,204  
Direct costs of network, sales and services, exclusive of depreciation and amortization, included below
    63,232       33,683       96,915  
Segment gross profit
  $ 33,236     $ 54,053       87,289  
                         
Other operating costs and expenses, including direct costs of customer support and depreciation and amortization
                    87,223  
Restructuring
                    1,201  
Loss from operations
                    (1,135 )
Non-operating expense
                    1,415  
Loss before income taxes and equity in loss (earnings) of equity-method investment
                  $ (2,550 )
                         
Nine Months Ended September 30, 2009:
                       
Revenues
  $ 97,535     $ 95,175     $ 192,710  
Direct costs of network, sales and services, exclusive of depreciation and amortization, included below
    71,896       36,844       108,740  
Segment gross profit
  $ 25,639     $ 58,331       83,970  
                         
Other operating costs and expenses, including direct costs of customer support and depreciation and amortization
                    97,656  
Impairments and restructuring
                    54,608  
Loss from operations
                    (68,294 )
Non-operating expense
                    301  
Loss before income taxes and equity in loss (earnings) of equity-method investment
                  $ (68,595 )
 
 
 
7

 
INTERNAP NETWORK SERVICES CORPORATION
UNAUDITED CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
During the nine months ending September 30, 2010, we identified and corrected an error impacting deferred rent expense related to prior years. This adjustment resulted in a decrease in direct costs of data center services of $0.3 million, which we determined to be immaterial to prior year financial statements.
 
Segment gross profit is segment revenues less direct costs of network, sales and services, exclusive of depreciation and amortization, and does not include direct costs of customer support, direct costs of amortization of acquired technologies or any other depreciation or amortization associated with direct costs.
 
Restructuring and Impairments
 
Restructuring
 
In 2001, 2007, 2009 and 2010, we implemented significant restructuring plans that resulted in substantial charges for real estate and network infrastructure obligations and personnel charges.
 
The following table displays the activity and balances for the restructuring activities for the nine months ended September 30, 2010 (in thousands):

 
   
December 31,
2009
Restructuring
Liability
   
Initial
Restructuring
Charges
   
Subsequent
Plan
Adjustments
   
Cash
Payments
   
September 30,
2010
Restructuring
Liability
 
Activity for 2010 restructuring charge:
                             
Real estate obligations
  $     $ 36     $     $ (12 )   $ 24  
                                         
Activity for 2009 restructuring charge:
                                       
Employee terminations
    36             18       (54 )      
Real estate obligations
    178                   (161 )     17  
                                         
Activity for 2007 restructuring charge:
                                       
Real estate obligations
    6,248             977       (1,150 )     6,075  
                                         
Activity for 2001 restructuring charge:
                                       
Real estate obligations
    2,480             226       (439 )     2,267  
                                         
Total
  $ 8,942     $ 36     $ 1,221     $ (1,816 )   $ 8,383  
 
During the nine months ending September 30, 2010, we made subsequent plan adjustments in sublease income assumptions for certain properties included in our previously-disclosed restructuring plans. Due to current economic conditions, these adjustments extend 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. Subsequent plan adjustments of $1.2 million and initial restructuring charges of $0.04 million for the nine months ended September 30, 2010 are included in “Impairments and restructuring” on the accompanying consolidated statements of operations.
 
Impairments
 
For purposes of valuing our goodwill and other intangible assets, we have the following three reporting units: IP products, IP services and data center services. The IP products and IP services reporting units have goodwill, while the data center services reporting unit does not have goodwill. We performed our annual impairment review as of August 1, 2010 and concluded that goodwill attributed to our IP products and IP services reporting units was not impaired as the fair value of each reporting units exceeded the carrying value of the reporting unit, including goodwill.
 
To determine the fair value of our reporting units, we utilize the discounted cash flow and market methods. We have consistently utilized both methods in our goodwill impairment tests and weight both results equally. We use both methods in our goodwill impairment tests as we believe both, in conjunction with each other, provide a reasonable estimate of the fair value of the reporting unit. The discounted cash flow method is specific to our anticipated future results of the reporting unit, while the market method is based on our market sector including our competitors.
 
We determined the assumptions supporting the discounted cash flow method, including the discount rate, using our best estimates as of the date of the impairment review. We have performed various sensitivity analyses on certain of the assumptions used in the discounted cash flow method, such as forecasted revenues and discount rate. We used reasonable judgment in developing our estimates and assumptions and there was no impairment indicated in our testing.
 
 
8

 

INTERNAP NETWORK SERVICES CORPORATION
UNAUDITED CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
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 we perform the valuation. 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 for expected cash flows; market comparables and capital expenditure forecasts. The use of different assumptions, inputs and judgments, or changes in circumstances, could materially affect the results of the valuation. Due to inherent uncertainty involved in making these estimates, actual results could differ from our estimates and could result in additional non-cash impairment charges in the future.
 
In addition to our annual test, we also assess on a quarterly basis whether any events have occurred or circumstances have changed that would indicate an impairment could exist on our intangible and long-lived assets. We concluded that no impairment indicators existed to cause us to re-assess our intangible and long-lived assets during the three months ended September 30, 2010.
 
Stock-Based Compensation
 
During the three and nine months ended September 30, 2010, we granted 0.1 million and 1.9 million stock options, respectively, and 0.01 million and 0.5 million shares of unvested restricted common stock, respectively. From time-to-time, we acquire shares of treasury stock as payment of taxes due from employees upon vesting of restricted stock, including $0.1 million for each of the three months ended September 30, 2010 and 2009, and $0.3 million for each of the nine months ended September 30, 2010 and 2009. Total stock-based compensation was $1.1 million for each of the three months ended September 30, 2010 and 2009, and $3.6 million and $4.4 million for the nine months ended September 30, 2010 and 2009, respectively.
 
5.            Income Taxes
 
At the end of each quarterly reporting period, we estimate the effective income tax rate we expect to be applicable for the full year. We use the expected effective income tax rate to provide for income taxes on a year-to-date basis. We reflect the tax effect of any tax law changes and certain other discrete events in the period in which they occur.
 
Our overall effective income tax rate, as a percentage of pre-tax ordinary income, for the nine months ended September 30, 2010 and 2009 was (36%) and (1%), respectively. The fluctuation in the effective income tax rate was due to recognition of income taxes in the United Kingdom (“U.K.”), permanent tax adjustment items, a change in valuation allowance and state income taxes.
 
The annual effective tax rate for 2010 could change due to a number of factors including, but not limited to, our geographic profit mix between the United States (“U.S.”), the U.K. and other foreign jurisdictions, new tax laws, new interpretations of existing tax law and rulings by and settlements with taxing authorities.
 
