Internap Corporation
INTERNAP NETWORK SERVICES CORP (Form: 10-Q, Received: 07/26/2012 17:16:59)


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 June 30, 2012
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.)
   
 
One Ravinia Drive, Suite 1300
Atlanta, Georgia 30346
(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 x 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 July 19, 2012, 53,244,258 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 JUNE 30, 2012
TABLE OF CONTENTS
         
       
Pages
         
   
PART I. FINANCIAL INFORMATION
   
         
ITEM 1.
 
FINANCIAL STATEMENTS
  1
         
   
Unaudited Condensed Consolidated Statements of Operations and Comprehensive Loss
  1
         
   
Unaudited Condensed Consolidated Balance Sheets
  2
         
   
Unaudited Condensed Consolidated Statements of Stockholders’ Equity
  3
         
   
Unaudited Condensed Consolidated Statements of Cash Flows
  4
         
   
Unaudited Condensed Notes to Consolidated Financial Statements
  5
         
ITEM 2.
 
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
  10
         
ITEM 3.
 
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
  17
         
ITEM 4.
 
CONTROLS AND PROCEDURES
  18
         
   
PART II. OTHER INFORMATION
   
         
ITEM 1.
 
LEGAL PROCEEDINGS
  18
         
ITEM 1A.
 
RISK FACTORS
  18
         
ITEM 2.
 
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
  18
         
ITEM 6.
 
EXHIBITS
  19
         
   
SIGNATURES
   
 
i
 
 
 

 
 
INTERNAP NETWORK SERVICES CORPORATION AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE LOSS
(In thousands, except per share amounts)
 
 
 
Three Months Ended
June 30,
    Six Months Ended
June 30,
 
 
2012
   
2011
   
2012
   
2011
 
Revenues:
                     
Data center services
$ 41,493     $ 32,481     $ 81,431     $ 64,023  
Internet protocol (IP) services
  27,194       27,929       54,284       55,791  
Total revenues
  68,687       60,410       135,715       119,814  
                               
Operating costs and expenses:
                             
Direct costs of network, sales and services, exclusive of depreciation
                             
and amortization, shown below:
                             
Data center services
  22,649       19,733       43,619       38,263  
IP services
  9,992       10,836       20,177       21,336  
Direct costs of customer support
  6,481       5,374       13,209       10,485  
Direct costs of amortization of acquired technologies
  1,179       875       2,359       1,750  
Sales and marketing
  8,314       7,731       16,404       15,564  
General and administrative
  10,676       7,449       20,901       16,577  
Depreciation and amortization
  8,664       8,768       16,579       16,822  
(Gain) loss on disposal of property and equipment, net
  (4 )     11       (20 )     84  
Restructuring and impairments
  645       1,304       688       1,492  
Total operating costs and expenses
  68,596       62,081       133,916       122,373  
Income (loss) from operations
  91       (1,671 )     1,799       (2,559 )
                               
Non-operating expense:
                             
Interest expense
  1,754       875       3,339       1,522  
Other, net
  254       48       295       87  
Total non-operating expense
  2,008       923       3,634       1,609  
                               
Loss before income taxes and equity in (earnings) of equity-method
investment
  (1,917 )     (2,594 )     (1,835 )     (4,168 )
Provision for income taxes
  179       106       215       179  
Equity in (earnings) of equity-method investment, net of taxes
  (99 )     (88 )     (160 )     (235 )
                               
Net loss
  (1,997 )     (2,612 )     (1,890 )     (4,112 )
                               
Other comprehensive (loss) income:
                             
Foreign currency translation adjustment, net of income taxes
  (114 )     20       (29 )     220  
                               
Comprehensive loss
$ (2,111 )   $ (2,592 )   $ (1,919 )   $ (3,892 )
                               
Basic and diluted net loss per share
$ (0.04 )   $ (0.05 )   $ (0.04 )   $ (0.08 )
Weighted average shares outstanding used in computing basic
and diluted net loss per share
  50,453       50,174       50,497       50,251  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
1

 

INTERNAP NETWORK SERVICES CORPORATION AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except par value amounts)
 
             
   
June 30,
2012
   
December 31,
2011
 
             
ASSETS
           
Current assets:
           
Cash and cash equivalents
 
$
27,624
   
$
29,772
 
Accounts receivable, net of allowance for doubtful accounts of $1,947 and $1,668, respectively
   
21,848
     
18,539
 
Prepaid expenses and other assets
   
12,299
     
13,270
 
Total current assets
   
61,771
     
61,581
 
                 
Property and equipment, net
   
229,096
     
198,369
 
Investment in joint venture
   
3,060
     
2,936
 
Intangible assets, net
   
24,115
     
26,886
 
Goodwill
   
59,605
     
59,471
 
Deposits and other assets
   
5,233
     
5,371
 
Deferred tax asset, net
   
1,957
     
2,096
 
Total assets
 
$
384,837
   
$
356,710
 
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
Current liabilities:
               
Accounts payable
 
$
28,359
   
$
21,746
 
Accrued liabilities
   
9,915
     
9,152
 
Deferred revenues
   
2,531
     
2,475
 
Revolving credit facility
   
     
100
 
Capital lease obligations
   
3,712
     
2,154
 
Term loan, less discount of $203 and $206, respectively
   
2,797
     
2,794
 
    Accrued contingent consideration
   
4,889
     
 
Restructuring liability
   
2,520
     
2,709
 
Other current liabilities
   
163
     
151
 
Total current liabilities
   
54,886
     
41,281
 
                 
Deferred revenues
   
2,457
     
2,323
 
Capital lease obligations
   
43,932
     
38,923
 
Revolving credit facility
   
14,856
     
 
Term loan, less discount of  $267 and $367, respectively
   
53,983
     
55,383
 
Accrued contingent consideration
   
     
4,626
 
Restructuring liability
   
4,092
     
4,884
 
Deferred rent
   
15,708
     
16,100
 
Other long-term liabilities
   
970
     
1,020
 
Total liabilities
   
190,884
     
164,540
 
Commitments and contingencies (Note 8)
               
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; 53,207 and 52,528 shares outstanding, respectively
   
53
     
53
 
Additional paid-in capital
   
1,239,653
     
1,235,554
 
Treasury stock, at cost; 240 and 231 shares, respectively
   
(1,663
)
   
(1,266
)
Accumulated deficit
   
(1,043,762
)
   
(1,041,872
)
Accumulated items of other comprehensive loss
   
(328
)
   
(299
)
   Total stockholders’ equity
   
193,953
     
192,170
 
   Total liabilities and stockholders’ equity
 
$
384,837
   
$
356,710
 
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
2

 