We continue to maintain a valuation allowance against our deferred tax assets of $128.0 million. The total deferred tax assets primarily consist of net operating loss carryforwards. We may recognize U.S. deferred tax assets in future periods when we estimate them to be realizable. Based on an analysis of our historic and projected future U.S. pre-tax income, we do not have sufficient positive evidence to expect a release of our valuation allowance against our U.S. deferred tax assets currently or within the next 12 months. Accordingly, we continue to maintain the full valuation allowance in the U.S. and all foreign jurisdictions, other than the U.K.
 
For the nine months ended September 30, 2010, there were no new material uncertain tax positions. Also, we do not expect the total amount of unrecognized tax benefits to significantly increase or decrease within the next 12 months.
 
6.            Loss Per Share
 
We calculated basic and diluted net loss per share as follows (in thousands, except per share amounts):
 
    Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
   
2010
 
2009
   
2010
 
2009
 
Net loss available to common stockholders
  $ (1,662 )   $ (1,975 )   $ (3,192 )   $ (69,227 )
Weighted average shares outstanding, basic and diluted
    50,026       49,638       50,391       49,058  
Net loss per share, basic and diluted
  $ (0.03 )   $ (0.04 )   $ (0.06 )   $ (1.41 )
                                 
Total anti-dilutive securities excluded from diluted net loss per share calculation for stock-based compensation plans
    5,926       5,258       5,926       5,258  
 

 
9

 
INTERNAP NETWORK SERVICES CORPORATION
UNAUDITED CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
7.            Fair Value Measurements
 
We account for certain assets and liabilities at fair value. The hierarchy below lists three levels of fair value based on the extent to which inputs used in measuring fair value are observable in the market. We categorize each of our fair value measurements in one of these three levels based on the lowest level input that is significant to the fair value measurement in its entirety. These levels are:
 
 
Level 1: Quoted prices in active markets for identical assets or liabilities;
 
Level 2: Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities; and
 
Level 3: Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
 
The following table represents the fair value hierarchy for our financial assets (cash equivalents, investments in marketable securities and other related assets) measured at fair value on a recurring basis (in thousands):
                         
September 30, 2010:
 
Level 1
   
Level 2
   
Level 3
   
Total
 
Available for sale securities:
                       
Money market funds (1)
  $ 19,282     $     $     $ 19,282  
    $ 19,282     $     $     $ 19,282  

   
Level 1
   
Level 2
   
Level 3
   
Total
 
December 31, 2009:
                       
Available for sale securities:
                       
Money market funds (2)
  $ 26,019     $     $     $ 26,019  
Trading securities:
                               
Auction rate securities (3)
                6,503       6,503  
ARS rights (3)
                497       497  
    $ 26,019     $     $ 7,000     $ 33,019  

                ________________________
 
(1)
Included in “Cash and cash equivalents” in the consolidated balance sheet as of September 30, 2010 in addition to $49.0 million of cash.
 
(2)
Included in “Cash and cash equivalents” in the consolidated balance sheet as of December 31, 2009 in addition to $47.9 million of cash.
 
(3)
Included in “Short-term investments in marketable securities” in the consolidated balance sheet as of December 31, 2009. ARS rights were rights that entitled us to sell the auction rate securities back to the investment provider at par value.
 
The following table summarizes changes in fair value of our Level 3 financial assets, auction rate securities and ARS rights, for the nine months ended September 30, 2010 (in thousands):
             
   
Auction
Rate
Securities
   
ARS
Rights
 
             
Balance, January 1, 2010
  $ 6,503     $ 497  
Total gains (losses) (realized and unrealized)
    497       (4 )
Settlements
    (7,000 )     (493 )
Balance, September 30, 2010
  $     $  
 
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. At September 30, 2010 and December 31, 2009, we estimate that the carrying values of our variable rate revolving credit facility and other liabilities at fixed rates approximated fair value based on current market rates of interest.
 
8.            Contingencies and 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 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 (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 common stock between March 28, 2007 and March 18, 2008.
 
 
10

 
INTERNAP NETWORK SERVICES CORPORATION
UNAUDITED CONDENSED 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 Holdings, Inc (“VitalStream”), which we acquired in February 2007, (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 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 as a defendant and lengthened the putative class period.
 
On September 11, 2009, we and the individual defendants filed motions to dismiss. 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. 
 
On September 15, 2010, the Court granted our motion to dismiss in part and denied the individual defendants' motion to dismiss. The Court dismissed plaintiffs' claims under Section 14(a) of the Exchange Act. With respect to plaintiffs' claims under Section 10(b) of the Exchange Act, the Court held that the Amended Complaint failed to satisfy the pleading requirements of the Private Securities Litigation Reform Act, but allowed plaintiffs' one final opportunity to amend the complaint. On October 26, 2010, plaintiffs filed their Third Amended Class Action Complaint. We intend to file a motion to dismiss this complaint.
 
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.
 
9.            Recent Accounting Pronouncements
 
Recently Issued Accounting Pronouncements That We Have Adopted
 
In January 2010, we adopted new accounting guidance issued by the Financial Accounting Standards Board (“FASB”), which amends the evaluation criteria to identify the primary beneficiary of a variable interest entity (“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 and is applicable to all new and existing VIEs. Adoption of this new guidance did not have a material impact on our consolidated financial statements.
 
In January 2010, we adopted new accounting guidance issued by the FASB which amends the disclosure requirements related to recurring and nonrecurring fair value measurements. The guidance requires new disclosures on the transfers of assets and liabilities between Level 1 (quoted prices in active market for identical assets or liabilities) and Level 2 (significant other observable inputs) of the fair value measurement hierarchy, including the reasons and the timing of the transfers. Additionally, the guidance requires a roll forward of activities on purchases, sales, issuances and settlements of the assets and liabilities measured using significant unobservable inputs (Level 3 fair value measurements), which will be effective during the first quarter of 2011. Other than requiring additional disclosures, adoption of this new guidance did not and will not have a material impact on our consolidated financial statements.
 
Recently Issued Accounting Pronouncements That We Have Not Yet Adopted
 
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, but do not expect adoption will materially impact our consolidated financial statements.
 
 
11

 
INTERNAP NETWORK SERVICES CORPORATION
UNAUDITED CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
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 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. We are currently evaluating the impact of this accounting guidance, 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.
 
10.            Capital Lease Obligations
 
During the nine months ended September 30, 2010, we entered into a lease agreement for a new company-controlled data center in Santa Clara, California and a lease amendment which expanded our company-controlled data center in Seattle, Washington. As a result, property and equipment and corresponding capital lease obligations increased by $16.7 million.
 