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

   
Common Stock
                               
   
Shares
   
Par
Value
   
Additional
Paid-In
Capital
   
Treasury
Stock
   
Accumulated
Deficit
   
Accumulated
Other
Comprehensive
Loss
   
Total
Stockholders’
Equity
 
                                           
SIX MONTHS ENDED JUNE 30, 2012:
                                         
Balance, December 31, 2011
   
52,528
   
$
53
   
$
1,235,554
   
$
(1,266
)
 
$
(1,041,872
)
 
$
(299
)
 
$
192,170
 
Net loss
   
     
     
     
     
(1,890
)
   
     
(1,890
)
Foreign currency
   translation adjustment
   
     
     
     
     
     
(29
)
   
(29
)
Stock-based
   compensation
   
     
     
3,252
     
     
     
     
3,252
 
    Other stock
   compensation plans
                                                       
   activity
   
679
     
     
847
     
(397
)
   
     
     
450
 
Balance, June 30, 2012
   
53,207
   
$
53
   
$
1,239,653
   
$
(1,663
)
 
$
(1,043,762
)
 
$
(328
)
 
$
193,953
 
                                                         
SIX MONTHS ENDED JUNE 30, 2011:
                                                       
Balance, December 31, 2010
   
52,017
   
$
52
   
$
1,229,684
   
$
(520
)
 
$
(1,040,170
)
 
$
(435
)
 
$
188,611
 
Net loss
   
     
     
     
     
(4,112
)
   
     
(4,112
)
Foreign currency
   translation adjustment
   
     
     
     
     
     
220
     
220
 
Stock-based
   compensation
   
     
     
2,132
     
     
     
     
2,132
 
Other stock
   compensation plans
   activity
   
384
     
1
     
834
     
(672
)
   
     
     
163
 
Balance, June 30, 2011
   
52,401
   
$
53
   
$
1,232,650
   
$
(1,192
)
 
$
(1,044,282
)
 
$
(215
)
 
$
187,014
 
 
The accompanying notes are an integral part of these consolidated financial statements.

 
3

 

INTERNAP NETWORK SERVICES CORPORATION AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
 
             
   
Six Months Ended
June 30,
 
   
2012
   
2011
 
Cash Flows From Operating Activities:
           
Net loss
 
$
(1,890
)
 
$
(4,112
)
Adjustments to reconcile net loss to net cash provided by operating activities:
               
Depreciation and amortization
   
18,938
     
18,572
 
(Gain) loss on disposal of property and equipment, net
   
(20
)
   
84
 
Impairment of capitalized software
   
258
     
 
Stock-based compensation expense, net of capitalized amount
   
3,019
     
1,900
 
Non-cash change in accrued contingent consideration
   
263
     
 
Equity in (earnings) of equity-method investment
   
(160
)
   
(235
)
Provision for doubtful accounts
   
626
     
480
 
Non-cash changes in deferred rent
   
(391
)
   
(215
)
Non-cash changes in capital lease obligations
   
547
     
229
 
Other, net
   
214
     
238
 
Changes in operating assets and liabilities:
               
Accounts receivable
   
(3,935
)
   
(1,301
Prepaid expenses, deposits and other assets
   
812
     
(1,333
)
Accounts payable
   
6,613
     
(7,129
)
Accrued and other liabilities
   
989
     
(2,105
)
Deferred revenues
   
189
     
(551
)
Accrued restructuring liability
   
(980
)
   
172
 
Net cash flows provided by operating activities
   
25,092
     
4,694
 
                 
Cash Flows From Investing Activities:
               
Purchases of property and equipment
   
(39,493
)
   
(23,177
)
Net cash flows used in investing activities
   
(39,493
)
   
(23,177
)
                 
Cash Flows From Financing Activities:
               
Principal payments on term loan
   
(1,500
)
   
(500
)
Proceeds from revolving credit facility
   
14,756
     
 
Payments on capital lease obligations
   
(1,386
)
   
(622
)
Proceeds from exercise of stock options
   
1,353
     
833
 
Tax withholdings related to net share settlements of restricted stock awards
   
(902
)
   
(671
)
Other, net
   
(58
)
   
(66
)
Net cash flows provided by (used in) financing activities
   
12,263
     
(1,026
)
Effect of exchange rates on cash and cash equivalents
   
(10
)
   
25
 
Net decrease in cash and cash equivalents
   
(2,148
)
   
(19,484
)
Cash and cash equivalents at beginning of period
   
29,772
     
59,582
 
Cash and cash equivalents at end of period
 
$
27,624
   
$
40,098
 
                 
Supplemental disclosure of cash flow information:
               
Cash paid for interest
 
$
3,140
   
$
1,904
 
Cash paid for income taxes
   
125
     
243
 
Non-cash acquisition of property and equipment under capital leases
   
7,406
     
9,258
 
Capitalized stock-based compensation
   
233
     
232
 
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
4

 

INTERNAP NETWORK SERVICES CORPORATION AND SUBSIDIARIES
UNAUDITED CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
  
1.           NATURE OF OPERATIONS AND BASIS OF PRESENTATION
 
Internap Network Services Corporation (“we,” “us,” “our” or “Internap”) provides high-performance information technology (“IT”) Infrastructure services that enable our customers to focus on their core business, improve service levels and lower the cost of IT operations. Our colocation, connectivity and hosting solutions are differentiated by superior performance and platform flexibility.

We provide services at 42 data centers across North America, Europe and the Asia-Pacific region and through 83 Internet Protocol (“IP”) service points, which include 25 content delivery network (“CDN”) points of presence (“POPs”).

We prepare 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 June 30, 2012 and our operating results, cash flows and changes in stockholders’ equity for the interim periods presented. The balance sheet at December 31, 2011 was derived from our audited financial statements, but does not include all disclosures required by GAAP. 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, 2011 filed with the SEC.

The preparation of financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to revenue recognition, doubtful accounts, goodwill and intangible assets, accruals, stock-based compensation, income taxes, restructuring charges, leases, long-term service contracts, contingencies and litigation. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ materially from these estimates.

The results of operations for the six months ended June 30, 2012 are not necessarily indicative of the results that may be expected for any future periods or for the year ending December 31, 2012 or subsequent years.
 
2.           OPERATING SEGMENTS
 
We operate in two business segments: data center services and IP services. The data center services segment includes colocation services, which involves providing physical space within our data centers, as well as associated services such as power, interconnection, environmental controls and security. This segment also includes hosting services in which customers own and manage their software applications and content, while we provide and maintain the hardware, operating system, data center infrastructure and interconnection. Hosting services include our managed hosting offering in which customers receive dedicated hardware environments. Our data center services also include our cloud computing, storage business and related software services. The IP services segment includes our patented Performance IP™ service, Accelerated IP or XIP™, CDN services and flow control platform (“FCP”) products.

The following table shows operating results for our business segments, along with reconciliations from segment profit to income (loss) before income taxes and equity in (earnings) of equity-method investment:
 
 
5

 
 
  
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
 
2012
   
2011
 
2012
   
2011
 
Revenues:
             
Data center services
$
41,493
 
$
32,481
 
$
81,431
   
$
64,023
 
IP services
 
27,194
   
27,929
   
54,284
     
55,791
 
Total revenues
 
68,687
   
60,410
   
135,715
     
119,814
 
                   
Direct costs of network, sales and services, exclusive of depreciation and
       amortization:
                         
Data center services
 
22,649
   
19,733
   
43,619
     
38,263
 
IP services
 
9,992
   
10,836
   
20,177
     
21,336
 
Total direct costs of network, sales and services, exclusive of depreciation
   and amortization
 
32,641
   
30,569
   
63,796
     
59,599
 
                   
Segment profit:
                 
Data center services
 
18,844
   
12,748
   
37,812
     
25,760
 
IP services
 
17,202
   
17,093
   
34,107
     
34,455
 
Total segment profit
 
36,046
   
29,841
   
71,919
     
60,215
 
                   
Restructuring
 
645
   
1,304
   
688
     
1,492
 
Other operating expenses, including direct costs of customer support, depreciation and amortization
 
35,310
   
30,208
   
69,432
     
61,282
 
Income (loss) from operations
 
91
   
(1,671
)
 
1,799
     
(2,559
)
Non-operating expense
 
2,008
   
923
   
3,634
     
1,609
 
Loss before income taxes and equity in (earnings) of equity-method investment
$
(1,917
)
$
(2,594
)
$
(1,835
)
 
$
(4,168
)
 
  3.           PROPERTY AND EQUIPMENT

During January 2012, we performed a reassessment of estimated useful lives of certain assets included in our property and equipment, as we determined we were generally using these assets longer than originally anticipated. As a result, the estimated useful lives of these assets were affected as follows:
 
   
Estimated Useful Life
(in years)
   
Original
   
Revised
Network equipment
   
3
     
5
Capitalized software
   
3
     
5
Leasehold improvements
   
7
     
10-25

Effective January 1, 2012, we accounted for the change in estimated useful lives as a change in accounting estimate on a prospective basis. For the six months ended June 30, 2012, depreciation and amortization expense was $7.0 million less than it would have been under the previous estimated useful lives.

During the three months ended June 30, 2012, we determined that we would not use certain items in the future and recorded an impairment charge of $0.3 million to capitalized software related to products and product support software primarily in the data center services segment.  We include the impairment charge in “Restructuring and impairments” on the accompanying statements of operations and comprehensive loss.

4.           ACCRUED CONTINGENT CONSIDERATION

In conjunction with our acquisition of Voxel Holdings, Inc. (“Voxel”) in December 2011, we recorded a liability for accrued contingent consideration of $5.0 million, at its fair value of $4.6 million, to be paid if we receive certain technology deliverables. At December 31, 2011, the liability was included as a long-term liability, as the expected delivery date was on or before December 30, 2013.  

During the three months ended June 30, 2012, the expected delivery date was revised to on or before February 28, 2013.  At June 30, 2012, the fair value of the liability was calculated at $4.9 million, resulting in an adjustment to the liability of $0.3 million, which is included as a non-operating expense in “Other, net” on the accompanying statements of operations and comprehensive loss.
 
 
6

 
 
5.           RESTRUCTURING

In prior years, we implemented significant restructuring plans that resulted in substantial charges for our real estate obligations. During the six months ended June 30, 2012, we recorded subsequent plan adjustments in sublease income assumptions for certain properties included in our previously-disclosed restructuring plans.
 
 The following table displays the restructuring activity and balances during the six months ended June 30, 2012 (in thousands):

                       
   
December 31, 2011
Restructuring
Liability
   
Subsequent
Plan
Adjustments
   
Cash
Payments
   
June 30, 2012
Restructuring
Liability
Activity for 2011 restructuring charge:
                     
Real estate obligations
  $ 361     $ (67 )   $ (138 )   $ 156
Activity for 2007 restructuring charge:
                             
Real estate obligations
    5,162       261       (769     4,654
Activity for 2001 restructuring charge:
                             
Real estate obligations
    2,070       120       (388     1,802
                               
Total
  $ 7,593     $ 314     $ (1,295 )   $ 6,612
 
6.           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 and investments in marketable securities) measured at fair value on a recurring basis (in thousands):

   
Level 1
   
Level 2
   
Level 3
   
Total
 
June 30, 2012:
                       
Available for sale securities:
                       
Money market funds (1)
 
$
4,237
   
$
   
$
   
$
4,237
 
   
$
4,237
   
$
   
$
   
$
4,237
 
 
   
Level 1
   
Level 2
   
Level 3
   
Total
 
December 31, 2011:
                       
Available for sale securities:
                       
Money market funds (1)
 
$
9,237
   
$
   
$
   
$
9,237
 
   
$
9,237
   
$
   
$
   
$
9,237
 
 

(1) Included in “Cash and cash equivalents” in the consolidated balance sheets as of June 30, 2012 and December 31, 2011 in addition to $23.4 million and $20.6 million, respectively, of cash. Unrealized gains and losses on money market funds were nominal due to the short-term nature of the investments.

The fair value of our term loan and revolving credit facility, including current maturities, was $70.6 million and $58.6 million at June 30, 2012 and December 31, 2011, respectively, and was estimated using discounted cash flow analysis based on incremental borrowing rates for similar types of borrowing arrangements.
 
 
7

 
 
7.           LOSS PER SHARE
 
We compute basic net loss per share by dividing net loss attributable to our common stockholders by the weighted average number of shares of common stock outstanding during the period. We exclude all outstanding options and unvested restricted stock as such securities are anti-dilutive for all periods presented.

Basic and diluted net loss per share is calculated as follows (in thousands, except per share amounts):

 
               
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
 
2012
 
2011
 
2012
   
2011
 
                           
Net loss available to common stockholders
$
(1,997
)
$
(2,612
)
$
(1,890
)
 
$
(4,112
)
Weighted average shares outstanding, basic and diluted
 
50,453
   
50,174
   
50,497
     
50,251
 
Net loss per share, basic and diluted
$
(0.04
)
$
(0.05
)
$
(0.04
)
 
$
(0.08
)
Anti-dilutive securities excluded from diluted net loss per share calculation for stock-based compensation plans
 
6,337
   
6,447
   
6,337
     
6,447
 

8.          COMMITMENTS, CONTINGENCIES AND LITIGATION 
 
Capital Leases

We record capital lease obligations and leased property and equipment at the lesser of the present value of future lease payments based upon the terms of the related lease agreement or the fair value of the assets held under capital leases. As of June 30, 2012, our capital leases had expiration dates ranging from 2013 to 2023.
 