As of September 30, 2010, future minimum capital lease payments together with the present value of the minimum lease payments for all capital leases are as follows (in thousands):
         
2010
 
$
717
 
2011
   
2,919
 
2012
   
3,003
 
2013
   
3,089
 
2014
   
3,481
 
Thereafter
   
20,125
 
Remaining capital lease payments
   
33,334
 
Less: amounts representing imputed interest
   
(12,910
)
Present value of minimum lease payments
   
20,424
 
Less: current portion
   
(1,020
)
   
$
19,404
 
 
11.            Commitments
 
During the nine months ended September 30, 2010, we entered into commitments for $20.8 million primarily related to IP, telecommunications and data center services.
 
As of September 30, 2010, future minimum payments under all service and purchase commitments are as follows (in thousands):
         
2010
 
$
4,666
 
2011
   
14,035
 
2012
   
6,889
 
2013
   
1,664
 
2014
   
1,456
 
Thereafter
   
1,731
 
   
$
30,441
 

 
12.            Credit Agreements

On November 2, 2010, we entered into a new $80.0 million credit agreement (the “Credit Agreement”) which replaced our prior $35.0 million credit facility. Concurrently with the execution of the Credit Agreement, we closed the loans under the Credit Agreement (the “Closing”) and paid off and terminated our prior credit facility, provided that any outstanding letters of credit under the prior credit facility remain in effect until their expiration or replacement.

 
12

 
INTERNAP NETWORK SERVICES CORPORATION
UNAUDITED CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
During the three months ended September 30, 2010, to effect a smooth transition to the Credit Agreement and obtain approval of increased capital expenditures, we entered into an arrangement with our previous lender to maintain a compensating cash balance in a demand deposit account in an amount in excess of any amounts drawn under our then-existing revolving credit facility, including outstanding letters of credits. At September 30, 2010, the balance of this arrangement was $24.5 million. This arrangement was terminated as a result of entering into the Credit Agreement on November 2, 2010.
 
Our obligations under the Credit Agreement are secured pursuant to a security agreement (the “Security Agreement”), under which we granted a security interest in substantially all of our assets, including the capital stock of our domestic subsidiaries and 65% of the capital stock of our foreign subsidiaries.

The Credit Agreement provides for a four-year revolving credit facility in an aggregate amount of up to $40.0 million (the “Revolving Credit Facility”), which includes a $10.0 million sub-limit for letters of credit.  

The Credit Agreement also provides for a four-year term loan in the amount of up to $40.0 million (the “Term Loan”). We borrowed $20.0 million under the Term Loan at Closing (the “Initial Term Loan”), and we have a one-time option to borrow an additional $20.0 million under the Term Loan during the two-year period immediately following the Closing (the “Delayed Term Loan”). 

We may use the proceeds of the Term Loan and the Revolving Credit Facility to (i) pay off existing indebtedness under our prior credit facility, (ii) fund the fees and expenses incurred in connection with the Credit Agreement, (iii) finance future acquisitions, and (iv) finance capital expenditures and other general corporate purposes. We have no agreements or commitments with respect to any acquisitions at this time.

The interest rate on the Revolving Credit Facility will be either (i) the Base Rate (as defined in the Credit Agreement) plus 1.5 percentage points, or (ii) the LIBOR Rate (as defined in the Credit Agreement) plus 3.25 percentage points, as we elect from time to time. The interest rate on the Term Loan will be either (x) the Base Rate plus 3.25 percentage points, or (y) the LIBOR Rate plus 3.25 percentage points, as we elect from time to time.

We must repay the Initial Term Loan annually in an amount equal to 5% of the original principal amount of the Initial Term Loan, to be paid in quarterly installments, with any amount remaining unpaid being due and payable on the fourth anniversary of the Closing (the “Maturity Date”). We must repay the Delayed Term Loan is repayable annually in an amount equal to 5% of the original principal amount of the Delayed Term Loan, to be paid in quarterly installments, with any amount remaining unpaid being due and payable on the Maturity Date.

The Credit Agreement includes customary representations, warranties, negative and affirmative covenants, including certain financial covenants relating to minimum liquidity and fixed charge coverage ratio, as well as customary events of default and certain default provisions that could result in acceleration of the Credit Agreement.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
This Quarterly Report on Form 10-Q, particularly Management’s Discussion and Analysis of Financial Condition and Results of Operations set forth below, and notes to our unaudited consolidated financial statements included herein, contain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include statements regarding industry trends, our future financial position and performance, business strategy, revenues and expenses in future periods, projected levels of growth and other matters that do not relate strictly to historical facts. These statements are often identified by the use of words such as “may,” “will,” “seeks,” “anticipates,” “believes,” “estimates,” “expects,” “projects,” “forecasts,” “plans,” “intends,” “continue,” “could,” “should” or similar expressions or variations. These statements are based on the beliefs and expectations of our management team based on information currently available. Such forward-looking statements are not guarantees of future performance and are subject to risks and uncertainties that could cause actual results to differ materially from those contemplated by forward-looking statements. Important factors currently known to our management that could cause or contribute to such differences include, but are not limited to, those referenced in this Quarterly Report on Form 10-Q under “Part II. Other Information—Item 1A. Risk Factors.” We undertake no obligation to update any forward-looking statements as a result of new information, future events or otherwise.
 
You should read the following discussion in conjunction with the unaudited condensed consolidated financial statements and accompanying notes provided under Part I, Item 1 of this Quarterly Report on Form 10-Q. As used herein references to “we,” “us,” “our,” or “Internap” refer to Internap Network Services Corporation.
 
Overview
 
We provide secure and reliable data center services and 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. We help our customers innovate their businesses, 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 at 36 data centers across North America, Europe and the Asia-Pacific region and through 74 Internet Protocol (“IP”) service points, which include 21 content delivery network (“CDN”) points of presence (“POPs”). We also have two additional domestic standalone data center locations and one additional international standalone CDN POP through which we provide IP services by extension. For the nine months ended September 30, 2010, revenues generated, and long-lived assets located outside the United States (“U.S.”) were less than 10% of our total revenues and assets.
 
We currently have approximately 2,800 customers across 28 metropolitan markets, serving a variety of industries, such as entertainment and media, including gaming; financial services; business services; software, including software-as-a-service (“SAAS”); hosting and information technology infrastructure; and telecommunications.
 
During the three months ended September 30, 2010, we opened a new company-controlled data center in Santa Clara, California and expanded one of our company-controlled data centers in Seattle, Washington. These data centers utilize green data center practices to minimize energy consumption and environmental impact. We also expanded our company-controlled data center in Houston, Texas. These expansions collectively added an additional 26,500 net sellable square feet to our company-controlled data center footprint.
 
Operating Segments
 
Data Center Services
 
Data center services, also known as colocation services, primarily include physical space for hosting customers’ network and other equipment as well as associated services such as redundant power and network connectivity, environmental controls and security.
 
Our data center services complement our high performance IP services for 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 CDN services, 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 service level agreements 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.
 