During 2011, we entered into a capital lease for new corporate office space in Atlanta, Georgia due to our Atlanta data center expansion into our then-existing corporate office space. During March 2012, we took possession of the space when it was available according to terms of the lease and recorded the related property and equipment and corresponding capital lease obligation of $7.4 million.
 
Future minimum capital lease payments and the present value of the minimum lease payments for all capital leases as of June 30, 2012, are as follows (in thousands): 
 
 
2012
 
$
7,905
 
 
2013
   
8,083
 
 
2014
   
8,270
 
 
2015
   
8,025
 
 
2016
   
6,716
 
 
Thereafter
   
31,591
 
 
Remaining capital lease payments
   
70,590
 
 
Less: amounts representing imputed interest
   
(22,946
)
 
Present value of minimum lease payments
   
47,644
 
 
Less: current portion
   
(3,712
)
     
$
43,932
 

Other Commitments

Our service and purchase commitments relate primarily related to IP, telecommunications and data center services.  As of June 30, 2012, future minimum payments under these commitments are as follows (in thousands):
 
 
2012
 
$
5,610
 
 
2013
   
4,072
 
 
2014
   
2,816
 
 
2015
   
2,266
 
 
2016
   
1,209
 
 
Thereafter
   
429
 
     
$
16,402
 

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.
 
 
8

 
 
Plaintiffs allege generally that, during the putative class period, we made misleading statements and omitted material information regarding (a) integration of VitalStream, which we acquired in 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 maintain our share price. 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. On December 10, 2010, we filed a motion to dismiss this complaint. On September 30, 2011, the Court granted in large part the motion to dismiss. The two remaining claims involve certain alleged misstatements concerning the progress of the integration of VitalStream and the stability of our CDN platform.
 
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. Given the developments in the securities class action described above, we intend to move to dismiss the derivative complaint.
 
While we will 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 described above may have a material adverse impact on our financial 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
 
During January 2012, we adopted new accounting guidance   related to convergence between GAAP and International Financial Reporting Standards (“IFRS”). The new guidance changes the wording used to describe many of the requirements in GAAP for measuring fair value and for disclosing information about fair value measurements to ensure consistency between GAAP and IFRS. The new guidance also expands the disclosures for fair value measurements that are estimated using significant unobservable (Level 3) inputs. The adoption had no impact on our financial condition or results of operations.

During January 2012, we adopted new accounting guidance related to the presentation of comprehensive income. The new guidance requires the presentation of components of net income and other comprehensive income either as one continuous statement or as two consecutive statements and eliminates the option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity. There is no change to the items that we must report in other comprehensive income or when we must reclassify an item of other comprehensive income to net income. Because the guidance impacts presentation only, it had no effect on our financial condition or results of operations.

During January 2012, we adopted new accounting guidance   which allows   an entity to make a qualitative evaluation about the likelihood of goodwill impairment. We will be required to perform the two-step impairment test only if we conclude, based on a qualitative assessment, the fair value of a reporting unit is more likely than not to be less than its carrying value. The adoption had no impact on our financial condition or results of operations. 
 
 
9

 
 
INTERNAP NETWORK SERVICES CORPORATION AND SUBSIDIARIES

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
This Quarterly Report on Form 10-Q contains “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 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 our Annual Report on Form 10-K for the year ended December 31, 2011 under Item 1A “Risk Factors.” We undertake no obligation to update any forward-looking statements as a result of new information, future events or otherwise.
 
As used herein, except as otherwise indicated by context, references to “we,” “us,” “our” or “Internap” refer to Internap Network Services Corporation.
 
Overview
 
Internap provides high-performance IT Infrastructure services that enable our customers to focus on their core business, improve service levels and lower the cost of IT operations. Our colocation, connectivity and hosting solutions are differentiated by superior performance and platform flexibility.
     
We currently have approximately 3,700 customers in 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; hosting and IT infrastructure; and telecommunications. For the three months ended June 30, 2012, revenues generated and long-lived assets located outside the United States (“U.S.”) were each less than 10% of our total revenues and assets.
 
Operating Segments
 
Data Center Services
 
Our data center services segment includes colocation services, which involves providing physical space within data centers and associated services such as power, interconnection, environmental controls and security. Colocation allows our customers to deploy and manage their servers, storage and other equipment in our secure data centers. The segment also includes hosting services in which customers own and manage their software applications and content, while we provide and maintain the hardware, operating system, data center infrastructure and interconnection. Hosting services include our managed hosting offering in which customers receive dedicated hardware environments. Our data center services also include our cloud computing, storage business and related software services. Our cloud business is characterized as “infrastructure-as-a-service,” in which customers use secure compute and storage resources by leveraging physical infrastructure that is shared with other customers. Our cloud offering allows customers to rapidly provision and de-provision resources as required.
 
Our data center services offer a broad spectrum of products which provide customers flexibility and the ability to bundle these services with our high performance IP connectivity and CDN services, along with hosting customers’ infrastructure, data and 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 (“SLAs”) and our team of dedicated support professionals.
 
We sell our colocation and/or hosting services at 42 data centers across North America, Europe and the Asia-Pacific region. We refer to 10 of these facilities as “company-controlled,” meaning we control the data centers’ operations, staffing and infrastructure and have directly negotiated long-term leases with the properties’ lessors. We refer to the remaining 32 data centers as “partner” sites. In these locations, we typically do not control operations and infrastructure and terms are shorter than those in company-controlled data centers. Our facilities feature our enhanced IP connectivity, are designed and operated to be fully-secure and provide best-in-class power and environmental reliability.

We believe the demand for data center services continues to outpace industry-wide supply. To address this demand, we continue to incur capital expenditures to build and expand company-controlled data centers. During 2012, we continued our build out of a new company-controlled data center in Los Angeles, California and we began the expansion of our company-controlled data center in Atlanta, Georgia. These expansions give us the capacity to increase the footprint of our company-controlled data centers by approximately 86,000 net sellable feet over time.
 
We include Voxel Holdings, Inc. (“Voxel”) operations in our data center services segment. We acquired Voxel, a global provider of scalable hosting and cloud services, on December 30, 2011.
 
 
10

 
 
IP Services
 
Our IP services segment includes our patented Performance IP™ service, Accelerated IP or XIP™, CDN services and flow control platform (“FCP”) products. By intelligently routing traffic with redundant, high-speed connections over multiple major Internet backbones, our IP services provide high-performance and highly-reliable delivery of content, applications and communications to end-users globally. We sell our IP services through 83 IP service points around the world, which include 25 CDN points of presence (“POPs”). Our SLAs guarantee performance across multiple networks covering a broader segment of the Internet in the United States, excluding local connections, than providers of conventional Internet connectivity, which typically only guarantee performance on their own network.

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 IT 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 POPs. Providing capacity-on-demand to handle large events and unanticipated traffic spikes, we deliver scalable high-quality content distribution and audience-analytic tools.

Recent Accounting Pronouncements

We summarize recent accounting pronouncements in note 9 to the accompanying consolidated financial statements.  The adoption of recent accounting pronouncements had no impact on our financial condition or results of operations.

Critical Accounting Policies and Estimates
 
Property and Equipment

During January 2012, we performed a reassessment of estimated useful lives of certain assets included in our property and equipment, as we determined we were generally using these assets longer than originally anticipated. As a result, the estimated useful lives of these assets were affected as follows:
             
   
Estimated Useful
Life (in years)
 
   
Original
   
Revised
 
Network equipment
   
3
     
5
 
Capitalized software
   
3
     
5
 
Leasehold improvements
   
7
     
10-25
 

Effective January 1, 2012, we accounted for the change in estimated useful lives as a change in accounting estimate on a prospective basis. For the six months ended June 30, 2012, depreciation and amortization expense, on assets held at December 31, 2011, was $7.0 million less than it would have been under the previous estimated useful lives.

We expect less depreciation expense in the future as a result of this change in accounting estimate. Accordingly, it is possible that we will recognize deferred tax assets in the future upon evidence of continued profitability. We do not expect to recognize the deferred tax assets in the next 12 months.

For additional information regarding all of our property and equipment accounting policies, see our Annual Report on Form 10-K for the year ended December 31, 2011.
 
 
11

 
 
  Results of Operations

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
June 30,
   
Increase (Decrease)
from June 30, 2011
to June 30, 2012
 
   
2012
   
2011
   
Amount
   
Percent
 
Revenues:
                       
Data center services
 
$
41,493
   
$
32,481
   
$
9,012
     
28
%
IP services
   
27,194
     
27,929
     
(735
)
   
(3
)
Total revenues
   
68,687
     
60,410
     
8,277
     
14
 
                                 
Operating costs and expenses:
                               
Direct costs of network, sales and services,
exclusive of depreciation and amortization,
shown below:
                               
Data center services
   
22,649
     
19,733
     
2,916
     
15
 
IP services
   
9,992
     
10,836
     
(844
)
   
(8
)
Direct costs of customer support
   
6,481
     
5,374
     
1,107
     
21
 
Direct costs of amortization of acquired technologies
   
1,179
     
875
     
304
     
35
 
Sales and marketing
   
8,314
     
7,731
     
583
     
8
 
General and administrative
   
10,676
     
7,449
     
3,227
     
43
 
Depreciation and amortization
   
8,664
     
8,768
     
(104
)
   
(1
)
(Gain) loss on disposal of property and equipment, net
   
(4
)
   
11
     
(15
)
   
(136
)
Restructuring
   
645
     
1,304
     
(659
)
   
(51
)
Total operating costs and expenses
   
68,596
     
62,081
     
6,515
     
10
 
Income (loss) from operations
 
$
91
   
$
(1,671
)
 
$
1,762
     
105
 
                                 
Interest expense
 
$
1,754
   
$
875
   
$
879
     
100
 

Three Months Ended June 30, 2012 and 2011
 
Data Center Services
 
Revenues for data center services increased $9.0 million, or 28%, to $41.5 million for the three months ended June 30, 2012, compared to $32.5 million for the same period in 2011. The increase in revenue was primarily due to revenue growth in company-controlled colocation and hosting services.
 
Direct costs of data center services, exclusive of depreciation and amortization, were $22.6 million for the three months ended June 30, 2012, compared to $19.7 million for the same period in 2011. The increase in direct costs was primarily due to the increase in our hosting services revenue and costs related to the expansion of our Atlanta data center.
 
Direct costs of data center services, exclusive of depreciation and amortization, have substantial fixed cost components, primarily rent for operating leases, but also significant demand-based pricing variables, such as utilities attributable to seasonal costs and customers’ changing power requirements. 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, and 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 will continue to focus on increasing revenues from company-controlled facilities as compared to partner sites. We also expect direct costs of data center services as a percentage of corresponding revenues to decrease as our recently-expanded company-controlled data centers continue to contribute to revenue and become more fully occupied. This is evidenced by the improvement in direct costs of data center services as a percentage of corresponding revenues of 55% during the three months ended June 30, 2012, compared to 61% during the same period in 2011.
 
 
12

 
 
IP Services
 
Revenues for IP services decreased $0.7 million, or 3%, to $27.2 million for the three months ended June 30, 2012, compared to $27.9 million for the same period in 2011. 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 38.4% for the three months ended June 30, 2012, compared to the same period in 2011, calculated based on an average over the number of months in the respective periods.

Direct costs of IP services, exclusive of depreciation and amortization, decreased $0.8 million, or 8%, to $10.0 million for the three months ended June 30, 2012, compared to $10.8 million for the same period in 2011. This decrease was primarily due to the decrease in revenue.
 
There have been ongoing industry-wide pricing declines over the last several years. Technological improvements and excess capacity have been the primary drivers for lower pricing of IP services and the more recent entrance of a large number of specialty service providers such as CDN vendors. We also continue to experience increasing traffic volume in our traditional IP services. The increase in IP traffic resulted from both new and existing customers using more applications and the nature of applications consuming greater amounts of bandwidth.

Other Operating Costs and Expenses
 
Compensation. Total compensation and benefits, including stock-based compensation, were $17.3 million and $13.7 million for the three months ended June 30, 2012 and 2011, respectively.
 
Cash-based compensation and benefits increased $2.9 million to $15.7 million during the three months ended June 30, 2012 from $12.7 million during the same period in 2011. The increase was primarily due to a $1.7 million increase in cash-based compensation and payroll taxes related to a higher employee headcount and increased salary levels, a $0.4 million increase in bonus compensation, a $0.4 million increase in severance and a $0.5 million increase in insurance.
 
Stock-based compensation, net of amount capitalized, increased to $1.6 million during the three months ended June 30, 2012 from $1.0 million during the same period in 2011. The increase was primarily due to stock-based compensation awarded in connection with the Voxel acquisition and forfeitures upon terminations of employment in the three months ended June 30, 2011.  The following table summarizes the amount of stock-based compensation, net of estimated forfeitures, included in the accompanying consolidated statements of operations during the three months ended June 30, 2012 and 2011 (in thousands):

   
2012
   
2011
 
Direct costs of customer support
 
$
205
   
$
179
 
Sales and marketing
   
243
     
262
 
General and administrative
   
1,167
     
548
 
   
$
1,615
   
$
989
 
 
Direct Costs of Customer Support . Direct costs of customer support increased 21% to $6.5 million during the three months ended June 30, 2012 from $5.4 million during the same period in 2011. The increase was primarily due to a $1.1 million increase in cash-based compensation and payroll taxes.
 