 
14

 
INTERNAP NETWORK SERVICES CORPORATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
 
We use a combination of facilities operated by us and by third parties, referred to as company-controlled data centers and partner sites, respectively. We offer a comprehensive solution at 38 service points, consisting of 10 company-controlled data centers and 28 partner sites. We charge monthly fees for data center services based on the amount of square footage and power that our customers use. We also have relationships with various data center providers to extend our private network access points (“P-NAP”) model into markets with high demand.

We believe the demand for data center services continues to outpace industry-wide supply. To address this demand, during 2010 we increased capital expenditures to expand company-controlled data centers. During the three months ended September 30, 2010, we opened a new company-controlled data center in Santa Clara and expanded one of our company-controlled data centers in Seattle and Houston. These expansions increased the footprint of our company-controlled data centers by 26,500 net sellable square feet, an increase of 28% compared to the net sellable square footage of company-controlled data center we reported as of September 30, 2009.

Direct costs of data center services, exclusive of depreciation and amortization, have substantial fixed cost components, primarily for rent, but also significant demand-based pricing variables, such as utilities, which are highest in the summer for cooling the facilities. Direct costs of data center services as a percentage of revenues vary with the mix of usage between company-controlled data centers and partner sites, as well as the utilization of total available space. While we recognize some of the initial operating costs of company-controlled data centers in advance of revenues, these sites are more profitable at certain levels of utilization than are partner sites. Conversely, costs in partner sites are more demand-based and therefore are more closely associated with the recognition of revenues. We seek to optimize the most profitable mix of available data center space operated by us and our partners. 

We have implemented Statement on Auditing Standards No. 70 (“SAS 70”) Type II controls and processes in our company-controlled data centers. Our implementation of SAS 70 Type II controls and processes provides assurances that controls and processes related to our data center security and environmental protection have been suitably designed and are operating effectively to protect and safeguard customers’ equipment. The underlying providers for several of our partner sites have also implemented SAS 70 Type II controls and processes.
 
IP Services
 
IP services represent our IP transit activities and include our high-performance Internet connectivity, CDN services and flow control platform (“FCP”) products. Our intelligent routing technology facilitates traffic over multiple carriers’ networks, as opposed to just one carrier’s network, to ensure highly-reliable performance over the Internet. We believe that our unique managed multi-network approach provides better performance, control and reliability as compared to conventional Internet connectivity alternatives.
 
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. 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 scalable high-quality content distribution and the analytic tools 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. 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.
 
Recent Accounting Pronouncements
 
We summarize recent accounting pronouncements in note 9 to the accompanying financial statements.
 
Results of Operations
 
Revenues
 
We generate revenues primarily from the sale of data center services and IP services. We recognize revenue each month provided that we have entered into a written contract, we have delivered the service to the customer, the fee for the service is fixed or determinable and collection is reasonably assured. Our revenues typically consist of monthly recurring revenues from contracts with terms of one year or more. Data center contracts usually have fixed charges for space occupied, power utilized and cable or fiber connections. IP service contracts usually have fixed minimum commitments based on a certain level of bandwidth usage with additional charges for any usage over a specified limit. If a customer’s usage of our services exceeds the monthly minimum commitment, we recognize revenue for such excess in the period of usage.
 
 
15

 
INTERNAP NETWORK SERVICES CORPORATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
 
Direct Costs of Network, Sales and Services
 
Direct costs of network, sales and services are comprised primarily of:
 
 
costs for connecting to and accessing network service providers and competitive local exchange providers;
 
facility and occupancy costs, including power and utilities, for hosting and operating our and our customers’ network equipment;
 
costs of FCP products and subscriptions sold;
 
costs incurred for providing additional third party services to our customers; and
 
royalties and costs of license fees for operating systems software.
 
If a network access point is not colocated with the respective Internet service provider, we may incur additional local loop charges on a recurring basis. Connectivity costs vary depending on customer demands and pricing variables while network access point facility costs are generally fixed. Direct costs of network, sales and services do not include compensation, depreciation or amortization.
 
Direct Costs of Customer Support
 
Direct costs of customer support consist primarily of compensation and other personnel costs for employees engaged in connecting customers to our network, installing customer equipment into network access point facilities and servicing customers through our network operations centers. In addition, we include facilities costs associated with the network operations centers, including costs related to servicing our data center customers, in direct costs of customer support.
 
Direct Costs of Amortization of Acquired Technologies
 
Direct costs of amortization are for technologies acquired through business combinations that are an integral part of the services and products we sell. We amortize the cost of the acquired technologies over original lives of three to eight years. The carrying value of acquired technologies at September 30, 2010 was $15.4 million and the weighted average remaining life was approximately four years. The carrying value of acquired technologies at December 31, 2009 was $18.4 million.
 
Sales and Marketing Costs
 
Sales and marketing costs consist of compensation, commissions and other costs for personnel engaged in marketing, sales and field service support functions, as well as advertising, tradeshows, direct response programs, new service point launch events, management of our external web site and other promotional costs.
 
General and Administrative Costs
 
General and administrative costs consist primarily of compensation and other expense for executive, finance, product development, human resources and administrative personnel, professional fees and other general corporate costs. General and administrative costs also include consultant fees and non-capitalized prototype costs related to the design, development and testing of our proprietary technology, enhancement of our network management software and development of internal systems.
 
Three and Nine Months Ended September 30, 2010 and 2009
 
Overview
 
Following is a summary of our results of operations and financial condition, which is followed by more in-depth discussion and analysis.
 
Total revenues were $60.3 million for the three months ended September 30, 2010, a decrease of $4.1 million, or 6%, compared to $64.4 million for the three months ended September 30, 2009. Data center services revenues were $31.5 million and IP services revenues were $28.8 million for the three months ended September 30, 2010. For the three months ended September 30, 2010, data center services revenues decreased $2.0 million, or 6%, while IP services revenues decreased $2.1 million, or 7%, compared to the same period in 2009.
 
Total revenues were $184.2 million for the nine months ended September 30, 2010, a decrease of $8.5 million, or 4%, compared to $192.7 million for the nine months ended September 30, 2009. Data center services revenues were $96.5 million and IP services revenues were $87.7 million for the nine months ended September 30, 2010, representing a decrease in data center services revenues of $1.1 million, or 1%, and a decrease in IP services revenues of $7.4 million, or 8%, compared to the same period in 2009.
 
Total operating costs and expenses, excluding goodwill impairment and restructuring disclosed separately, were $60.9 million and $66.2 million for the three months ended September 30, 2010 and 2009, respectively, and $184.1 million and $206.4 million for the nine months ended September 30, 2010 and 2009, respectively.
 