Direct Costs of Amortization of Acquired Technologies . Direct costs of amortization of acquired technologies increased 35% to $1.2 million during the three months ended June 30, 2012 from $0.9 million during the same period in 2011. The increase was primarily due to the amortization on the intangible assets acquired in the Voxel acquisition.
 
Sales and Marketing . Sales and marketing costs increased 8% to $8.3 million during the three months ended June 30, 2012 from $7.7 million during the same period in 2011. The increase was primarily due to a $0.3 million increase in cash-based compensation and payroll taxes.
 
General and Administrative . General and administrative costs increased 43% to $10.7 million during the three months ended June 30, 2012 from $7.4 million during the same period in 2011. The increase was primarily due to a $0.3 million increase in cash-based compensation and payroll taxes, a $0.4 million increase in bonus compensation, a $0.6 million increase in stock-based compensation, a $0.5 million increase in taxes and licenses and a $0.6 million increase in outside professional fees primarily for recruiting and labor.
 
Depreciation and Amortization . Depreciation and amortization decreased 1% to $8.7 million during the three months ended June 30, 2012, compared to $8.8 million during the same period in 2011. The decrease was primarily due to our change in estimated useful lives of $3.5 million on assets held at December 31, 2011, partially offset by the effects of our expansion of company-controlled data centers, private network access points (“P-NAP”) infrastructure and capitalized software.
 
 
13

 
 
Restructuring and Impairments .  For the three months ended June 30, 2012, restructuring and impairments included $0.3 million for adjustments to previously implemented restructuring plans and $0.3 million for impairment on capitalized software.

Interest Expense . Interest expense increased to $1.8 million during the three months ended June 30, 2012, compared to $0.9 million during the same period in 2011. The increase in interest expense was primarily due to new capital lease obligations related to expansion of our company-controlled data centers and the increase in our term loan and revolving credit facility.

Six Months Ended June 30, 2012 and 2011

The following table sets forth selected consolidated statements of operations data during the periods presented, including comparative information between the periods (dollars in thousands):
 
   
Six Months Ended
June 30,
   
Increase (Decrease)
from June 30, 2011
to June 30, 2012
 
   
2012
   
2011
   
Amount
   
Percent
 
Revenues:
                       
Data center services
 
$
81,431
   
$
64,023
   
$
17,408
     
27
%
IP services
   
54,284
     
55,791
     
(1,507
)
   
(3
)
Total revenues
   
135,715
     
119,814
     
15,901
     
13
 
                                 
Operating costs and expenses:
                               
Direct costs of network, sales and services,
exclusive of depreciation and amortization,
shown below:
                               
Data center services
   
43,619
     
38,263
     
5,356
     
14
 
IP services
   
20,177
     
21,336
     
(1,159
)
   
(5
)
Direct costs of customer support
   
13,209
     
10,485
     
2,724
     
26
 
Direct costs of amortization of acquired technologies
   
2,359
     
1,750
     
609
     
35
 
Sales and marketing
   
16,404
     
15,564
     
840
     
5
 
General and administrative
   
20,901
     
16,577
     
4,324
     
26
 
Depreciation and amortization
   
16,579
     
16,822
     
(243
)
   
(1
)
(Gain) loss on disposal of property and equipment, net
   
(20
)
   
84
     
(104
)
   
(124
)
Restructuring
   
688
     
1,492
     
(804
)
   
(54
)
Total operating costs and expenses
   
133,916
     
122,373
     
11,543
     
9
 
Income (loss) from operations
 
$
1,799
   
$
(2,559
)
 
$
4,358
     
(170
)
                                 
Interest expense
 
$
3,339
   
$
1,522
   
$
1,817
     
119
 

Data Center Services
 
Revenues for data center services increased $17.4 million, or 27%, to $81.4 million for the six months ended June 30, 2012, compared to $64.0 million for the same period in 2011. The increase in revenue was primarily due to revenue growth in company-controlled colocation and hosting services.
 
Direct costs of data center services, exclusive of depreciation and amortization, were $43.6 million for the six months ended June 30, 2012, compared to $38.3 million for the same period in 2011. The increase in direct costs was primarily due to the increase in our hosting services revenue and costs related to the expansion of our Atlanta data center, partially offset by a $0.5 million nonrecurring settlement of past charges with a data center vendor.

Direct costs of data center services as a percentage of corresponding revenues was 54% during the six months ended June 30, 2012, compared to 60% during the same period in 2011.
 
IP Services
 
Revenues for IP services decreased $1.5 million, or 3%, to $54.3 million for the six months ended June 30, 2012, compared to $55.8 million for the same period in 2011. 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 32.2% for the six months ended June 30, 2012, compared to the same period in 2011, calculated based on an average over the number of months in the respective periods.

Direct costs of IP services, exclusive of depreciation and amortization, decreased $1.2 million, or 5%, to $20.2 million for the six months ended June 30, 2012, compared to $21.3 million for the same period in 2011. This decrease was primarily due to the decrease in revenue.
 
 
14

 
 
Other Operating Costs and Expenses
 
Compensation. Total compensation and benefits, including stock-based compensation, were $34.0 million and $28.5 million for the six months ended June 30, 2012 and 2011, respectively.
 
Cash-based compensation and benefits increased $4.6 million to $31.2 million during the six months ended June 30, 2012 from $26.6 million during the same period in 2011. The increase was primarily due to a $3.5 million increase in cash-based compensation and payroll taxes related to a higher employee headcount and increased salary levels, a $0.4 million increase attributable to credits we recorded in 2011 related to prior years’ Georgia Headquarters Tax Credit, a $0.7 million increase in insurance and a $0.5 million increase in bonus compensation, partially offset by a $0.3 million decrease in severance and a $0.3 million increase in capitalized payroll costs related to software development.
 
Stock-based compensation, net of amount capitalized, increased to $3.0 million during the six months ended June 30, 2012 from $1.9 million during the same period in 2011. The increase was primarily due to stock-based compensation awarded in connection with the Voxel acquisition in the six months ended June 30, 2012 and forfeitures upon terminations of employment in the six months ended June 30, 2011.  The following table summarizes the amount of stock-based compensation, net of estimated forfeitures, included in the accompanying consolidated statements of operations during the six months ended June 30, 2012 and 2011 (in thousands):

   
2012
   
2011
 
Direct costs of customer support
 
$
455
   
$
358
 
Sales and marketing
   
424
     
490
 
General and administrative
   
2,140
     
1,052
 
   
$
3,019
   
$
1,900
 
 
Direct Costs of Customer Support . Direct costs of customer support increased 26% to $13.2 million during the six months ended June 30, 2012 from $10.5 million during the same period in 2011. The increase was primarily due to a $2.3 million increase in cash-based compensation and payroll costs.
 