 
16

 
INTERNAP NETWORK SERVICES CORPORATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
 
At September 30, 2010, we had $68.3 million in cash and cash equivalents and $40.4 million in debt obligations, which included $20.4 million in capital leases and $20.0 million borrowed under our revolving credit facility. Net cash flows provided by operations were $28.2 million for the nine months ended September 30, 2010.

 
The following table sets forth selected consolidated statements of operations data during the periods presented, including comparative information between the periods (dollars in thousands):
                                                 
   
Three Months Ended
September 30,
   
Increase (decrease)
from
September 30, 2009
to
September 30, 2010
   
Nine Months Ended
September 30,
   
Increase (decrease)
from
September 30, 2009
to
September 30, 2010
 
   
2010
   
2009
   
Amount
   
Percent
   
2010
   
2009
   
Amount
   
Percent
 
Revenues:
                                               
Data center services
  $ 31,550     $ 33,547     $ (1,997 )     (6 )%   $ 96,468     $ 97,535     $ (1,067 )     (1 )%
IP services
    28,765       30,867       (2,102 )     (7 )     87,736       95,175       (7,439 )     (8 )
Total revenues
    60,315       64,414       (4,099 )     (6 )     184,204       192,710       (8,506 )     (4 )
                                                                 
Operating costs and expenses:
                                                               
Direct costs of network, sales and services, exclusive of depreciation and amortization, shown below:
                                                               
Data center services
    20,405       24,450       (4,045 )     (17 )     63,232       71,896       (8,664 )     (12 )
IP services
    11,162       12,047       (885 )     (7 )     33,683       36,844       (3,161 )     (9 )
Direct costs of network, sales and services, exclusive of depreciation and amortization, as a percentage of revenue, show below:
                                                               
Data center services
    64 %     72 %                     65 %     73 %                
IP services
    38 %     39 %                     38 %     38 %                
                                                                 
Direct costs of customer support
    5,438       4,767       671       14       15,793       13,608       2,185       16  
Direct costs of amortization of acquired technologies
    979       979                   2,937       7,370       (4,433 )     (60 )
Sales and marketing
    7,451       5,955       1,496       25       21,577       20,701       876       4  
General and administrative
    7,828       10,626       (2,798 )     (26 )     24,521       35,062       (10,541 )     (30 )
Depreciation and amortization
    7,601       7,313       288       4       22,388       20,895       1,493       7  
Loss (gain) on disposal of property and equipment
    (13 )     20       (33 )     165       7       20       (13 )     (65 )
Impairments and restructuring
                            1,201       54,608       (53,407 )     (98 )
Total operating costs and expenses
    60,851       66,157       (5,306 )     (8 )     185,339       261,004       (75,665 )     (29 )
Loss from operations
  $ (536 )   $ (1,743 )   $ 1,207       69 %   $ (1,135 )   $ (68,294 )   $ 67,159       98 %
Interest expense
  $ 618     $ 189     $ 429       227 %   $ 1,439     $ 557     $ 882       158 %
Provision for income taxes
  $ 634     $ 93     $ 541       582 %   $ 919     $ 575     $ 344       60 %

 
17

 
INTERNAP NETWORK SERVICES CORPORATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
 
Three Months Ended September 30, 2010 and 2009
 
Data Center Services
 
Revenues for data center services decreased $2.0 million, or 6%, to $31.5 million for the three months ended September 30, 2010, compared to $33.5 million for the same period in 2009. The decrease was a direct result of our ongoing efforts to proactively churn certain less profitable customer contracts in partner sites.
 
Direct costs of data center services, exclusive of depreciation and amortization, decreased $4.1 million, or 17%, to $20.4 million for the three months ended September 30, 2010, compared to $24.5 million for the same period in 2009. The decrease was also the result of our ongoing efforts to proactively churn certain less profitable customer contracts in partner sites, partially offset by an increase in facilities costs resulting from our expansion of company-controlled data centers.
 
IP Services
 
Revenues for IP services decreased $2.1 million, or 7%, to $28.8 million for the three months ended September 30, 2010, compared to $30.9 million for the same period in 2009. The decrease was driven by a decline in IP pricing for new and renewing customers and the loss of legacy contracts at higher effective prices, partially offset by an increase in overall traffic. IP traffic increased approximately 22% from the three months ended September 30, 2009 to the three months ended September 30, 2010, calculated based on an average over the sum of the months in the respective periods.
 
Direct costs of IP services, exclusive of depreciation and amortization, decreased $0.8 million, or 7%, to $11.2 million for the three months ended September 30, 2010, compared to $12.0 million for the same period in 2009. This decrease is due to lower connectivity costs, which vary based upon customer traffic volume and other demand-based pricing variables. In addition, costs for IP services are subject to ongoing negotiations for pricing and minimum commitments. As our IP traffic continues to grow, we expect to obtain lower bandwidth rates and more opportunities to proactively manage network costs, such as utilization and traffic optimization among network service providers.
 
Compensation
 
Total compensation and benefits, including stock-based compensation, was $14.3 million and $14.1 million for the three months ended September 30, 2010 and 2009, respectively.

Cash-based compensation and benefits were $13.1 million for the three months ended September 30, 2010 compared to $13.0 million for the same period in 2009.
 
Stock-based compensation was $1.1 million for each of the three months ended September 30, 2010 and 2009. The following table summarizes the amount of stock-based compensation, net of estimated forfeitures, included in the accompanying consolidated statements of operations (in thousands):
             
 
Three Months Ended
September 30,
 
 
2010
 
2009
 
             
Direct costs of customer support
  $ 294     $ 285  
Sales and marketing
    263       362  
General and administrative
    557       424  
    $ 1,114     $ 1,071  
 
Direct Costs of Customer Support
 
Direct costs of customer support increased $0.6 million, or 14%, to $5.4 million for the three months ended September 30, 2010 compared to $4.8 million for the same period in 2009. The increase was primarily due to additional cash-based compensation related to increased headcount given our expansion of company-controlled data centers and the resulting expansion of our customer support function.
 
Direct Costs of Amortization
 
Direct costs of amortization of acquired technologies was $1.0 million for the three months ended September 30, 2010 and 2009.
 
 
18

 
INTERNAP NETWORK SERVICES CORPORATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
 
Sales and Marketing
 
Sales and marketing costs increased $1.5 million, or 25%, to $7.5 million for the three months ended September 30, 2010, compared to $6.0 million for the same period in 2009. The increase was primarily due to an increase of $1.0 million in commissions related to an increased number of sales representatives, $0.3 million in marketing and $0.2 million in professional services related to recruiting.
 
General and Administrative
 
General and administrative costs decreased $2.8 million, or 26%, to $7.8 million for the three months ended September 30, 2010, compared to $10.6 million for the same period in 2009. The decrease was primarily due to a reduction in employee headcount of $0.4 million, executive severance of $0.5 million that we paid in the prior period and decreases of $1.0 million in professional services and $0.3 million in bad debt expense.
 
Depreciation and Amortization
 
Depreciation and amortization, excluding acquired technologies, increased 4% to $7.6 million for the three months ended September 30, 2010, compared to $7.3 million for the same period in 2009. The increase was primarily due to the effects of our expansion of company-controlled data centers and P-NAP infrastructure.
 
Interest Expense
 
Interest expense for the three months ended September 30, 2010 and 2009 was $0.6 million and $0.2 million, respectively. The increase in interest expense was primarily due to $16.7 million in new capital lease obligations related to our expansion of company-controlled data centers in Santa Clara, California and expansion of our data center in Seattle, Washington.
 
Provision for Income Taxes
 
We recorded a provision for income taxes of $0.6 million for the three months ended September 30, 2010, compared to $0.1 million for the same period in 2009. Our effective income tax rate, as a percentage of pre-tax income, for the three months ended September 30, 2010 and 2009, was (55%) and (5%), respectively. The fluctuation in the effective income tax rate was attributable to recognition of income taxes in the United Kingdom (“U.K.”), permanent tax adjustment items, a change in valuation allowance and state income taxes.
 
Nine Months Ended September 30, 2010 and 2009
 
Data Center Services
 
Revenues for data center services decreased $1.0 million, or 1%, to $96.5 million for the nine months ended September 30, 2010, compared to $97.5 million for the same period in 2009. The decrease was a direct result of our ongoing efforts to proactively churn certain less profitable customer contracts in partner sites.
 
Direct costs of data center services, exclusive of depreciation and amortization, decreased $8.7 million, or 12%, to $63.2 million for the nine months ended September 30, 2010, compared to $71.9 million for the same period in 2009. The decrease was also the result of our ongoing efforts to proactively churn certain less profitable customer contracts in partner sites, partially offset by an increase in facilities costs resulting from our expansion of company-controlled data centers.
 
IP Services
 
Revenues for IP services decreased $7.5 million, or 8%, to $87.7 million for the nine months ended September 30, 2010, compared to $95.2 million for the same period in 2009. The decrease was driven by a decline in IP pricing for new and renewing customers and the loss of legacy contracts at higher effective prices, partially offset by an increase in overall traffic. IP traffic increased approximately 34% from the nine months ended September 30, 2009 to the nine months ended September 30, 2010, calculated based on an average over the sum of the months in the respective periods.
 
Direct costs of IP services, exclusive of depreciation and amortization, decreased $3.1 million, or 9%, to $33.7 million for the nine months ended September 30, 2010, compared to $36.8 million for the same period in 2009. This decrease is due to lower connectivity costs, which vary based upon customer traffic volume and other demand-based pricing variables. In addition, costs for IP services are subject to ongoing negotiations for pricing and minimum commitments. As our IP traffic continues to grow, we expect to obtain lower bandwidth rates and more opportunities to proactively manage network costs, such as utilization and traffic optimization among network service providers.
 
Compensation
 
Total compensation and benefits, including stock-based compensation, was $41.7 million and $44.9 million for the nine months ended September 30, 2010 and 2009, respectively.
 
 
19

 
INTERNAP NETWORK SERVICES CORPORATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
 
For the nine months ended September 30, 2010, cash-based compensation and benefits decreased $2.3 million to $38.1 million from $40.4 million for the same period in 2009. The decrease was primarily attributable to a benefit of $0.3 million as the result of reduced employee headcount, executive severance of $0.5 million that we paid in the prior period, a $1.6 million Georgia Headquarters Tax Credit (“HQC”), $0.9 million related to the transition of our chief executive officer incurred in 2009 and a benefit of $0.4 million related to the reversal of a bonus accrual for the year ended December 31, 2009, offset by a $0.5 million increase in our bonus accrual for the year ending December 31, 2010 and a $1.5 million increase in commissions. The HQC is a state of Georgia sponsored incentive to relocate corporate headquarters to and increase employment in Georgia. We record the HQC when approved by the Georgia Department of Revenue and are required to apply the credit against our payroll liability.
 
Stock-based compensation decreased $0.8 million to $3.6 million for the nine months ended September 30, 2010 from $4.4 million for the same period in 2009. The decrease was primarily attributable to a reduction of stock-based compensation expense of $0.8 million related to the transition of our chief executive officer incurred during the nine months ended September 30, 2009. The following table summarizes the amount of stock-based compensation, net of estimated forfeitures, included in the accompanying consolidated statements of operations (in thousands):
             
 
Nine Months Ended
September 30,
 
 
2010
 
2009
 
             
Direct costs of customer support
  $ 897     $ 827  
Sales and marketing
    790       1,102  
General and administrative
    1,865       2,505  
    $ 3,552     $ 4,434  
 
Direct Costs of Customer Support
 
Direct costs of customer support increased $2.2 million, or 16%, to $15.8 million for the nine months ended September 30, 2010 from $13.6 million for the same period in 2009. The increase was primarily due to a $2.5 million increase in cash-based compensation and employee benefits related to increased headcount given our expansion of company-controlled data centers and the resulting expansion of our customer support function, of which $1.1 million resulted from a transfer of employees from the sales and marketing support function to the customer support function as described below in “Sales and Marketing,” partially offset by $0.3 million related to executive severance incurred in 2009 and the HQC benefit of $0.5 million.
 
Direct Costs of Amortization
 
Direct costs of amortization of acquired technologies decreased $4.5 million, or 60%, to $2.9 million for the nine months ended September 30, 2010 from $7.4 million for the same period in 2009. In conjunction with consolidating our business segments during the second quarter of 2009, we also performed an analysis of 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 in the second quarter of 2009 of $4.1 million in acquired CDN technology due to a strategic change in how we manage our business.
 
Sales and Marketing
 
Sales and marketing costs increased $0.9 million, or 4%, to $21.6 million for the nine months ended September 30, 2010, compared to $20.7 million for the same period in 2009. The increase was primarily due to a $1.7 million increase in commissions as a result of an increased number of sales representatives, a $0.5 million increase in marketing and a $0.5 million increase in professional services related to recruiting, partially offset by a $0.4 million decrease in non-essential sales facilities cost, a $0.3 million decrease in stock-based compensation and a $1.4 million decrease in cash-based compensation as the result of reduced employee headcount in this function, of which $1.1 million resulted from a transfer of employees from the sales and marketing support function to the customer support function, whereby these positions were redefined and the reporting structure aligned under the customer support function.
 
General and Administrative
 
General and administrative costs decreased $10.5 million, or 30%, to $24.5 million for the nine months ended September 30, 2010, compared to $35.0 million for the same period in 2009. The decrease resulted primarily from a $1.5 million decrease in cash-based compensation related to reduced employee headcount, a $0.5 million decrease in severance incurred in 2009, a benefit of $1.7 million related to cash-based and stock-based compensation for the transition of our chief executive officer incurred in 2009, a $0.9 million HQC, a $1.0 million decrease in bad debt expense and a $4.7 million decrease in professional services. Professional services costs were higher in the prior period due primarily to the use of consultants for finance and temporary information technology, personnel recruiting services and higher accounting and audit fees.
 
 
20

 
INTERNAP NETWORK SERVICES CORPORATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
 
Depreciation and Amortization
 
Depreciation and amortization, excluding acquired technologies, increased 7% to $22.4 million for the nine months ended September 30, 2010, compared to $20.9 million for the same period in 2009. The increase was primarily due to the effects of our expansion of company-controlled data centers and P-NAP infrastructure.
 
Impairments and Restructurings
 
Impairments and restructuring for the nine months ended September 30, 2010 and 2009 were $1.2 million and $54.6 million, respectively. In conjunction with consolidating our business segments during the second quarter of 2009, we also performed an analysis of potential goodwill impairment. The analysis resulted in an impairment charge of $51.5 million to goodwill in our IP services segment and former CDN services segment. The restructuring charge incurred in the nine months ended September 30, 2010 was primarily related to plan adjustments in sublease income assumptions for certain properties included in our previously disclosed 2007 and 2001 restructuring plans.
 
Interest Expense
 
Interest expense for the nine months ended September 30, 2010 and 2009 was $1.4 million and $0.5 million, respectively. The increase in interest expense is primarily due to the $16.7 million in new capital lease obligations related to our expansion of company-controlled data center in Santa Clara, California and expansion of our data center in Seattle, Washington during 2010.
 
Provision for Income Taxes
 
We recorded a provision for income taxes of $0.9 million for the nine months ended September 30, 2010, compared to $0.6 million for the same period in 2009. Our effective income tax rate, as a percentage of pre-tax income, for the nine months ended September 30, 2010 and 2009, was (36%) and (1%), respectively. The fluctuation in the effective income tax rate was attributable to recognition of income taxes in the U.K., permanent tax adjustment items, a change in valuation allowance and state income taxes.
 
We continue to maintain a valuation allowance against our deferred tax assets of $128.0 million. The total deferred tax assets primarily consist of net operating loss carryforwards. We may recognize U.S. deferred tax assets in future periods when we estimate them to be realizable. Based on an analysis of our historic and projected future U.S. pre-tax income, we do not have sufficient positive evidence to expect a release of our valuation allowance against our U.S. deferred tax assets currently or within the next 12 months. Accordingly, we continue to maintain the full valuation allowance in the U.S. and all foreign jurisdictions, other than the U.K.
 
Liquidity and Capital Resources
 
Cash Flow for the Nine Months Ended September 30, 2010 and 2009
 
Net Cash from Operating Activities
 
Net cash provided by operating activities was $28.2 million for the nine months ended September 30, 2010. Our net loss, after adjustments for non-cash items, generated cash from operations of $27.8 million while changes in operating assets and liabilities generated cash from operations of $0.4 million. We anticipate continuing to generate cash flows from our results of operations, adjusted for non-cash items, and managing changes in operating assets and liabilities toward a net $0 change over time. We also expect to use cash flows from operating activities to fund a portion of our capital expenditures and other requirements and to meet our other commitments and obligations, including outstanding debt, as they become due.
 
The primary non-cash adjustment in the nine months ended September 30, 2010 was $25.3 million for depreciation and amortization, including direct costs of amortization of acquired technologies, which included the effects of the expansion of our company-controlled data centers and P-NAP facilities. Non-cash adjustments also included $3.6 million for stock-based compensation expense. The changes in operating assets and liabilities included a $7.0 million increase in accounts payable primarily due to expenses incurred as a result of the upgrade and expansion of our company-controlled data centers, which was offset by a $2.2 million decrease in accrued and other liabilities and deferred revenues, a $2.3 million increase in accounts receivable and a $1.7 million increase in prepaid expenses, deposits and other assets. Days sales outstanding at September 30, 2010 were 30 days, down from 34 days at September 30, 2009.
 
 
21

 
INTERNAP NETWORK SERVICES CORPORATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
 
Net cash provided by operating activities was $27.2 million for the nine months ended September 30, 2009. Our net loss, after adjustments for non-cash items, generated cash from operations of $18.3 million, while changes in operating assets and liabilities generated cash from operations of $8.9 million.
 
Net Cash from Investing Activities
 
Net cash used in investing activities for the nine months ended September 30, 2010 was $36.2 million, due to capital expenditures of $43.2 million, offset by maturities of investments in marketable securities of $7.0 million. Capital expenditures related to the continued expansion and upgrade of our company-controlled data centers and network infrastructure.
 
Net cash used in investing activities for the nine months ended September 30, 2009 was $5.7 million, due to capital expenditures of $13.0 million, offset by maturities of investments in marketable securities of $7.2 million. Our capital expenditures related to the continued expansion and upgrade of our company-controlled data centers and network infrastructure.
 
Net Cash from Financing Activities
 
Net cash provided by financing activities for the nine months ended September 30, 2010 was $2.4 million, primarily due to cash received upon the exercise of stock options. We also repaid and re-borrowed $58.5 million on our revolving credit facility. As a result of these activities, we had a balance of $20.0 million in notes payable.
 
Net cash used in financing activities for the nine months ended September 30, 2009 was $0.6 million, primarily due to $0.3 million for the acquisition of shares of treasury stock as payment of taxes due from employees for stock-based compensation and payments on capital leases of $0.2 million. We also repaid and re-borrowed $59.0 million on our revolving credit facility.
 
Liquidity
 
We continue to monitor and review our performance and operations in light of global economic conditions. The current economic environment may impact the ability of our customers to meet their obligations to us, which could result in delayed collection of accounts receivable and an increase in our provision for doubtful accounts. 
 
We expect to meet our cash requirements for the next 12 months through a combination of net cash provided by operating activities and existing cash and cash equivalents. We may also utilize additional borrowings under our new credit facility described below in “Credit Facility,” especially for capital expenditures, particularly if we consider it economically favorable to do so. Our capital requirements depend on a number of factors, including the continued market acceptance of our services and products and the ability to expand and retain our customer base. If our cash requirements vary materially from those currently expected or if we fail to generate sufficient cash flows from the sales of our services and products, we may require greater or additional financing sooner than anticipated. We can offer no assurance that we will be able to obtain additional financing on commercially favorable terms, or at all, and provisions in our new credit facility limit our ability to incur additional indebtedness. We believe we have sufficient cash to operate our business for the next 12 months.
 
We have experienced significant impairments and operational restructurings in recent years, which 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. For the three and nine months ended September 30, 2010, we had a net loss of $1.7 million and $3.2 million, respectively. As of September 30, 2010, our accumulated deficit was $1.0 billion. We do not expect to incur impairment charges on a regular basis, but we cannot guarantee that we will not incur other similar charges in the future or that we will be profitable in the future. Also, we are currently in a time of uncertain economic conditions and continue to see signs of cautious behavior from our customers. We continue to analyze our business to control our costs, principally through making process enhancements and renegotiating network contracts for more favorable pricing and terms. We may not be able to sustain or increase profitability on a quarterly basis, and our failure to do so may adversely affect our business, including our ability to raise additional funds. 
 
Credit Agreements
 
As of September 30, 2010, we had 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. This revolving credit facility was available to finance working capital, capital expenditures and other general corporate purposes. We made customary representations, warranties, negative and affirmative covenants to our lender (including certain financial covenants relating to a leverage ratio, a debt service coverage ratio and a minimum liquidity requirement, as well as a prohibition against paying dividends, limitations on capital expenditures, customary events of default and certain default provisions that could result in acceleration of all outstanding amounts due under the credit facility). As of September 30, 2010, we were in compliance with these covenants.
 
As of September 30, 2010, the revolving credit facility had an outstanding principal amount of $20.0 million (due September 2011), a total of $4.1 million of letters of credit issued and $10.9 million in borrowing capacity. The interest rate on the revolving credit facility as of September 30, 2010 was 3.25% based on our bank’s prime rate. Subsequent to September 30, 2010, we repaid $19.5 million of the outstanding balance. To effect a smooth transition to our new Credit Agreement (described below and in note 12 to the accompanying financial statements) and obtain approval of increased capital expenditures, we entered into an arrangement with our lender to maintain a compensating cash balance in a demand deposit account in an amount in excess of any amounts drawn under our then-existing revolving credit facility, including outstanding letters of credits. At September 30, 2010, the balance of this arrangement was $24.5 million. This arrangement was terminated as a result of entering into the Credit Agreement on November 2, 2010.
 
On November 2, 2010, we entered into an $80.0 million credit agreement (the “Credit Agreement”), which replaced our prior $35.0 million credit facility described above. Concurrently with the execution of the Credit Agreement, we closed the loans under the Credit Agreement and paid off and terminated our prior credit facility, provided that any outstanding letters of credit under the prior credit facility remain in effect until their expiration or replacement.
 
 
22

 
INTERNAP NETWORK SERVICES CORPORATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
 
Capital Leases
 
During the nine months ended September 30, 2010, we entered into a lease for a new company-controlled data center in Santa Clara, California and a lease amendment which expanded our company-controlled data center in Seattle, Washington. As a result, property and equipment and corresponding capital lease obligations increased by $16.7 million compared to the nine months ended September 30, 2009.
 
We summarize future minimum capital lease payments together with the present value of the minimum lease payments for all capital leases as of September 30, 2010 in note 10 to the accompanying financial statements.
 
Commitments and Other Obligations
 
We have commitments and other obligations that are contractual in nature and will represent a use of cash in the future. Service commitments primarily represent purchase commitments made to our largest bandwidth vendors and payments to lease, operate and maintain data centers for resale to customers. Our ability to improve cash provided by operations in the future would be negatively impacted if we do not grow our business at a rate that would allow us to offset the purchase commitments and other obligations with corresponding revenue growth.
 
During the nine months ended September 30, 2010, we entered into commitments for $20.8 million primarily related to IP, telecommunications and data center services.
 
The following table summarizes our credit obligations and future contractual commitments as of September 30, 2010:
 
        Payments Due by Period  
   
Total
   
Less
than 1
Year
   
1 – 3
Years
   
3 – 5
Years
   
More
than 5
Years
 
Revolving credit facility
  $ 20,064     $ 20,064     $     $     $  
Capital lease obligations
    33,334       714       5,922       6,570       20,128  
Operating lease commitments
    179,190       6,522       51,721       50,519       70,428  
Service and purchase commitments
    30,441       4,666       20,924       3,120       1,731  
Total
  $ 263,029     $ 31,966     $ 78,567     $ 60,209     $ 92,287  
 
 
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
Other Investments
 
We have invested $4.1 million in Internap Japan, our joint venture with NTT-ME Corporation and NTT Holdings. We account for this investment using the equity method and to date we have recognized $2.8 million in equity-method losses, representing our proportionate share of the aggregate joint venture losses and income. The joint venture investment is subject to foreign currency exchange rate risk.

Interest Rate Risk
 
Our objective in managing interest rate risk is to maintain favorable long-term fixed rate or a balance of fixed and variable rate debt that will lower our overall borrowing costs within reasonable risk parameters. Currently, our strategy for managing interest rate risk does not include the use of derivative securities. As of September 30, 2010, our long-term debt consisted of $20.0 million borrowed under our revolving credit facility with an interest rate of 3.25% based on our bank’s prime rate. We estimate that a change in the interest rate of 100 basis points would change our interest expense and payments by $0.2 million per year, assuming we maintain a comparable amount of outstanding principal throughout the year. On November 2, 2010, we repaid the remaining balance outstanding on our prior revolving credit facility in conjunction with our new $80.0 million Credit Agreement as discussed in note 12 to the accompanying financial statements.
 
Foreign Currency Risk
 
Substantially all of our revenue is currently in U.S. dollars and from customers primarily in the U.S. We do not believe, therefore, that we currently have any significant direct foreign currency exchange rate risk.
 
ITEM 4. CONTROLS AND PROCEDURES
 
Disclosure Controls and Procedures
 
Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of September 30, 2010.
 
 
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Changes in Internal Control over Financial Reporting
 
No changes occurred in our internal controls over financial reporting during the period covered by this Quarterly Report on Form 10-Q that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.

 
PART II. OTHER INFORMATION
 
ITEM 1. LEGAL PROCEEDINGS
 
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 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 (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 common 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 Holdings, Inc (“VitalStream”), which we acquired in February 2007, (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 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 as a defendant and lengthened the putative class period.
 
On September 11, 2009, we and the individual defendants filed motions to dismiss. 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. 
 
On September 15, 2010, the Court granted our motion to dismiss and denied the individual defendants' motion to dismiss. The Court dismissed plaintiffs' claims under Section 14(a) of the Exchange Act. With respect to plaintiffs' claims under Section 10(b) of the Exchange Act, the Court held that the Amended Complaint failed to satisfy the pleading requirements of the Private Securities Litigation Reform Act, but allowed plaintiffs' one final opportunity to amend the complaint. On October 26, 2010, plaintiffs filed their Third Amended Class Action Complaint. We intend to file a motion to dismiss this complaint.
 
Derivative Action Litigation