Direct Costs of Amortization of Acquired Technologies . Direct costs of amortization of acquired technologies increased 35% to $2.4 million during the six months ended June 30, 2012 from $1.8 million during the same period in 2011. The increase was primarily due to the amortization on the intangible assets acquired in the Voxel acquisition.
 
Sales and Marketing . Sales and marketing costs increased 5% to $16.4 million during the six months ended June 30, 2012 from $15.6 million during the same period in 2011. The increase was primarily due to a $0.4 million increase in cash-based compensation and payroll taxes.
 
General and Administrative . General and administrative costs increased 26% to $20.9 million during the six months ended June 30, 2012 from $16.6 million during the same period in 2011. The increase was primarily due to a $0.7 million increase in cash-based compensation costs and payroll taxes, a $0.5 million increase in bonus compensation, a $0.3 million increase in employee benefits, a $0.9 million increase in taxes and licenses, a $1.1 million increase in stock-based compensation and a $0.6 million increase in outside professional fees primarily for recruiting and labor, partially offset by a $0.5 million decrease in severance.
 
Depreciation and Amortization . Depreciation and amortization decreased 1% to $16.6 million during the six months ended June 30, 2012, compared to $16.8 million during the same period in 2011. The decrease was primarily due to our change in estimated useful lives of $7.0 million on assets held at December 31, 2011, partially offset by the effects of our expansion of company-controlled data centers, P-NAP infrastructure and capitalized software.
 
Restructuring and Impairments .  For the six months ended June 30, 2012, restructuring and impairments included $0.4 million for adjustments to previously implemented restructuring plans and $0.3 million for impairment on capitalized software.

Interest Expense . Interest expense increased to $3.3 million during the six months ended June 30, 2012, compared to $1.5 million during the same period in 2011. The increase in interest expense was primarily due to new capital lease obligations related to expansion of our company-controlled data centers and the increase in our term loan and revolving credit facility.
 
 
15

 
 
Liquidity and Capital Resources
 
Liquidity

We 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 credit facility described below in “—Credit Agreement,” particularly for capital expenditures 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 IT Infrastructure services 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 selling our IT Infrastructure services, 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 credit facility limit our ability to incur additional indebtedness. We believe we have sufficient cash to operate our business for the next 12 months. Our anticipated uses of cash include capital expenditures, working capital needs and required payments on our credit agreement and other commitments.

We have experienced significant impairments and operational restructurings in recent years and we have a history of quarterly and annual period net losses. During the six months ended June 30, 2012, we had a net loss of $1.9 million. As of June 30, 2012, 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 continue to see signs of cautious behavior from our customers given economic conditions. 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 Agreement

We have a $119.0 million credit agreement (the “Credit Agreement”) that expires in November 2014. The Credit Agreement provides for a revolving credit facility up to $60.0 million and a term loan of $59.0 million.

As of June 30, 2012, the revolving credit facility had an outstanding balance of $14.9 million and we issued $12.2 million letters of credit, resulting in $32.9 million in borrowing capacity. The term loan had an outstanding principal amount of $57.3 million, which is to be repaid in $750,000 quarterly installments on the last day of each fiscal quarter, with the remaining unpaid balance due on November 2, 2014. As of June 30, 2012, the interest rates on the revolving credit facility and term loan were 5.0% and 3.7%, respectively.

The Credit Agreement includes customary representations, warranties, negative and affirmative covenants, including certain financial covenants relating to minimum liquidity, fixed charge coverage ratio and senior leverage ratio, and customary events of default that could result in acceleration of the Credit Agreement. As of June 30, 2012, we were in compliance with these covenants. 

Capital Leases

During 2011, we entered into a capital lease for new corporate office space in Atlanta, Georgia due to our Atlanta data center expansion into our then-existing corporate office space. During March 2012, we took possession of the space when it was available according to terms of the lease and recorded the related property and equipment and corresponding capital lease obligation of $7.4 million.

Our future minimum lease payments on all capital lease obligations at June 30, 2012 were $47.6 million. We summarize our existing capital lease obligations in note 8 to the accompanying consolidated financial statements.

Commitments and Other Obligations

We have commitments and other obligations that are contractual in nature and represent a use of cash in the future. Service commitments primarily relate to IP, telecommunications and data center services.  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 service commitments with corresponding revenue growth.
 
 
16

 
 
The following table summarizes our commitments and other obligations as of June 30, 2012 (in thousands):
 
   
Total
   
Less than
1 year
   
1-3 Years
   
3-5 Years
   
More than 5
years
 
Revolving credit facility (1)
  $ 16,777     $ 760     $ 16,017     $     $  
Term loan (2)
    61,994       5,106       56,888              
Capital lease obligations
    70,590       7,905       16,353       14,741       31,591  
Accrued contingent consideration (3)
    5,000       5,000                    
Operating lease commitments
    143,908       28,089       48,817       31,088       35,914  
Service and purchase commitments
    16,402       5,610       6,888       3,475       429  
                                         
Total
  $ 314,671     $ 52,470     $ 144,963     $ 49,304     $ 67,934  
                                       
(1)   
The interest rate on the revolving credit facility will be either (i) the Base Rate (as defined in the agreement) plus 1.75 percentage points or (ii) the LIBOR Rate plus 3.50 percentage points, as we elect from time to time. As of June 30, 2012, the interest rate was 5.0% and the projected interest included in the debt payments above incorporates this rate.
(2)
The interest rate on the term loan will be either (i) the Base Rate plus 3.50 percentage points or (ii) the LIBOR Rate plus 3.50 percentage points, as we elect from time to time. As of June 30, 2012, the interest rate was 3.7% and the projected interest included in the debt payments above incorporates this rate.
(3)
Amount to be paid upon receipt of certain Voxel technology deliverables. The liability is shown at present value of $4.9 million on the accompanying consolidated balance sheets. Payment date is expected to be on or before February 28, 2013.

Cash Flows for the Six Months Ended June 30, 2012 and 2011
 
Operating Activities. Net cash provided by operating activities for the six months ended June 30, 2012 was $25.1 million. Our net loss, after adjustments for non-cash items, generated cash from operations of $21.4 million, while changes in operating assets and liabilities provided cash from operations of $3.7 million. We 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.
 
The primary non-cash adjustment for the six months ended June 30, 2012 was $18.9 million for depreciation and amortization, which included the effects of the expansion of our company-controlled data centers and P-NAP facilities. Non-cash adjustments also included $3.0 million for stock-based compensation expense. The changes in operating assets and liabilities included a $3.9 million increase in accounts receivable and a $6.6 million increase in accounts payable.
 
Days sales outstanding at June 30, 2012 was 29 days, up from 27 days at June 30, 2011. Days sales outstanding are measured as of a point in time and may fluctuate based on a number of factors, including, among other things, changes in revenues, cash collections, allowance for doubtful accounts and the amount of revenues billed in advance.
 
Investing Activities. Net cash used in investing activities for the six months ended June 30, 2012 was $39.5 million for capital expenditures, which related to the continued expansion and upgrade of our company-controlled data centers and network infrastructure.

Financing Activities. Net cash provided by financing activities for the six months June 30, 2012 was $12.3 million primarily due to proceeds from the revolving credit facility, offset by principal payments on the term loan and capital leases.
  
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Other Investments
 
Prior to 2012, we invested $4.1 million in Internap Japan Co., Ltd., our joint venture with NTT-ME Corporation and NTT Holdings. We account for this investment using the equity method and we have recognized $2.0 million in equity-method losses over the life of the investment, 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 June 30, 2012, our long-term debt consisted of $57.3 million borrowed under our term loan and $14.9 million borrowed under our revolving credit facility. Interest on the term loan was 3.7% based on either (i) the Base Rate (as defined in the agreement) plus 3.50 percentage points, or (ii) the LIBOR Rate plus 3.50 percentage points, as we elect from time to time. Interest on the revolving credit facility was 5.0% based on either (x) the Base Rate plus 1.75 percentage points or (y) the LIBOR Rate plus 3.50 percentage points, as we elect from time to time. We estimate that a change in the interest rate of 100 basis points would change our interest expense and payments by $0.7 million per year, assuming we do not increase our amount outstanding.

Foreign Currency Risk
 
Substantially all of our revenue is currently in U.S. dollars and from customers in the U.S. We do not believe, therefore, that we currently have any significant direct foreign currency exchange rate risk.
 
 
17

 
 
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 June 30, 2012.
 
Changes in Internal Control over Financial Reporting
 
There was no change in our internal control over financial reporting that occurred during the three months ended June 30, 2012 that has materially affected, or that is reasonably likely to materially affect, our internal control over financial reporting.

  
PART II.  OTHER INFORMATION
 
ITEM 1. LEGAL PROCEEDINGS
 
We are subject to legal proceedings, claims and litigation arising in the ordinary course of business. Although the outcome of these matters is currently not determinable, we do not expect that the ultimate costs to resolve these matters will have a material adverse impact on our financial condition, results of operations or cash flows.

ITEM 1A. RISK FACTORS
 
There have been no material changes from the Risk Factors we previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2011 filed with the Securities and Exchange Commission on February 23, 2012.
 
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

The following table sets forth information regarding our repurchases of securities for each calendar month in the three months ended June 30, 2012:
 
 
18

 

ISSUER PURCHASES OF EQUITY SECURITIES
 
Period
Total
Number
of Shares
Purchased*
 
Average 
Price
Paid per 
Share
 
Total  
Number of  
Shares  
Purchased as
Part of  
Publicly  
Announced
Plans or  
Programs
Maximum  
Number
(or
 Approximate
Dollar Value) of
Shares That  
May Yet Be  
Purchased
Under the Plans
or Programs
    April 1 to 30, 2012
16,330
 
$
7.17
 
    May 1 to 31, 2012
3,859
   
7.34
 
    June 1 to 30, 2012
5,351
   
6.60
 
    Total
25,540
 
$
7.08
 
 

*           These shares were surrendered to us to satisfy tax withholding obligations in connection with the vesting of shares of restricted stock previously issued to employees and directors.

ITEM 6. EXHIBITS
 
Exhibit
Number
 
Description
 
     
     
31.1
 
Rule 13a-14(a)/15d-14(a) Certification, executed by J. Eric Cooney, President, Chief Executive Officer and Director of Internap.
     
31.2
 
Rule 13a-14(a)/15d-14(a) Certification, executed by John D. Maggard, Interim Chief Financial Officer of Internap.
     
32.1
 
Section 1350 Certification, executed by J. Eric Cooney, President, Chief Executive Officer and Director of Internap.
     
32.2
 
Section 1350 Certification, executed by John D. Maggard, Interim Chief Financial Officer of Internap.
     
101.INS   XBRL Instance Document.
     
101.SCH   XBRL Taxonomy Extension Schema Document.
     
101.CAL   XBRL Taxonomy Extension Calculation Linkbase Document.
     
101.DEF   XBRL Taxonomy Extension Definition Linkbase Document.
     
101.LAB   XBRL Taxonomy Extension Label Linkbase Document.
     
101.PRE   XBRL Taxonomy Extension Presentation Linkbase Document.
 
 
19

 
                
INTERNAP NETWORK SERVICES CORPORATION AND SUBSIDIARIES
 
SIGNATURE
 
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized
       
 
INTERNAP NETWORK SERVICES CORPORATION
 
       
 
By:
/s/ John D. Maggard
 
   
John D. Maggard
 
   
Interim Chief Financial Officer
 
   
(Principal Accounting Officer)
 
Date: July 26, 2012
 
 
20
 

Exhibit 31.1
 
 CERTIFICATION
 
I, J. Eric Cooney, certify that:
 
1.
I have reviewed this Quarterly Report on Form 10-Q of Internap Network Services Corporation; 
 
2.
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
  
3.
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
  
4.
The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
  
 
a.
designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
  
 
b.
designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
  
 
c.
evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
  
 
d.
disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting.
  
5.
The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and to the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
  
 
a.
all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
 
 
b.
any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

 
By:
/s/ J. Eric Cooney
 
   
J. Eric Cooney
 
   
President, Chief Executive Officer and Director
       
 
Date:
July 26, 2012
 
 

Exhibit 31.2
   
CERTIFICATION
 
I, John D. Maggard,  certify that: 
 
1.
I have reviewed this Quarterly Report on Form 10-Q of Internap Network Services Corporation;
  
2.
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 
 
3.
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 
 
4.
The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: 
 
 
a.
designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; 
 
 
b.
designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; 
 
 
c.
evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and 
 
 
d.
disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting. 
 
5.
The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and to the audit committee of the registrant’s board of directors (or persons performing the equivalent functions): 
 
 
a.
all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and 
 
 
b.
any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
 
 
       
 
By:
/s/ John D. Maggard
 
   
John D. Maggard
 
   
Interim Chief Financial Officer
       
 
Date: