Internap Corporation
INTERNAP NETWORK SERVICES CORP (Form: 10-K, Received: 02/23/2012 17:15:30)


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
 
 
FORM 10-K
 
 
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended December 31, 2011
 
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: 000-31989
 
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)
 
(Zip Code)
 
(404) 302-9700
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
 
Title of each class
 
Name of exchange on which registered
Common Stock, $0.001 par value
 
The NASDAQ Stock Market LLC
   
(NASDAQ Global Market)
 
Securities registered pursuant to Section 12(g) of the Act: None
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes  o No x
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes  o No x
 
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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405)  is not contained herein,  and will not be contained, to the best of  registrant’s knowledge,  in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
 
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 the 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 Act). Yes  o No x
 
The aggregate market value of the registrant’s outstanding common stock held by non-affiliates of the registrant was $372,852,762 based on a closing price of $7.35 on June 30, 2011, as quoted on the NASDAQ Global Market.
 
As of February 13, 2012, 52,732,488 shares of the registrant’s common stock, par value $0.001 per share, were issued and outstanding.
 
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive proxy statement for the registrant’s annual meeting of stockholders to be held June 14, 2012 are incorporated by reference into Part III of this report. Except as expressly incorporated by reference, the registrant’s Proxy Statement shall not be deemed to be a part of this report on Form 10-K.
 


 
 
 
 
 
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FORWARD-LOOKING STATEMENTS
 
This Annual Report on Form 10-K, particularly Management’s Discussion and Analysis of Financial Condition and Results of Operations set forth below, and notes to our audited 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 Annual Report on Form 10-K 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,” “Internap” or the “Company” refer to Internap Network Services Corporation.
 
P ART I
 
I TEM 1. BUSINESS
 
Overview
 
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 currently operate 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 (“SaaS”); hosting and information technology infrastructure; and telecommunications.
 
We were incorporated as a Washington corporation in 1996 and reincorporated in Delaware in 2001. Our principal executive offices are located at 250 Williams Street, Atlanta, Georgia 30303, and our telephone number is (404) 302-9700. Our common stock trades on the NASDAQ Global Market under the symbol “INAP.” Our website address is www.internap.com .
 
Industry Background
 
The Internet is the communications platform for business-critical Web- and Internet-based applications, such as electronic commerce, Voice over IP (“VoIP”), supply chain management, customer relationship management, project coordination, streaming media, video conferencing and collaboration. Businesses are redesigning their IT operations models to take advantage of new, more cost-effective application delivery models, such as SaaS, hosting and cloud computing. These delivery models rely on the Internet as the primary means of communicating with customers and users. This results in enhanced expectations of performance, availability and transparent delivery for the business application to work as expected.
 
The Need to Reduce IT Costs While Improving Performance and Capabilities
 
Companies continue to move more data, applications and operations online. Rapid shifts in technology, and the associated costs of training employees and maintaining or upgrading equipment and facilities to support more complex applications, have led companies to increasingly outsource their IT Infrastructure. IT outsourcing providers can purchase and deploy capabilities at scale, thereby providing cost effective IT Infrastructure services while at the same time offering companies secure, offsite environments for equipment or an outsourced hosting service for applications and business-critical websites.
 
The Demand for Multiple Infrastructure Services to Support Enterprise IT Needs
 
Increasingly, enterprises require a mix of services to meet their needs. Most enterprises rely on a mix of infrastructure services to support the varied performance, compliance, security or cost requirements of different applications. Businesses in different stages of their lifecycle may leverage different services. As businesses grow and IT workloads become more predictable, the economics and performance gains from dedicated infrastructure may drive companies to managed hosting or colocation services. On the other hand, businesses that have traditionally relied solely on dedicated infrastructure are increasingly leveraging virtualization to better support specific application and business requirements for rapid scalability or cost efficiency.
 
 
- 1 -

 
 
The Growing Demand for Delivery of Rich Media Content over the Internet
 
The proliferation of Internet-connected devices and broadband Internet connections coupled with increased consumption of media over the Internet, including personalized content, have created a demand for delivery of rich media content. As the volume and quality of dynamic content progresses, viewers expect superior performance regardless of the type of website they visit. Companies that need to deliver rich media content can employ acceleration, compression and mirroring techniques to improve their end users’ experience, services generally referred to as content delivery network (“CDN”).
 
The Problem of Inefficient Routing of Data Traffic on the Internet
 
An internet service provider (“ISP”) only controls the routing of data within its network and its routing practices tend to compound the inefficiencies of the Internet. When an ISP receives a packet that is not destined for one of its own customers, it must route that packet to another ISP to complete the delivery of the packet. An ISP will often route the data from private connections, or peered data, to the nearest point of traffic exchange, in an effort to get the packet off its network and onto a competitor’s network as quickly as possible. Once the origination traffic leaves the ISP’s network, service level agreements (“SLAs”) with that ISP typically do not apply since that carrier cannot control the quality of another ISP’s network. Consequently, to complete a communication, data ordinarily passes through multiple networks and peering points without consideration for congestion or other factors that inhibit performance. This transfer can result in lost data, slower and more erratic transmission speeds and an overall lower quality of service. The quality of service can be further degraded by basic routing protocols that make assumptions about the “best” path or network on which to route traffic, without consideration of the performance of that network. Equally important, customers have no control over the transmission arrangements and have no single point of contact that they can hold accountable for degradation in service levels. As a result, it is virtually impossible for a single ISP to offer a high quality of service across disparate networks.
 
Our Segments
 
Data Center Services
 
Our data center services segment includes colocation services, which involve providing physical space within data centers and associated services such as redundant power, interconnection, environmental controls and security. Colocation allows our customers to deploy and manage their servers, storage and other equipment in 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 and storage business. 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 Internet Protocol (“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 SLAs and our team of dedicated support professionals.
 
We sell our colocation and/or hosting services at 38 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 28 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 company-controlled 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 increased capital expenditures to expand company-controlled data centers. During 2011, we opened a new company-controlled data center in Dallas, Texas and began to build out a new company-controlled data center in Los Angeles, California. These expansions give us the capacity to increase the footprint of our company-controlled data centers by approximately 110,000 net sellable square feet over time.
 
On December 30, 2011, we acquired Voxel Holdings, Inc. (“Voxel”), a global provider of scalable hosting and cloud services.  Voxel’s offerings are complementary to our existing portfolio and provide a level of automation and self-service that will be available to our customer base and also extend our addressable market. We will integrate Voxel’s operations into our data center services segment.
 
 
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IP Services
 
Our IP services segment includes our patented Performance IP™ service, XIP™ Acceleration-as-a-Service solution, 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. Our IP services are sold through 77 IP service points around the world, which include 18 CDN points of presence (“POPs”) and one additional standalone CDN POP. 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- analytics tools.
 
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.
 
For more information about our segments, see note 4 to our consolidated financial statements.
 
Data Centers, Network Access Points and Points of Presence
 
We provide services through our network access points across North America, Europe and the Asia-Pacific region. Our P-NAPs and data centers feature multiple direct high-speed connections to major ISPs. We provide access to the Internet for our CDN customers through our CDN POPs. As of December 31, 2011, we provided services worldwide through 77 IP service points, which includes 19 CDN POPs and 38 data centers. We directly operate 10 of these data center sites and have operating agreements with third parties for the remaining locations. We have P-NAPs, CDN POPs and/or data centers in the following markets, some of which have multiple sites:
 
Internap operated
 
Domestic sites operated
under third party agreements
 
International sites operated
under third party agreements
 
Atlanta
 
Atlanta
 
Orange County
 
Amsterdam
 
Paris
 
Boston
 
Chicago
 
San Diego
 
Frankfurt
 
Singapore
 
Dallas
 
Dallas
 
Philadelphia
 
Hong Kong
 
Sydney
 
Houston
 
Denver
 
Phoenix
 
London
 
Tokyo (1)
 
New York
 
Los Angeles
 
San Francisco
 
Osaka (1)
 
Toronto
 
Santa Clara
 
Miami
 
San Jose
         
Seattle
 
New York
 
Santa Clara
         
   
Oakland
 
Seattle
         
       
Washington DC
         
 

(1)
Through our joint venture in Internap Japan Co., Ltd. with NTT-ME Corporation and Nippon Telegraph and Telephone Corporation.
 
Financial Information about Geographic Areas
 
For each of the three years ended December 31, 2011, we derived less than 10% of our total revenues from operations outside the United States.
 
Sales and Marketing
 
We employ a direct sales team and have sales offices in key cities across North America, and offices in the United Kingdom, Hong Kong and Singapore.
 
Research and Development
 
Research and development costs, which include product development costs, are included in general and administrative costs and are expensed as incurred. These costs primarily consist of compensation and consulting fees related to our development and enhancement of IP routing technology, progressive download and streaming technology for our CDN, acceleration and cloud technologies and network engineering costs associated with changes to the functionality of our proprietary services and network architecture. Research and development costs were $0.2 million, $1.9 million and $3.8 million during the years ended December 31, 2011, 2010 and 2009, respectively. These costs do not include $2.8 million , $0.9 million and $0.9 million of internal-use software costs capitalized during the years ended December 31, 2011, 2010 and 2009, respectively.
 
 
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Customers
 
As of December 31, 2011, we had approximately 3,700 customers,  which included 1,000 hosting customers that were added following the Voxel acquisition completed on December 30, 2011.  We provide services to customers in a variety of industries, such as entertainment and media, including gaming; financial services; business services; software, including SaaS; hosting and information technology infrastructure; and telecommunications. Our customer base, however, is not concentrated in any particular industry. In each of the past three years, no single customer accounted for 10% or more of our net revenues.
 
Competition
 
The market for our services is intensely competitive and is characterized by technological change, the introduction of new products and services and price erosion. We believe that the principal factors of competition for service providers in our target markets include speed and reliability of connectivity, quality of facilities, breadth of product offering, level of customer service and technical support, price and brand recognition. We believe that we compete favorably on the basis of these factors.
 
Our current and potential competition primarily consists of:
 
 
colocation and hosting providers, including Equinix, Inc.; Rackspace, Inc.; Peer 1 Network Enterprises, Inc.; Telx Group, Inc.; Cincinnati Bell (CyrusOne) and CenturyLink, Inc.;
 
 
 
ISPs that provide connectivity services, including AT&T Inc.; Sprint Nextel Corporation; Verizon Communications Inc.; Level 3 Communications, Inc. and Verio, an NTT Communications Company;
 
 
providers of storage solutions, such as content delivery or storage such as Akamai Technologies, Inc.; Limelight Networks, Inc.; CD Networks Co., Ltd. and Edgecast Networks; and
 
 
software-based, Internet infrastructure companies focused on IP route control and wide area network optimization products such as Riverbed Technology, Inc.; F5 Networks, Inc. and Radware Ltd.
 
Competition will likely continue to result in price pressure on us. Many of our competitors have longer operating histories and presence in key markets, greater name recognition, larger customer bases and significantly greater financial, sales and marketing, distribution, engineering, technical and other resources than we have. As a result, these competitors may be able to introduce emerging technologies on a broader scale and adapt more quickly to changes in customer requirements, potentially at lower costs, or to devote greater resources to the promotion and sale of their services and products. In all of our markets, we also may face competition from newly established competitors, suppliers of services or products based on new or emerging technologies and customers that choose to develop their own network services or products. We also may encounter further consolidation in the markets in which we compete. Increased competition could result in pricing pressures, decreased gross margins and loss of market share, which may materially and adversely affect our business, consolidated financial condition, results of operations and cash flows.
 
Intellectual Property
 
Our success and ability to compete depend in part on our ability to develop and maintain the proprietary aspects of our IT Infrastructure services and operate without infringing on the proprietary rights of others. We rely on a combination of patent, trademark, trade secret and contractual restrictions to protect the proprietary aspects of our technology. As of December 31, 2011, we had 22 patents (17 issued in the United States and five issued internationally) that extend to various dates between 2017 and 2031, and 10 registered trademarks in the United States. Although we believe the protection afforded by our patents, trademarks and trade secrets has value, the rapidly changing technology in our industry and uncertainties in the legal process make our future success dependent primarily on the innovative skills, technological expertise and management abilities of our employees rather than on the protection afforded by patent, trademark and trade secret laws. We seek to limit disclosure of our intellectual property by requiring employees and consultants with access to our proprietary information to execute confidentiality agreements with us.
 
Employees
 
As of December 31, 2011, we had approximately 500 employees.  None of our employees are represented by a labor union, and we have not experienced any work stoppages. We consider the relationships with our employees to be good.
 
I TEM 1A. RISK FACTORS
 
We operate in a changing environment that involves numerous known and unknown risks and uncertainties that could have a materially adverse impact on our operations. The risks described below highlight some of the factors that have affected, and in the future could affect, our operations. You should carefully consider these risks. These risks are not the only ones we may face. Additional risks and uncertainties of which we are unaware or that we currently deem immaterial also may become important factors that affect us. If any of the events or circumstances described in the following risks occurs, our business, consolidated financial condition, results of operations, cash flows or any combination of the foregoing, could be materially and adversely affected.
 
Our risks are described in detail below; however, the more significant risks we face can be summarized into several broad categories, including:
 
The future evolution of the technology industries in which we operate is difficult to predict, highly competitive and requires continual innovation and development, strategic planning, capital investment, demand planning and space utilization management to remain viable. We face on-going challenges to develop new services and products to maintain current customers and obtain new ones, whether in a cost-effective manner or at all. In addition, technological advantages typically devalue rapidly creating constant pressure on pricing and cost structures and hindering our ability to maintain or increase margins.
 
 
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We are dependent on numerous suppliers, vendors and other third-party providers across a wide spectrum of products and services to operate our business. These include real-estate, network capacity and access points, network equipment and supplies, power and other vendors. In many cases the suppliers of these products and services are not only vendors, they are also competitors. While we maintain contractual agreements with these suppliers, we have limited ability to guarantee they will meet their obligations, or that we will be able to continue to obtain the products and services necessary to operate our business in sufficient supply, or at an acceptable cost.
 
Our business model involves designing, deploying and maintaining a complex set of network infrastructures at considerable capital expense. We invest significant resources to help maintain the integrity of our infrastructure and support our customers; however, we face constant challenges related to our network infrastructure, including capital forecasting, demand planning, space utilization management, physical failures, obsolescence, maintaining redundancies, security breaches, power demand and other risks.
 
Our financial results have fluctuated over time and we have a history of losses, including in each of the past three years. We have also incurred significant charges related to impairments and restructuring efforts, which, along with other factors, may contribute to volatility in our stock price.
 
Risks Related to our Industries
 
We cannot predict with certainty the future evolution of the market for technology and products, and may be unable to respond effectively and on a timely basis to rapid technological change.
 
Our industry is characterized by rapidly changing technology, industry standards and customer needs, as well as by frequent new product and service introductions. New technologies and industry standards have the potential to replace or provide lower cost alternatives to our services. The adoption of such new technologies or industry standards could render our existing services or products obsolete and unmarketable. Our failure to anticipate the prevailing standards, to adapt our technology to any changes in the prevailing standards or the failure of common standards to emerge could materially and adversely affect our business. Our pursuit of necessary technological advances may require substantial time and expense, and we may be unable to successfully adapt our network and services to alternative access devices and technologies. If the Internet becomes subject to a form of central management, or if ISPs establish an economic settlement arrangement regarding the exchange of traffic between Internet networks, the demand for our IP and CDN services could be materially and adversely affected. Likewise, technological advances in computer processing, storage, capacity, component size or advances in power management could change which could result in a decreased demand for our data center and hosting services.
 
If we are unable to develop new and enhanced services and products that achieve widespread market acceptance, or if we are unable to improve the performance and features of our existing services and products or adapt our business model to keep pace with industry trends, our business and operating results could be adversely affected.
 
Our industry is constantly evolving. The process of expending research and development to create new services and products, and the technologies that support them, is expensive, time and labor intensive and uncertain. We may fail to understand the market demand for new services and products or not be able to overcome technical problems with new services. The demand for top research and development talent is high, and there is significant competition for these scarce resources.
 
Our future success may depend on our ability to respond to the rapidly changing needs of our customers by expending research and development in a cost-effective manner to acquire talent, develop and introduce new services, products and product upgrades on a timely basis. New product development and introduction involves a significant commitment of time and resources and is subject to a number of risks and challenges, including:
 
 
sourcing, identifying, obtaining and maintaining qualified research and development staff with the appropriate skill and expertise;
 
 
managing the length of the development cycle for new products and product enhancements, which historically has been longer than expected;
 
 
identifying and adapting to emerging and evolving industry standards and to technological developments by our competitors’ and customers’ services and products;
 
 
entering into new or unproven markets where we have limited experience;
 
 
managing new product and service strategies and integrating them with our existing services and products;
 
 
incorporating acquired products and technologies;
 
 
trade compliance issues affecting our ability to ship new products to international markets;
 
 
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developing or expanding efficient sales channels; and
 
 
obtaining required technology licenses and technical access from operating system software vendors on reasonable terms to enable the development and deployment of interoperable products.
 
In addition, if we cannot adapt our business models to keep pace with industry trends, our revenue could be negatively impacted. If we are not successful in managing these risks and challenges, or if our new services, products and product upgrades are not technologically competitive or do not achieve market acceptance, we may lose market share, resulting in a decrease in our revenues and earnings.
 
Our capital investment strategy for data center and IT Infrastructure expansion may contain erroneous assumptions causing our return on invested capital to be materially lower than expected.
 
Our strategic decision to invest capital in expanding our data center and IT Infrastructure is based on, among other things, significant assumptions relative to expected growth of these markets, our competitors’ plans and current and expected occupancy rates. We have no way of ensuring the data or models we use to deploy capital into existing markets, or to create new markets, has been or will be accurate. Errors or imprecision in these estimates, especially those related to customer demand, could cause actual results to differ materially from expected results and could adversely affect our business, consolidated financial condition, results of operations and cash flows.
 
We may experience difficulties in executing our capital investment strategy to expand our IT Infrastructure, upgrade existing facilities or establish new facilities, products, services or capabilities.
 
As part of our strategy, we may continue to expand our IT Infrastructure, particularly into new geographic markets. We expect that we may encounter challenges and difficulties in implementing our expansion plans. This could cause us to grow at a slower pace than projected in our capital investment modeling. These challenges and difficulties relate to our ability to:
 
 
identify and obtain the use of locations meeting our selection criteria on competitive terms;
 
 
estimate costs and control delays;
 
 
obtain necessary permits on a timely basis, if at all;
 
 
generate sufficient cash flow from operations or through current or additional debt or equity financings to support these expansion plans;
 
 
establish key relationships with IT Infrastructure providers; and
 
 
hire, train, retain and manage sufficient additional operational and technical employees and supporting personnel.
 
If we encounter greater than anticipated difficulties in implementing our expansion plans, are unable to deploy new IT Infrastructure or do not adequately control expenses associated with the deployment of new IT Infrastructure, it may be necessary to take additional actions, which could divert management’s attention and strain our operational and financial resources. We may not successfully address any or all of these challenges, and our failure to do so would adversely affect our business, consolidated financial condition, results of operations and cash flows.
 
Our estimation of future data center space needs may be inaccurate, leading to missed sales opportunities or additional expenses through unnecessary carrying costs.
 
Adding data center space involves significant capital outlays well ahead of planned usage. Although we believe we can accurately project future space needs in particular markets, these plans require significant estimates and assumptions based on available market data. Errors or imprecision in these estimates or the data on which the estimates are based could result in either an oversupply or undersupply of space and cause actual results to differ materially from expected results and correspondingly have a material adverse impact on our business, consolidated financial condition, results of operations and cash flows.
 
Pricing pressure may continue to decrease our revenue for certain services such as Internet connectivity, data transit and data storage services.
 
Pricing for Internet connectivity, data transit and data storage services has declined significantly in recent years and may continue to decline, which would significantly impact our IP services segment. By bundling their services and reducing the overall cost of their service offerings, certain of our competitors may be able to provide customers with reduced costs in connection with their Internet connectivity, data transit and data storage services or private network services, thereby significantly increasing the pressure on us to decrease our prices. Increased price competition, significant price deflation and other related competitive pressures have eroded, and could continue to erode, our revenue and could materially and adversely affect our results of operations if we are unable to control or reduce our costs. Because we rely on ISPs to deliver our services and have agreed with some of these providers to purchase minimum amounts of service at predetermined prices, our profitability could be adversely affected by competitive price reductions to our customers even if accompanied with an increased number of customers.
 
 
- 6 -

 
 
The market in which we operate is highly competitive and is likely to consolidate, and we may lack the financial and other resources, expertise or capability necessary to capture increased market share or maintain our market share.
 
We compete in the IT Infrastructure services market. This market is rapidly evolving, highly competitive and likely to be characterized by overcapacity, industry consolidation and continued pricing pressure. Our competitors may consolidate with one another or acquire software-application vendors or technology providers, enabling them to more effectively compete with us. We believe that participants in this market must grow rapidly and achieve a significant presence to compete effectively. This consolidation could affect prices and other competitive factors in ways that would impede our ability to compete successfully in the IT infrastructure market. Further, our business is not as developed as that of many of our competitors. Many of our competitors have substantially greater financial, technical and market resources, greater name recognition and more established relationships in the industry. Many of our competitors may be able to:
 
 
develop and expand their IT infrastructure and service offerings more rapidly;
 
 
adapt to new or emerging technologies and changes in customer requirements more quickly;
 
 
take advantage of acquisitions and other opportunities more readily; or
 
 
devote greater resources to the marketing and sale of their services and adopt more aggressive pricing policies than we can.
 
In addition, ISPs may make technological advancements, such as the introduction of improved routing protocols to enhance the quality of their services, which could negatively impact the demand for our IT Infrastructure services. W e also expect that we will face additional competition as we expand our product offerings, including competition from technology and telecommunications companies, and non-technology companies which are entering the market through leveraging their existing or expanded network services and cloud infrastructure. Further, the ability of some of these potential competitors to bundle other services and products with their network services could place us at a competitive disadvantage. Various companies also are exploring the possibility of providing, or are currently providing, high-speed, intelligent data services that use connections to more than one network or use alternative delivery methods, including the cable television infrastructure, direct broadcast satellites and wireless local loops.
 
We may lack the financial and other resources, expertise or capability necessary to maintain or capture increased market share in the future. Increased competition and technological advancements by our competitors could materially and adversely affect our business, consolidated financial condition, results of operations and cash flows.
 
Failure to retain existing customers or add new customers may cause declines in revenue.
 
In addition to adding new customers, we must sell additional services to existing customers and encourage them to increase their usage levels to increase our revenue. If our existing and prospective customers do not perceive our services to be of sufficiently high value and quality, we may not be able to retain our current customers or attract new customers. Our customers have no obligation to renew their agreements for our services after the expiration of their initial commitment, and these service agreements may not be renewed at the same or higher price or level of service, if at all. Due to the significant upfront costs of implementing IT Infrastructure, if our customers fail to renew or cancel their agreements, we may not be able to recover the initial costs associated with bringing additional infrastructure on-line.
 
Our customers’ renewal rates may decline or fluctuate as a result of a number of factors, including:
 
 
their satisfaction or dissatisfaction with our services;
 
 
our ability to provide features and functionality demanded by our customers;
 
 
the prices of our services and products as compared with those of our competitors;
 
 
mergers and acquisitions affecting our customer base; and
 
 
reduction in our customers’ spending levels.
 
If our customers do not renew their agreements with us or if they renew on less favorable terms, our revenue may decline and our business may suffer. Similarly, our customer agreements often provide for minimum commitments that may be significantly below our customers’ historical usage levels. Consequently, these customers could significantly curtail their usage without incurring any incremental fees under our agreements. In this event, our revenue would be lower than expected and our operating results could suffer.
 
We have a long sales cycle for our IT Infrastructure services and the implementation efforts required by customers to activate them can be substantial.
 
Our IT Infrastructure services are complex and require substantial sales efforts and technical consultation to implement. A customer’s decision to outsource some or all of its IT Infrastructure typically involves a significant commitment of resources. Some customers may be reluctant to purchase our IT Infrastructure services due to their inability to accurately forecast future demand, delay in decision-making or inability to obtain necessary internal approvals to commit resources. We may expend time and resources pursuing a particular sale or customer that does not result in revenue. Delays due to the length of our sales cycle may harm our ability to meet our forecasts and materially and adversely affect our revenues and operating results.
 
 
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We may lose customers if they elect to develop or maintain some or all of their IT Infrastructure services internally.
 
Our customers and potential customers may decide to develop or maintain their own IT Infrastructure rather than outsource to services providers like us. These in-house IT Infrastructure services could be perceived to be superior or more cost effective compared to our services. If we fail to offer IT Infrastructure services that compete favorably with in-sourced services, if we fail to differentiate our IT Infrastructure services or if competitors introduce new IT Infrastructure services that compete with or surpass the quality or the price/performance of our services, we may lose customers or fail to attract customers that may consider pursuing this in-sourced approach, and our business, consolidated financial condition and results of operations would suffer as a result.
 
In addition, our customers’ business models may change in ways that we do not anticipate and these changes could reduce or eliminate our customers’ needs for our services. If this occurs, we could lose customers or potential customers, and our business and financial results would suffer. As a result of these or similar potential developments in the future, it is possible that competitive dynamics in our market may require us to reduce our prices, which could harm our revenue, gross margin and operating results.
 
If governments modify or increase regulation of the Internet, or goods or services necessary to operate the Internet or our IT Infrastructure, our services could become more costly.
 
International bodies and federal, state and local governments have adopted a number of laws and regulations that affect the Internet and are likely to continue to seek to implement additional laws and regulations. In addition, federal and state agencies have adopted or are actively considering regulation of various aspects of the Internet and/or IP services, including taxation of transactions, regulation of broadband providers and broadband Internet access, enhanced data privacy and retention legislation and various energy regulations. Additionally, potential laws and regulations not specifically directed at the Internet, but targeted at goods or services necessary to operate the Internet, could have a negative impact on us. Of specific concern are the legal, political and scientific developments regarding climate change. These factors may impact the delivery of our services or products by driving up the cost of power, which is a significant cost of operating our data centers and other service points.
 
We face the risk that the Federal Communications Commission (“FCC”) may increase regulation or that Congress or one or more states will approve legislation significantly affecting our business. For example, Congress and the FCC are considering various forms of “net neutrality” regulations intended to preserve the open Internet. While aimed primarily at regulating fixed and mobile broadband Internet providers, the regulation contemplates extending to periphery Internet “edge” and “specialized services” providers, which may include us. The adoption of any future laws or regulations, or modification of existing laws to include our company, products or services, might decrease the growth of the Internet, decrease demand for our services, impose taxes or other costly technical requirements, regulate the Internet, Internet access or IP services or otherwise increase the cost of doing business on the Internet. Also, our company, products or services could be reclassified so that we are covered by legislation not intended for our business, but which, because of the classification, we become subject to. Any of these actions could significantly harm our customers or us.
 
In addition, laws relating to the liability of private network operators and information carried on or disseminated through their networks are unsettled, both in the U.S. and abroad. The nature of any new laws and regulations and the interpretation of applicability to the Internet of existing laws governing intellectual property ownership and infringement, copyright, trademark, trade secret, obscenity, libel, employment, personal privacy, consumer protection and other issues are uncertain and developing. We may become subject to legal claims such as defamation, invasion of privacy or copyright infringement in connection with content stored on or distributed through our network. We cannot predict the impact, if any, that future regulation or regulatory changes may have on our business.
 
Risks Related to our Business
 
We depend on third-party suppliers for key elements of our IT Infrastructure. If we are unable to obtain these items on a cost-effective basis, or at all, or if such services are interrupted, limited or terminated, our growth prospects and business operations may be adversely affected.
 
In delivering our services, we rely on a number of Internet networks, many of which are built and operated by third parties. To provide high performance connectivity services to our customers through our network access points, we purchase connections from several ISPs. We can offer no assurances that these ISPs will continue to provide service to us on a cost-effective basis or on competitive terms, if at all, or that these providers will provide us with additional capacity to adequately meet customer demand or to expand our business. Consolidation among ISPs limits the number of vendors from which we obtain service, possibly resulting in higher network costs to us. We may be unable to establish and maintain relationships with other ISPs that may emerge or that are significant in geographic areas, such as Asia, India and Europe, in which we may locate our future network access points. Any of these situations could limit our growth prospects and materially and adversely affect our business.
 
 
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We also depend on other companies to supply various key elements of our network infrastructure, including the network access loops between our network access points and our ISP, local loops between our network access points and our customers’ networks and certain end-user access networks. Pricing for such network access loops and local loops has risen significantly over time and operators of these networks may take measures that could degrade, disrupt or increase the cost of our or our customers’ access to certain of these end-user access networks by restricting or prohibiting the use of their networks to support or facilitate our services, or by charging increased fees. Some of our competitors have their own network access loops and local loops and are, therefore, not subject to the same or similar availability and pricing issues.
 
For data center and managed hosting facilities, we rely on a number of vendors to provide physical space, convert or build space to our specifications, provide power, internal cabling and wiring, climate control and system redundancy. We typically obtain physical space through long-term leases. We utilize multiple other vendors to perform leasehold improvements necessary to make the physical space available for occupancy. The demand for premium data center and managed hosting space in several key markets has outpaced supply over recent years and the imbalance is projected to continue over the near term. This has limited our physical space options and increased, and will continue to increase, our costs to add capacity. If we are not able to procure space through renewing our existing leases or entering new leases, or not able to contain cost for physical space, or are not able to pass these costs on to our customers, our results will be adversely affected.
 
In addition, we currently purchase infrastructure equipment such as servers, routers, switches and storage components from a limited number of vendors. We do not carry significant inventories of the products we purchase, and we have no guaranteed supply arrangements with our vendors. A loss of a significant vendor could delay any build-out of our infrastructure and increase our costs. If our limited source of suppliers fails to provide products or services that comply with evolving Internet standards or that interoperate with other products or services we use in our network infrastructure, we may be unable to meet all or a portion of our customer service commitments, which could materially and adversely affect our results.
 
Any failure of our physical IT infrastructure could lead to significant costs and disruptions that could harm our business reputation, consolidated financial condition, results of operations and cash flows.
 
Our business depends on providing customers with highly-reliable service. We must protect our IT Infrastructure and our customers’ data and their equipment located in our data centers. The services we provide in each of our data centers are subject to failure resulting from numerous factors, including:
 
 
human error;
 
 
physical or electronic security breaches;
 
 
fire, earthquake, hurricane, flood, tornado and other natural disasters;
 
 
improper maintenance of the buildings in which our data centers are located;
 
 
water damage, extreme temperatures, fiber cuts;
 
 
power loss or equipment failure;
 
 
sabotage and vandalism; and
 
 
failures experienced by underlying service providers upon which our business relies.
 
Problems at one or more of the data centers operated by us or our partner sites, whether or not within our control, could result in service interruptions or significant equipment damage. Most of our customers have SLAs that require us to meet minimum performance obligations. As a result, service interruptions or equipment damage in our data centers could impact our ability to perform as required by SLAs and we could face claims related to such failures. We have in the past given credits to our customers as a result of service interruptions due to equipment failures. Because our data centers are critical to our customers’ businesses, service interruptions or significant equipment damage in our data centers also could result in lost profits or other indirect or consequential damages to our customers. We cannot guarantee that a court would enforce any contractual limitations on our liability in the event that a customer brings a lawsuit against us as the result of a problem at one of our data centers.
 
Any loss of services, equipment damage or inability to meet performance obligations in our SLAs could reduce the confidence of our customers and could result in lost customers or an inability to attract new customers, which would adversely affect both our ability to generate revenues and our operating results.
 
Furthermore, we are dependent upon ISPs and telecommunications carriers in the U.S., Europe and Asia-Pacific region, some of whom have experienced significant system failures and electrical outages in the past. Users of our services may experience difficulties due to system failures unrelated to our systems and services. If, for any reason, these providers fail to provide the required services, our business, consolidated financial condition, results of operations and cash flows could be materially adversely impacted.
 
 
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Our business operations depend on contracts with vendors and suppliers who may not meet their contractual obligations.
 
Tracking, monitoring and managing our contracts and vendor relationships is critical to our business operations; however, we have limited control over the vendors’ performance of these contracts. Even if these contracts contain terms favorable to us in the event of a breach, there is no guarantee the damages due us under the contract would cover the losses suffered or would even be paid. Also, each contract contains specific terms and conditions that may change over time based on contract expiration, assignment, assumption or renegotiation. There is no guarantee that these changes would be favorable to us, and to the event they were not, our operations could be materially impacted.
 
These contracts may contain provisions, rights, options or obligations that result in favorable or non-favorable impacts on us depending on actions taken, or not taken. While we intend to pursue all contractual provisions favorable to our business, the appropriate actions under a particular contract may require estimates, judgments and assumptions to be made concerning future events for which we have limited basis for estimation. We cannot guarantee that we will take the appropriate action under a particular contract to maximize the benefit to us, which could have a material adverse impact on operations.
 
In addition, we license intellectual property rights from third-party owners. If such owners do not properly maintain or enforce the intellectual property underlying such licenses, our competitive position and business prospects could be harmed. Our licensors may fail to maintain these patents or intellectual property registrations, may determine not to pursue litigation against other companies that are infringing these patents or intellectual property registrations or may pursue such litigation less aggressively than we would.
 
Our inability to renew our data center leases, or renew on favorable terms, could negatively impact our financial results.
 
Generally, our leases provide us with the opportunity to renew the lease at our option for periods typically ranging from five to 10 years. Many of these options however, if renewed, provide that rent for the renewal period will be the fair market rental rate at the time of renewal. If the fair market rental rates are significantly higher than our current rental rates, we may be unable to offset these costs by charging more for our services, which could have a negative impact on our financial results. Conversely, if rental rates drop significantly in the near term, we would not be able to take advantage of the drop in rates until the expiration of the lease as we would be bound by the terms of the existing lease agreement.
 
In addition, for the leases that do not contain renewal options, or for which the option to renew has been exhausted or passed, we cannot guarantee the lessor will renew the lease, or will do so at a rate that will allow us to maintain profitability on that particular space. While we proactively monitor these leases, and conduct on-going negotiations with lessors, our ability to re-negotiate renewals is inherently limited by the original contract language, including option renewal clauses.
 
A failure in the redundancies in our network operations centers, network access points or computer systems could cause a significant disruption in Internet connectivity which could impact our ability to service our customers.
 
While we maintain multiple layers of redundancy in our operating facilities, if we experience a problem at our network operations centers, including the failure of redundant systems, we may be unable to provide Internet connectivity services to our customers, provide customer service and support or monitor our network infrastructure or network access points, any of which would seriously harm our business and operating results. Also, because we are obligated to provide continuous Internet availability under our SLAs, we may be required to issue a significant amount of customer credits as a result of such interruptions in service. These credits could negatively affect our revenues and results of operations. In addition, interruptions in service to our customers could potentially harm our customer relations, expose us to potential lawsuits or necessitate additional capital expenditures.
 
A significant number of our network access points are located in facilities owned and operated by third parties. In many of those arrangements, we do not have property rights similar to those customarily possessed by a lessee or subtenant but instead have lesser rights of occupancy. In certain situations, the financial condition of those parties providing occupancy to us could have an adverse impact on the continued occupancy arrangement or the level of service delivered to us under such arrangements.
 
Our business could be harmed by prolonged electrical power outages or shortages, increased costs of energy or general availability of electrical resources.
 
Our IT Infrastructure is susceptible to regional costs and supply of power, electrical power shortages, planned or unplanned power outages and availability of adequate power resources. Power outages could harm our customers and our business. While we attempt to limit exposure to system downtime by using backup generators, uninterruptible power systems and other redundancies, we may not be able to limit our exposure entirely. Even with these protections in place we have experienced power outages in the past and may in the future. In addition, our energy costs have increased and may continue to increase for a variety of reasons including increased pressure on legislators to pass green legislation. As energy costs increase, we may not be able to pass on to our customers the increased cost of energy, which could harm our business and operating results.
 
In each of our markets, we rely on utility companies to provide a sufficient amount of power for current and future customers. We cannot ensure that these third parties will deliver such power in adequate quantities or on a consistent basis. At the same time, power and cooling requirements are growing on a per-unit basis. As a result, some customers are consuming an increasing amount of power per square foot of space utilized. Inability to increase power capacity to meet increased customer demands would limit our ability to grow our business, which could have a negative impact on our relationships with our customers and our consolidated financial condition, results of operations and cash flows.
 
 
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Our network and software are subject to potential security breaches and similar threats that could result in liability and harm our reputation.
 
A number of widespread and disabling attacks on public and private networks have occurred. The number and severity of these attacks may increase in the future as network assailants take advantage of outdated software, security breaches or incompatibility between or among networks. Computer viruses, intrusions and similar disruptive problems could cause us to be liable for damages under agreements with our customers, and our reputation could suffer, thereby resulting in a  loss of current customers and deterring potential customers from working with us. Security problems or other attacks caused by third parties could lead to interruptions and delays or to the cessation of service to our customers. Furthermore, inappropriate use of the network by third parties could also jeopardize the security of confidential information stored in our computer systems and in those of our customers and could expose us to liability under unsolicited commercial e-mail, or “spam,” regulations. In the past, third parties have occasionally circumvented some of these industry-standard measures. We can offer no assurance that the measures we implement will not be circumvented. Our efforts to eliminate computer viruses and alleviate other security problems, or any circumvention of those efforts, may result in increased costs, interruptions, delays or cessation of service to our customers and negatively impact hosted customers’ on-line business transactions. Affected customers might file claims against us under such circumstances, and our insurance may not be available or adequate to cover these claims.
 
The increased use of high-power density equipment may limit our ability to fully utilize our data centers.
 
Customers continue to increase their use of high-power density equipment, which has significantly increased the demand for power. The current demand for electrical power may exceed our designed capacity in these facilities. As electrical power, rather than space, is typically the primary factor limiting capacity in our data centers, our ability to fully utilize our data centers may be limited in these facilities. If we are unable to adequately utilize our data centers, our ability to grow our business cost-effectively could be materially and adversely affected.
 
Our business requires the continued development of effective and efficient business support systems to support our customer growth and related services.
 
The growth of our business depends on our ability to continue to develop effective and efficient business support policies, processes and internal systems. This is a complicated undertaking requiring significant resources and expertise. Business support systems are needed for:
 
 
sourcing, evaluating and targeting potential customers and managing existing customers;
 
 
implementing customer orders for services;
 
 
delivering these services;
 
 
timely billing for these services;
 
 
budgeting, forecasting, tracking and reporting our results of operations; and
 
 
providing technical and operational support to customers and tracking the resolution of customer issues.
 
If the number of customers that we serve or our services portfolio increases, we may need to develop additional business support systems on a schedule sufficient to meet proposed service rollout dates. The failure to continue to develop effective and efficient business support systems, and update or optimize these systems to a level commensurate with our competition, could harm our ability to implement our business plans, maintain competitiveness and meet our financial goals and objectives.
 
We depend upon our key employees and may be unable to attract or retain sufficient numbers of qualified personnel.
 
Our future performance depends upon the continued contributions of our executive management team and other key employees. To the extent we are able to expand our operations, we may need to increase our workforce. Accordingly, our future success depends on our ability to attract, hire, train and retain highly skilled management, technical, sales, research and development, marketing and customer support personnel. Competition for qualified employees is intense, and we compete for qualified employees with companies that may have greater financial resources than we have. We may not be successful in attracting, hiring and retaining the people we need, which would seriously impede our ability to implement our business strategy.
 
Additionally, changes in our senior management team during the past several years, both through voluntary and involuntary separation, have resulted in loss of valuable company intellectual capital and in paying significant severance and hiring costs. With reduced staffing, or staffing new to the organization, we may not be able to maintain an adequate separation of duties in key areas of monitoring, oversight and review functions and may not have adequate succession plans in place to mitigate the impact of future personnel losses. If we continue to experience similar levels of turnover in our senior management team, the execution of our corporate strategy could be affected and the costs and effects of such changes could negatively impact our operations.
 
 
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Our international operations may not be successful.
 
We have limited experience operating internationally and have only recently begun to achieve some success in our international operations. We currently have network access points or CDN POPs in Amsterdam, Frankfurt, Hong Kong, London, Singapore, Sydney and Toronto. We also participate in a joint venture with NTT-ME Corporation and Nippon Telegraph and Telephone Corporation, which operates network access points in Tokyo and Osaka, Japan. We may develop or acquire network access points or complementary businesses in additional international markets. The risks associated with expansion of our international business operations include:
 
 
challenges in establishing and maintaining relationships with foreign customers and foreign ISPs and local vendors, including data center and local network operators;
 
 
challenges in staffing and managing network operations centers and network access points across disparate geographic areas;
 
 
potential loss of proprietary information due to misappropriation or laws that may be less protective of our intellectual property rights than the laws in the U.S.;
 
 
challenges in reducing operating expense or other costs required by local laws, and longer accounts receivable payment cycles and difficulties in collecting accounts receivable;
 
 
exposure to fluctuations in foreign currency exchange rates;
 
 
costs of customizing network access points for foreign countries and customers; and
 
 
compliance with requirements of foreign laws, regulations and other governmental controls, including trade and labor restrictions and related laws that may reduce the flexibility of our business operations or favor local competition.
 
We may be unsuccessful in our efforts to address the risks associated with our international operations, including the international operations of Voxel which we recently acquired, which may limit our international sales growth and materially and adversely affect our business and results of operations.
 
We may acquire other businesses, and these acquisitions involve integration and other risks that could harm our business.
 
We may pursue acquisitions of complementary businesses, products, services and technologies to expand our geographic footprint, enhance our existing services, expand our service offerings or enlarge our customer base. If we complete future acquisitions, we may be required to incur or assume additional debt, make capital expenditures or issue additional shares of our common stock or securities convertible into our common stock as consideration, which would dilute our existing stockholders’ ownership interest and may adversely affect our results of operations. If we fail to identify and acquire needed companies or assets, if we acquire the wrong companies or assets, if we fail to address the risks associated with integrating an acquired company or if we do not successfully integrate an acquired company, we would not be able to effectively manage our growth through acquisitions which could adversely affect our results.
 
In this regard, our  recent  acquisition of Voxel may not provide the benefits we anticipate and we may not be successful in our efforts to integrate Voxel into our business, either of which could negatively impact our business.
 
Risks Related to our Capital Stock and Other Business Risks
 
We have a history of losses and may not sustain profitability.
 
For the years ended December 31, 2011, 2010 and 2009, we incurred net losses of $1.7 million, $3.6 million and $69.7 million, respectively. At December 31, 2011, our accumulated deficit was $1.0 billion. Given the competitive and evolving nature of the industry in which we operate, we may not be able to achieve or sustain profitability, and our failure to do so could materially and adversely affect our business, including our ability to raise additional funds.
 
Failure to sustain or increase our revenues will cause our business and financial results to suffer.
 
We have considerable fixed expenses, and we expect to continue to incur significant expenses, particularly with the expansion of our data center facilities. We incur a substantial portion of these expenditures upfront, and are only able to recover these costs over time. We must, therefore, at least sustain or generate higher revenues to maintain profitability. Although revenue from our data center services segment has generally been growing, this segment has lower margins than our IP services segment. If we are unable to increase our margins in the data center services segment, our business may suffer.
 
Numerous factors could affect our ability to increase revenue, either alone or in combination with other factors, including:
 
 
failure to increase sales of our services and products;
 
 
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pricing pressures;
 
 
significant increases in cost of goods sold or other operating expenses;
 
 
failure of our services or products to operate as expected;
 
 
loss of customers or inability to attract new customers or loss of existing customers at a rate greater than our increase in new customers;
 
 
customers’ failure to pay on a timely basis or at all or failure to continue to purchase our IT Infrastructure services in accordance with their contractual commitments; or
 
 
network failures and any breach or unauthorized access to our network.
 
Our results of operations have fluctuated in the past and likely will continue to fluctuate, which could negatively impact the price of our common stock.
 
We have experienced fluctuations in our results of operations on a quarterly and annual basis. Fluctuation in our operating results may cause the market price of our common stock to decline. We expect to experience continued fluctuations in our operating results in the foreseeable future due to a variety of factors, including:
 
 
competition and the introduction of new services by our competitors;
 
 
continued pricing pressures;
 
 
fluctuations in the demand and sales cycle for our services;
 
 
fluctuations in the market for qualified sales and other personnel;
 
 
the cost and availability of adequate public utilities, including power;
 
 
our ability to obtain local loop connections to our network access points at favorable prices;
 
 
general economic conditions; and
 
 
any impairments or restructurings charges that we may incur in the future.
 
In addition, fluctuations in our results of operations may arise from strategic decisions we have made or may make with respect to the timing and magnitude of capital expenditures such as those associated with the expansion of our data center facilities, the deployment of additional network access points, the terms of our network connectivity purchase agreements and the cost of servers, storage and other equipment necessary to deploy managed hosting and cloud services. A relatively large portion of our expenses are fixed in the short-term, particularly with respect to lease and personnel expense, depreciation and amortization and interest expense. Our results of operations, therefore, are particularly sensitive to fluctuations in revenue. We can offer no assurance that the results of any particular period are an indication of future performance in our business operations. Fluctuations in our results of operations could have a negative impact on our ability to raise additional capital and execute our business plan. Our operating results in one or more future quarters may fail to meet the expectations of securities analysts or investors, which could cause an immediate and significant decline in the trading price of our stock.
 
We may incur additional goodwill and other intangible asset impairment charges, restructuring charges or both.
 
The assumptions, inputs and judgments used in performing the valuation analysis and assessments of goodwill and other intangible assets are inherently subjective and reflect estimates based on known facts and circumstances at the time the valuation is performed. The use of different assumptions, inputs and judgments or changes in circumstances could materially affect the results of the valuation and assessments. Due to the inherent uncertainty involved in making these estimates, actual results could differ from our estimates.
 
When circumstances warrant, we may elect to exit certain business activities or change the manner in which we conduct ongoing operations. When we make such a change, we will estimate the costs to exit a business or restructure ongoing operations. The components of the estimates may include estimates and assumptions regarding the timing and costs of future events and activities that represent our best expectations based on known facts and circumstances at the time of estimation. Should circumstances warrant, we will adjust our previous estimates to reflect what we then believe to be a more accurate representation of expected future costs. Because our estimates and assumptions regarding impairment and restructuring charges include probabilities of future events, such as expected operating results, future economic conditions, the ability to find a sublease tenant within a reasonable period of time or the rate at which a sublease tenant will pay for the available space, such estimates are inherently vulnerable to changes due to unforeseen circumstances that could materially and adversely affect our results of operations. Adverse changes in any of these factors could result in an additional impairment and restructuring charges in the future.
 
 
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Our stock price may be volatile.
 
The market for our equity securities has been extremely volatile. Our stock price could suffer in the future as a result of any failure to meet the expectations of public market analysts and investors about our results of operations from quarter to quarter. The following factors could cause the price of our common stock in the public market to fluctuate significantly:
 
 
actual or anticipated variations in our quarterly and annual results of operations;
 
 
changes in market valuations of companies in the industries in which we may compete;
 
 
changes in expectations of future financial performance or changes in estimates of securities analysts;
 
 
fluctuations in stock market prices and volumes;
 
 
future issuances of common stock or other securities;
 
 
the addition or departure of key personnel; and
 
 
announcements by us or our competitors of acquisitions, investments or strategic alliances.
 
Our stockholders may experience significant dilution, which could depress the market price of our common stock.
 
Holders of our stock options may exercise those options to purchase our common stock, which would increase the number of shares of our common stock that are outstanding in the future. As of December 31, 2011, options to purchase an aggregate of 4.6 million shares of our common stock at a weighted average exercise price of $6.13 were outstanding. Also, the vesting of 1.2 million outstanding shares of restricted stock will increase the weighted average number of shares used for calculating diluted net loss per share. Greater than expected capital requirements could require us to obtain additional financing through the issuance of securities, which could be in the form of common stock or preferred stock or other securities having greater rights than our common stock. The issuance of our common stock or other securities, whether upon the exercise of options, the future vesting and issuance of stock awards to our executives and employees, in financing transactions or otherwise, could depress the market price of our common stock by increasing the number of shares of common stock or other securities outstanding on an absolute basis or as a result of the timing of additional shares of common stock becoming available on the market.
 
Our existing credit agreement puts limitations upon us.
 
Our existing credit agreement puts operating and financial limitations on us and requires us to meet certain financial covenants, including those that limit our ability to incur further indebtedness or make certain acquisitions or investments. In addition, these covenants require us to maintain minimum liquidity levels and senior leverage ratio and create liens on a majority our assets. If we do not satisfy these covenants, we would be in default under the credit agreement. Any defaults, if not waived, could result in our lenders ceasing to make loans or extending credit to us, accelerating or declaring all or any obligations immediately due or taking possession of or liquidating collateral. If any of these events occur, we may not be able to borrow sufficient funds to refinance the credit agreement on terms that are acceptable to us, or at all, which could materially and adversely impact our business, consolidated financial condition, results of operations and cash flows.
 
Finally, our ability to access the capital markets may be limited at a time when we would like or need to do so, which could have an impact on our flexibility to pursue expansion opportunities and maintain our desired level of revenue growth in the future.
 
Any failure to meet our debt obligations and other long-term commitments would damage our business.
 
As of December 31, 2011, our total debt, including capital leases, was $99.9 million. If we use more cash than we generate in the future, our level of indebtedness could adversely affect our future operations by increasing our vulnerability to adverse changes in general economic and industry conditions and by limiting or prohibiting our ability to obtain additional financing for future capital expenditures, acquisitions and general corporate and other purposes. In addition, if we are unable to make interest or principal payments when due, we would be in default under the terms of our long-term debt obligations, which would result in all principal and interest becoming due and payable which, in turn, would seriously harm our business.
 
We also have other long-term commitments for operating leases and service contracts totaling $177.0 million in the future with a minimum of $37.6 million payable in 2012. If we are unable to make payments when due, we would be in breach of contractual terms of the agreements, which may result in disruptions of our services which, in turn, would seriously harm our business.
 
 
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Our ability to use U.S. net operating loss carryforwards might be limited.
 
As of December 31, 2011, we had net operating loss carryforwards of $180.7 million for U.S. federal tax purposes. These loss carryforwards expire between 2018 and 2026. To the extent these net operating loss carryforwards are available, we intend to use them to reduce the corporate income tax liability associated with our operations. Section 382 of the U.S. Internal Revenue Code generally imposes an annual limitation on the amount of net operating loss carryforwards that might be used to offset taxable income when a corporation has undergone significant changes in stock ownership. To the extent our use of net operating loss carryforwards is significantly limited, our income could be subject to corporate income tax earlier than it would if we were able to use net operating loss carryforwards, which could result in lower profits.
 
If we fail to adequately protect our intellectual property, we may lose rights to some of our most valuable assets.
 
We rely on a combination of patent, trademark, trade secret and other intellectual property law, nondisclosure agreements and other protective measures to protect our proprietary rights. We also utilize unpatented proprietary know-how and trade secrets and employ various methods to protect such intellectual property. We believe our intellectual property rights are significant and that the loss of all or a substantial portion of such rights could have a material adverse impact on our results of operations. We can offer no assurance that the steps we have taken to protect our intellectual property will be sufficient to prevent misappropriation of our technology, or that our trade secrets will not become known or be independently discovered by competitors. In addition, the laws of many foreign countries do not protect our intellectual property to the same extent as the laws of the U.S.. From time-to-time, third parties have or may assert infringement claims against us or against our customers in connection with their use of our products or services.
 
In addition, we rely on the intellectual property of others. We may desire or be required to renew or to obtain licenses from these other parties to further develop and market commercially-viable products or services effectively. We can offer no assurance that any necessary licenses will be available on reasonable terms, or at all.
 
Changes to conform to new accounting principles and/or financial regulation may be costly and disrupt our current planning, analysis and reporting processes.
 
Accounting oversight bodies in the U.S. and internationally are actively contemplating and enacting a number of new accounting regulations. To comply with these changes, we may need to incur a significant amount of time and resources to adapt personnel, processes, reporting and systems. For example, changes proposed to lease accounting conventions in generally accepted accounting principles in the U.S. would require reclassification of most of our operating leases to capital lease treatment. This would significantly change the nature of our balance sheet. Likewise, International Financial Reporting Standards (“IFRS”), if adopted, would necessitate wholesale changes in our accounting processes and modification to our financial reporting and supporting systems. This would have a large impact on revenue recognition and fixed asset reporting.
 
In addition, new laws relating to public company governance practices, such as the Dodd-Frank Act Wall Street Reform and Consumer Protection Act which is being implemented over time, will modify existing corporate governance practices and potentially increase liability related to stockholder actions, whistleblower claims and governmental enforcement actions.
 
While we have implemented internal practices to proactively review, assess and adapt to these new and constantly changing regulations, we cannot predict with certainty the impact, if any, that future regulation or regulatory changes may have on our business or the potential costs we may incur related to compliance with these new laws and regulations.
 
We may face litigation and liability due to claims of infringement of third-party intellectual property rights.
 
The infrastructure services industry is characterized by the existence of a large number of patents and frequent litigation based on allegations of patent infringement. From time-to-time, third parties may assert patent, copyright, trademark, trade secret and other intellectual property rights to technologies that are important to our business. Any claims that our IT infrastructure services infringe or may infringe proprietary rights of third parties, with or without merit, could be time-consuming, result in costly litigation, divert the efforts of our technical and management personnel or require us to enter into royalty or licensing agreements, any of which could significantly impact our operating results. In addition, our customer agreements generally require us to indemnify our customers for expenses and liabilities resulting from claimed infringement of patents or copyrights of third parties, subject to certain limitations. If an infringement claim against us were to be successful, and we were not able to obtain a license to the relevant technology or a substitute technology on acceptable terms or redesign our services or products to avoid infringement, our ability to compete successfully in our market would be materially impaired.
 
We are currently subject to a securities class action lawsuit and a derivative action lawsuit, the unfavorable outcomes of which could have a material adverse impact on our financial condition, results of operations and cash flows.
 
In November 2008, a putative securities class action lawsuit was filed against us and our former chief executive officer and in November 2009, a putative derivative lawsuit was filed purportedly on our behalf against certain of our directors and officers. While we are, and will continue to, vigorously contest these lawsuits, we cannot determine the final resolution of these lawsuits or when they might be resolved. In addition to the expenses incurred in defending this litigation and any damages that may be awarded in the event of an adverse ruling, our management’s efforts and attention will be diverted from the ordinary business operations to address these claims. Regardless of the outcome, this litigation may have a material adverse impact on our results because of defense costs, including costs related to our indemnification obligations, diversion of resources and other factors. We discuss these lawsuits further in Item 3 “Legal Proceedings” below.
 
 
- 15 -

 
 
We do not expect to pay dividends on our common stock, and investors would only be able to receive cash in respect of the shares of common stock upon the sale of their shares.
 
We have no intention in the foreseeable future to pay any cash dividends on our common stock, and the covenants in our credit agreement limit our ability to pay dividends. Therefore, an investor in our common stock may obtain an economic benefit from the common stock only after an increase in its trading price and only by selling the common stock.
 
Provisions of our charter documents and Delaware law may have anti-takeover effects that could prevent a change in control even if the change in control would be beneficial to our stockholders.
 
Provisions of our Certificate of Incorporation and Bylaws, and provisions of Delaware law, could discourage, delay or prevent a merger, acquisition or other change in control of our company. These provisions are intended to protect stockholders’ interests by providing our board of directors a means to attempt to deny coercive takeover attempts or to negotiate with a potential acquirer in order to obtain more favorable terms. Such provisions include a board of directors that is classified so that only one-third of directors stand for election each year. These provisions could also discourage proxy contests and make it more difficult for stockholders to elect directors and take other corporate actions.
 
I TEM 1B. UNRESOLVED STAFF COMMENTS
 
None.
 
I TEM 2. PROPERTIES
 
Our principal executive offices are located in Atlanta, Georgia adjacent to one of our network operations center, P-NAPs and data center facilities. Our Atlanta headquarters consists of 120,298 square feet under a lease agreement that expires in 2020.  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 existing corporate office space.  We will take possession of the space in 2012 when the space is available according to terms of the lease. The new space consists of approximately 62,000 square foot under a lease that will expire in 2019.
 
Leased facilities in our top markets include Atlanta, Boston, Dallas, Houston, Los Angeles, New York metro area, Northern California and Seattle. We believe our existing facilities are adequate for our current needs and that suitable additional or alternative space will be available in the future on commercially reasonable terms as needed.
 
I TEM 3. 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 (i) integration of VitalStream Holdings, Inc. (“VitalStream”), which we acquired in 2007, (ii) customer issues and related credits due to services outages and (iii) 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.
 
 
- 16 -

 
 
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.
 
I TEM 4. MINE SAFETY DISCLOSURES
 
Not applicable.
 
P ART II
 
I TEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
 
Our common stock is listed on the NASDAQ Global Market under the symbol “INAP.” The following table presents, for the periods indicated, the range of high and low per share sales prices of our common stock, as reported on the NASDAQ Global Market. Our fiscal year ends on December 31.
 
Year Ended December 31, 2011:
 
 
High
   
Low
 
Fourth Quarter
  $ 6.45     $ 4.55  
Third Quarter
    7.52       4.35  
Second Quarter
    8.56       6.58  
First Quarter
    7.89       5.91  

Year Ended December 31, 2010:
 
 
High
   
Low
 
Fourth Quarter
  $ 6.42     $ 4.39  
Third Quarter
    5.12       3.90  
Second Quarter
    6.16       4.12  
First Quarter
    6.46       4.32  
 
As of February 13, 2012, we had approximately 800 stockholders of record of our common stock.
 
We have never declared or paid any cash dividends on our capital stock, and we do not anticipate paying cash dividends in the foreseeable future. We are prohibited from paying cash dividends under covenants contained in our credit agreement. We currently intend to retain our earnings, if any, for future growth. Future dividends on our common stock, if any, will be at the discretion of our board of directors and will depend on, among other things, our operations, capital requirements and surplus, general financial condition, contractual restrictions and such other factors as our board of directors may deem relevant.
 
 
- 17 -

 
 
The following table provides information regarding our current equity compensation plans as of December 31, 2011 (shares in thousands):

Equity Compensation Plan Information
 
Plan category
 
Number of securities
to be issued upon
exercise of
outstanding options,
warrants and rights
(a)
   
Weighted-average
exercise price of
outstanding options,
warrants and rights
(b)
   
Number of securities
remaining available
for future issuance
under equity
compensation
plans (excluding
securities reflected
in column (a))
(c)
 
Equity compensation plans approved by security holders
    4,643 (1)   $ 6.13       4,963  
                         
Equity compensation plans not approved by security holders
                 
                         
Total
    4,643     $ 6.13       4,963  


(1)
Excludes purchase rights under the previously effective 2004 Employee Stock Purchase Plan (the “ESPP”). Under the ESPP, each eligible employee was entitled to purchase up to $12,500 worth of our common stock at each semi-annual purchase date (the last business day of June and December each year), but not more than $25,000 worth of such stock (based on the fair market value per share on the purchase date(s)) per calendar year. The purchase price per share was equal to 95% of the closing selling price per share of our common stock on the purchase date. Our board of directors approved suspension of participation in the ESPP effective July 1, 2011.
 
ISSUER PURCHASES OF EQUITY SECURITIES
 
The following table sets forth information regarding our repurchases of securities for each calendar month in the quarter ended December 31, 2011:

Period
    Total Number of Shares
Purchased (1)
   
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
 
October 1 to 31, 2011
   
2,345
   
$
5.11
     
     
 
November 1 to 30, 2011
   
1,052
     
5.13
     
     
 
December 1 to 31, 2011
   
6,572
     
5.64
     
     
 
Total
   
9,969
   
$
5.46
     
     
 


(1)
Employees surrendered these shares to us as payment of statutory minimum payroll taxes due in connection with the vesting of restricted stock.
 
 
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We have derived the selected financial data shown below for each of the five years in the period ended December 31, 2011 from our accompanying consolidated financial statements. The following data should be read in conjunction with the accompanying consolidated financial statements and related notes contained and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in this Annual Report on Form 10-K (in thousands, except per share data).
 
   
Year Ended December 31,
 
   
2011 (1)
   
2010
   
2009 (2)
   
2008 (3)
   
2007 (4)
 
Consolidated Statements of Operations Data:
                             
Revenues
  $ 244,628     $ 244,164     $ 256,259     $ 253,989     $ 234,090  
Operating costs and expenses:
                                       
Direct costs of network, sales and services, exclusive of depreciation and amortization, shown below
    120,310       127,423       143,016       135,877       118,394  
Direct costs of customer support
    21,278       19,861       18,034       16,217       16,547  
Direct costs of amortization of acquired technologies
    3,500       3,811       8,349       6,649       4,165  
Sales and marketing
    29,715       29,232       28,131       30,888       31,533  
General and administrative
    33,952       33,048       44,645       44,235       39,076  
Depreciation and amortization
    36,926       30,158       28,282       23,865       22,242  
Loss (gain) on disposals of property and equipment, net
    37       116       26       (16 )     (5 )
Restructuring and impairments
    2,833       1,411       54,698       101,441       11,349  
Other
                            500  
Total operating costs and expenses
    248,551       245,060       325,181       359,156       243,801  
Loss from operations
    (3,923 )     (896 )     (68,922 )     (105,167 )     (9,711 )
Non-operating expense (income)
    3,866       2,170       461       (245 )     (937 )
Loss before income taxes and equity in (earnings) of equity-method investment
    (7,789 )     (3,066 )     (69,383 )     (104,922 )     (8,774 )
(Benefit) provision for income taxes
    (5,612 )     952       357       174       (3,080 )
Equity in (earnings) of equity-method investment, net of taxes
    (475 )     (396 )     (15 )     (283 )     (139 )
Net loss
  $ (1,702 )   $ (3,622 )   $ (69,725 )   $ (104,813 )   $ (5,555 )
                                         
Net loss per share:
                                       
Basic and diluted
  $ (0.03 )   $ (0.07 )   $ (1.41 )   $ (2.13 )   $ (0.12 )

   
December 31,
 
 
 
2011
   
2010
   
2009 (2)
   
2008 (3)
   
2007
 
Consolidated Balance Sheets Data:
                                       
Cash and cash equivalents, investments in marketable securities and other related assets and restricted cash (5)
  $ 29,772     $ 59,582     $ 80,926     $ 61,096     $ 75,719  
Total assets
    356,710       293,142       267,502       330,083       427,010  
Credit facilities, due after one year, and capital lease obligations, less current portion
    94,673       37,889       23,217       23,244       17,806  
Total stockholders’ equity
    192,170       188,611       184,402       248,195       346,633  

   
Year Ended December 31,
 
 
 
2011
   
2010
   
2009
   
2008
   
2007
 
Other Financial Data:
                                       
Purchases of property and equipment
  $ 68,596     $ 62,235     $ 17,278     $ 51,154     $ 30,271  
Net cash flows provided by operating activities
    28,630       39,602       37,520       37,951       27,526  
Net cash flows used in investing activities
    (96,265 )     (55,184 )     (9,900 )     (41,690 )     (36,393 )
Net cash flows provided by (used in) financing activities
    37,901       1,224       (598 )     (821 )     15,240  
 

(1)
On December 30, 2011, we completed our acquisition of Voxel. We allocated the purchase price to Voxel’s net tangible and intangible assets based on their estimated fair values as of December 30, 2011. We recorded the excess purchase price over the value of the net tangible and identifiable intangible assets as goodwill. In addition, as a result of our purchase price accounting, our net loss was reduced by a $6.1 million deferred tax benefit that offset our existing income tax expense of $0.5 million.
 
 
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(2)
We completed an assessment of goodwill and other intangible assets for impairment as of June 1, 2009, in connection with our decision to consolidate our business segments, which resulted in aggregate impairment charges of $51.5 million for goodwill and $4.1 million for other acquired intangible assets.
(3)
As a result of our annual goodwill impairment test on August 1, 2008, we recorded a $99.7 million impairment charge to adjust goodwill in our former CDN services segment to its implied fair value.
(4)
On February 20, 2007, we completed our acquisition of VitalStream, whereby it became our wholly-owned subsidiary. Prior to this acquisition, we did not offer proprietary CDN services, but instead, we were a reseller of third party CDN services. Under the purchase method of accounting, we allocated the total estimated purchase price to VitalStream’s net tangible and intangible assets based on their estimated fair values as of February 20, 2007. We recorded the excess purchase price over the value of the net tangible and identifiable intangible assets as goodwill. Also, as a result of the acquisition, we issued 12.2 million shares of our  common stock.
(5)
The following table provides a reconciliation of total cash and cash equivalents, investments in marketable securities and other related assets and restricted cash to the amounts reported in our audited consolidated balance sheets (in thousands):
 
   
December 31,
 
   
2011
   
2010
   
2009
   
2008
   
2007
 
Cash and cash equivalents
  $ 29,772     $ 59,582     $ 73,926     $ 46,870     $ 52,030  
Investments in marketable securities and other related assets:
                                       
Short-term
                7,000       7,199       19,569  
Long-term
                      7,027        
Restricted cash
                            4,120  
    $ 29,772     $ 59,582     $ 80,926     $ 61,096     $ 75,719  
 
Investments in marketable securities and other related assets include auction rate securities and corresponding rights of $0, $0 and $7,000 as of December 31, 2011, 2010 and 2009, respectively. We classified these as short-term investments as of December 31, 2009.
 
 
The following discussion should be read in conjunction with the accompanying consolidated financial statements and notes provided under Part II, Item 8 of this Annual Report Form 10-K.
 
2011 Financial Highlights and Outlook
 
Data center services .  Revenue increased $5.3 million during 2011 primarily due to net revenue growth in company-controlled colocation and hosting services. We expect our data center revenue growth to continue in future periods, as we have expanded the number and size of the data center sites that we operate and expect to add additional space as part of our continuing data center growth initiative.
 
We believe the demand for data center services continues to outpace industry-wide supply. To address this demand, during 2011, we opened a new company-controlled data center in Dallas, Texas and began to build out a new company-controlled data center in Los Angeles, California. These expansions give us the capacity to increase the footprint of our company-controlled data centers by approximately 110,000 net sellable square feet over time. Our expansion of company-controlled data centers has contributed to total lower overall utilization of net sellable square feet as of December 31, 2011, compared to 2010. At December 31, 2011, we had approximately 220,000 net sellable square feet of data center space with a utilization rate of 65%, compared to approximately 199,000 net sellable square feet of data center space with a utilization rate of 68% at December 31, 2010. We expect our recent company-controlled data center expansions will continue to increase our share of occupied square footage in company-controlled data centers. At December 31, 2011, 72% of our total net sellable square feet were in company-controlled data centers versus partner sites, as compared to 68% of our total net sellable square feet at December 31, 2010.

In addition, on December 30, 2011, we acquired Voxel, a global provider of scalable hosting and cloud services. Voxel’s offerings are complementary to our existing portfolio and provide a level of automation and self-service that will be available to our customer base and also extend our addressable market, enabling us to better serve early- to mid-stage IT Infrastructure customers seeking dedicated hosting services.
 
IP services .  Revenue decreased $4.8 million during 2011; however, IP traffic increased approximately 19% during 2011, compared to 2010,  calculated based on an average over the number of months in the respective periods. W e continue to experience pricing pressure for our IP services, which has contributed to the decrease in IP services revenue year-over-year. Due to competitive forces, we have been required to lower pricing of our IP services, although this decrease in pricing has been offset by an increase in demand for our IP services. 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 ISPs.
 
 
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Credit Agreement

In December 2011, we amended our credit agreement (the “Amendment ). The Amendment increases the total availability by $40.0 million. We summarize the Amendment in “—Liquidity and Capital Resources—Capital Resources—Credit Agreement” and in note 11 to the accompanying consolidated financial statements. Concurrently with the effective date and funding of the Amendment, we acquired Voxel.
 
Subsequent Events
 
Approval of Annual Performance Bonuses and Increases in Base Salary
 
On February 22, 2012, our compensation committee, in the case of named executive officers other than our Chief Executive Officer, and our board of directors, in the case of our Chief Executive Officer, approved bonuses under our 2011 Short-Term Incentive Plan, which we previously filed as Exhibit 10.29 to our Annual Report on Form 10-K for the fiscal year ended December 31, 2010. These bonuses were awarded based upon achievement of personal and corporate objectives, in the case of named executive officers other than the Chief Executive Officer and Chief Financial Officer, and achievement of coporate objectives, in the case of the Chief Executive Officer and Chief Financial Officer. We will pay the bonuses in cash on or before March 15, 2012.
 
Name and Title
 
 
Bonus
 
J. Eric Cooney, Chief Executive Officer
  $ 210,140  
George E. Kilguss III, Senior Vice President and Chief Financial Officer
    67,726  
Steven A. Orchard, Senior Vice President, Operations and Support
    42,029  
Richard A. Shank, Senior Vice President, Global Sales 1     29,263  
         
(1)    Mr. Shank joined our company on September 19, 2011.        
 
In addition, our compensation committee approved an increase in the base salary of the following executive officers effective April 1, 2012:  Mr. Kilguss from $300,000 to $308,400 and Mr. Orchard from $210,000 to $220,500.
 
Approval of Long-Term Incentive Grants
 
On February 22, 2012, our compensation committee, in the case of named executive officers other than our Chief Executive Officer, and our board of directors, in the case of our Chief Executive Officer, approved long-term incentive grants based on the individual’s role in our company and individual performance. The grants will be made on February 24, 2012. Of each award, 70% of the total grant will be in the form of stock options and 30% will be in the form of time-based restricted common stock. The stock options vest 25% after one year and in equal monthly increments for three years thereafter. The time-based restricted common stock vests in four equal annual installments on the anniversary of the grant date. The options have a 10-year term and will have an exercise price equal to the fair market value of our common stock on February 24, 2012, the grant date. The following grants were approved:
 
   
Number of Awards (#)
 
Name and Title
 
Options
   
Restricted
Stock
 
J. Eric Cooney, Chief Executive Officer
    172,600       35,950  
George E. Kilguss III, Senior Vice President and Chief Financial Officer
    90,447       18,841  
Steven A. Orchard, Senior Vice President, Operations and Support
    40,561       8,449  
Richard A. Shank, Senior Vice President, Global Sales
    37,109       7,730  
 
2012 Short-Term Incentive Plan
 
On February 22, 2012, our compensation committee approved the 2012 Short Term Incentive Plan. Under the plan, certain employees (including named executive officers) may be eligible for the award of a cash bonus after our 2012 fiscal year end. The cash bonus of each participant (other than our Chief Executive Officer and Chief Financial Officer) will be based on achievement of corporate and personal objectives, with a target award level expressed as a percentage of salary. The cash bonus of our Chief Executive Officer and Chief Financial Officer will be based on achievement of corporate objectives only, with a target award level expressed as a percentage of salary. The corporate objectives are based on revenue and earnings before interest, taxes, depreciation and amortization (“EBITDA”). The personal objectives are individualized for each participant.
 
 
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The table below identifies the target incentives as a percentage of base salary and the split between corporate and personal objectives for named executive officers:
 
STI
Participation Level
 
Target Incentive
(% Salary)
 
Corporate
Objectives
   
Personal
Objectives
 
CEO and CFO
  Up to 100%     100 %      
Other Named Executive Officers
  Up to 50%     70 %     30 %
 
For named executive officers, the maximum bonus potential is up to two times the target incentive based on achievement of stretch corporate objectives.  Our compensation committee may amend, modify, terminate or suspend operation of the plan at any time. If a participant is not an employee on the date awards from the plan are paid (other than by reason of death or disability), the participant shall not have earned and will not receive any payment under the plan.
 
The above description is qualified in its entirety by reference to the full text of the 2012 Short Term Incentive Plan, which is being filed as Exhibit 10.31 to this Annual Report on Form 10-K.

Critical Accounting Policies and Estimates
 
This discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which we have prepared in accordance with accounting principles generally accepted in the U.S. (“GAAP”). The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expense and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those summarized below. 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.
 
In addition to our significant accounting policies summarized in note 2 to our accompanying consolidated financial statements, we believe the following policies are the most sensitive to judgments and estimates in the preparation of our consolidated financial statements.
 
Revenue Recognition
 
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 and 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 and variable charges for space occupied, power utilized, interconnection and computing resources consumed. 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 exceeds the monthly minimum commitment, we recognize revenue for such excess in the period of usage.
 
In January 2011, we adopted new guidance, which eliminates the residual method of allocation for multiple-deliverable revenue arrangements, and requires that we allocate arrangement consideration at the inception of an arrangement to all deliverables using the relative selling price method. This new guidance also establishes a selling price hierarchy for determining the selling price of a deliverable, which includes (i) vendor-specific objective evidence, if available, (ii) third-party evidence, if vendor-specific objective evidence is not available, and (iii) best estimated selling price, if neither vendor-specific nor third-party evidence is available. Additionally, the guidance expands the disclosure requirements related to a vendor’s multiple-deliverable revenue arrangements. Adoption of this guidance did not have a material impact on our consolidated financial statements.     
 
Vendor-specific objective evidence is generally limited to the price charged when we sell the same or similar product separately. If we seldom sell a product or service separately, it is unlikely that we will determine vendor-specific objective evidence for the product or service. We define vendor-specific objective evidence as an average price of recent standalone transactions that we price within a narrow range as defined by us.
 
We determine third-party evidence based on the prices charged by our competitors for a similar deliverable when sold separately. It is difficult for us to obtain sufficient information on competitor pricing to substantiate third-party evidence and therefore we may not always be able to use this measure.
 
If we are unable to establish selling price using vendor-specific objective evidence or third-party evidence, and we receive or materially modify a sales order after our implementation date of January 1, 2011, we use best estimated selling price in our allocation of arrangement consideration. The objective of best estimated selling price is to determine the price at which we would transact if we sold the product or service on a standalone basis.  Our determination of best estimated selling price involves a weighting of several factors including, but not limited to, pricing practices and market conditions.
 
We analyze the selling prices used in our allocation of arrangement consideration on an annual basis at a minimum. We will analyze selling prices on a more frequent basis if a significant change in our business necessitates a more timely analysis or if we experience significant variances in our selling prices.
 
 
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We account for each deliverable within a multiple-deliverable revenue arrangement as a separate unit of accounting under the new guidance if both of the following criteria are met: (i) the delivered item or items have value to the customer on a standalone basis and (ii) for an arrangement that includes a general right of return relative to the delivered item(s), we consider delivery or performance of the undelivered item(s) probable and substantially in our control. We consider a deliverable to have standalone value if we sell this item separately or if the item is sold by another vendor or could be resold by the customer. Further, our revenue arrangements generally do not include a right of return relative to delivered products.
 
We combine deliverables not meeting the criteria for being a separate unit of accounting with a deliverable that does meet that criterion. We then determine the appropriate allocation of arrangement consideration and recognition of revenue for the combined unit of accounting.
 
Deferred revenue consists of revenue for services to be delivered in the future and consists primarily of advance billings, which we amortize over the respective service period. We defer and amortize revenues associated with billings for installation of customer network equipment over the estimated life of the customer relationship, which was, on average, approximately four years for 2011 and 2010 and three years for 2009. We defer and amortize revenues for installation services because the installation service is integral to our primary service offering and does not have value to customers on a stand-alone basis. We also defer and amortize the associated incremental direct costs.
 
We record a reserve amount for SLAs and other sales adjustments, which reduces gross revenues and accounts receivable. We identify adjustments for SLAs within the billing period and reduce revenues accordingly. We base the amount for sales adjustments upon specific customer information, including customer disputes, credit adjustments not yet processed through the billing system and historical activity. If the financial condition of our customer deteriorates or if we become aware of new information impacting a customer’s credit risk, we may make additional adjustments.
 
We routinely review the collectability of our accounts receivable and payment status of our customers. If we determine that collection of revenue is uncertain, we do not recognize revenue until collection is reasonably assured. Additionally, we maintain an allowance for doubtful accounts resulting from the inability of our customers to make required payments on accounts receivable. We base the allowance for doubtful accounts upon general customer information, which primarily includes our historical cash collection experience and the aging of our accounts receivable. We assess the payment status of customers by reference to the terms under which we provide services or goods, with any payments not made on or before their due date considered past-due. Once we have exhausted all collection efforts, we write the uncollectible balance off against the allowance for doubtful accounts. We routinely perform credit checks for new and existing customers and require deposits or prepayments for customers that we perceive as being a credit risk.
 
Goodwill and Other Intangible and Long-lived Assets
 
Our annual assessment of goodwill for impairment includes comparing the fair value of each reporting unit to the carrying value, referred to as step one. We estimate fair value using a combination of discounted cash flow models and market approaches. If the fair value of a reporting unit exceeds its carrying value, goodwill is not impaired and no further testing is necessary. If the carrying value of a reporting unit exceeds its fair value, we perform a second test, referred to as step two, to measure the amount of impairment to goodwill, if any. To measure the amount of any impairment, we determine the implied fair value of goodwill in the same manner as if we were acquiring the affected reporting unit in a business combination. Specifically, we allocate the fair value of the affected reporting unit to all of the assets and liabilities of that unit, including any unrecognized intangible assets, in a hypothetical calculation that would yield the implied fair value of goodwill. If the implied fair value of goodwill is less than the goodwill recorded on our consolidated balance sheet, we record an impairment charge for the difference.
 
We base the impairment analysis of goodwill on estimated fair values. The assumptions, inputs and judgments used in performing the valuation analysis are inherently subjective and reflect estimates based on known facts and circumstances at the time we perform the valuation. These estimates and assumptions primarily include, but are not limited to, discount rates; terminal growth rates; projected revenues and costs; projected EBITDA for expected cash flows; market comparables and capital expenditures forecasts. The use of different assumptions, inputs and judgments, or changes in circumstances, could materially affect the results of the valuation. Due to the inherent uncertainty involved in making these estimates, actual results could differ from our estimates and could result in additional non-cash impairment charges in the future.
 
We perform our annual goodwill impairment test as of August 1 absent any impairment indicators or other changes that may cause more frequent analysis. We did not identify an impairment as a result of our annual August 1, 2011 impairment test and none of our reporting units were at risk of failing step one. In addition, we assess on a quarterly basis whether any events have occurred or circumstances have changed that would indicate an impairment could exist. We considered the likelihood of triggering events that might cause us to reassess goodwill on an interim basis and concluded that none had occurred subsequent to August 1, 2011.
 
Other intangible assets, including developed technologies and patents, have finite lives and we record these assets at cost less accumulated amortization. We calculate amortization on a straight-line basis over the estimated economic useful life of the assets, which are three to eight years for developed technologies and 15 years for patents. We assess other intangible assets and long-lived assets on a quarterly basis whenever any events have occurred or circumstances have changed that would indicate impairment could exist. Our assessment is based on estimated future cash flows directly associated with the asset or asset group. If we determine that the carrying value is not recoverable, we may record an impairment charge, reduce the estimated remaining useful life or both. We concluded that no impairment indicators existed to cause us to reassess our other intangible during the year ended December 31, 2011. However, on December 30, 2011, we acquired Voxel. We discuss the acqusition above in “—2011 Financial Highlights and Outlook” and it is summarized in note 3 to the accompanying consolidated financial statements. While Voxel’s products are complementary to our existing IT Infrastructure services, we will not use certain of our assets in the same manner as we would have used them had the acquisition not taken place. As such, we evaluated our suite of IT Infrastructure services for impairment. The evaluation resulted in an impairment charge of $0.5 million to developed software related to our Cloud portal functionality, included in the data center services segment.  We record the impairment in “Restructuring and impairments” on the accompanying statement of  operations.
 
 
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Property and Equipment
 
We carry property and equipment at original acquisition cost less accumulated depreciation and amortization. We calculate depreciation and amortization on a straight-line basis over the estimated useful lives of the assets. Estimated useful lives used for network equipment are generally three years; furniture, equipment and software are three to seven years; and leasehold improvements are seven years or over the lease term, depending on the nature of the improvement, but in no event beyond the expected lease term and none over 20 years. We capitalize additions and improvements that increase the value or extend the life of an asset. We expense maintenance and repairs as incurred. We charge gains or losses from disposals of property and equipment to operations.
 
Subsequent to December 31, 2011, 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 development
    3       5  
Leasehold improvements
    7       10-25  
 
E ffective January 1, 2012, we will account for the change in estimated useful lives as a change in accounting estimate on a prospective basis, which will result in less depreciation expense than we would have otherwise recorded. For the year ended December 31, 2012, we expect depreciation expense, on assets that existed as of December 31, 2011,  to be $14.1 million less than it would have been under the previous useful lives.
 
The assessment for recognition of deferred tax assets based on the change in estimated useful lives is not reasonably determinable.  We expect pretax book income to be larger in the future as a result of this change in accounting estimate.  Accordingly, it is possible that we will recognize deffererd tax assets in the future if there is evidence of profitable growth.  We do not expect to recognize the deferred tax assets in the next 12 months; however, it is possible that we could achieve profitable growth in future periods.
 
Restructuring
 
When circumstances warrant, we may elect to exit certain business activities or change the manner in which we conduct ongoing operations. If we make such a change, we will estimate the costs to exit a business or restructure ongoing operations. The components of the estimates may include estimates and assumptions regarding the timing and costs of future events and activities that represent our best expectations based on known facts and circumstances at the time of estimation. If circumstances warrant, we will adjust our previous estimates to reflect what we then believe to be a more accurate representation of expected future costs. Because our estimates and assumptions regarding restructuring charges include probabilities of future events, such as our ability to find a sublease tenant within a reasonable period of time or the rate at which a sublease tenant will pay for the available space, such estimates are inherently vulnerable to changes due to unforeseen circumstances that could materially and adversely affect our results of operations. If the amount of time that we expect it to take to find sublease tenants in all of the vacant space already in restructuring were to increase by three months and assuming no other changes to the properties in restructuring, we would record an additional $0.3 million in restructuring charges in the consolidated statement of operations during the period in which the change in estimate occurred. We monitor market conditions at each period end reporting date and will continue to assess our key assumptions and estimates used in the calculation of our restructuring accrual.
 
Income Taxes
 
We record a valuation allowance to reduce our deferred tax assets to their estimated realizable value. Although we consider the potential for future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance, if we determine we would be able to realize our deferred tax assets in the future in excess of our net recorded amount, an adjustment to reduce the valuation allowance would increase net income in the period we made such determination. We may recognize deferred tax assets in future periods if and when we estimate them to be realizable, such as establishing our expected continuing profitability or that of certain of our foreign subsidiaries.
 
 
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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 United Kingdom (“U.K.”).
 
Stock-Based Compensation
 
We measure stock-based compensation cost at the grant date based on the calculated fair value of the award. We recognize the expense over the employee’s requisite service period, generally the vesting period of the award. We estimate the fair value of stock options at the grant date using the Black-Scholes option pricing model with weighted average assumptions for the activity under our stock plans. Option pricing model input assumptions, such as expected term, expected volatility and risk-free interest rate, impact the fair value estimate. Further, the forfeiture rate impacts the amount of aggregate compensation. These assumptions are subjective and generally require significant analysis and judgment to develop.
 
The expected term represents the weighted average period of time that we expect granted options to be outstanding, considering the vesting schedules and our historical exercise patterns. Because our options are not publicly traded, we assume volatility based on the historical volatility of our stock. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant for periods corresponding to the expected option term. We have also used historical data to estimate option exercises, employee termination and stock option forfeiture rates. Changes in any of these assumptions could materially impact our results of operations in the period the change is made. A 10% increase in stock-based compensation would result in additional expense of $0.4 million.
 
Capitalized Software Costs
 
We capitalize software development costs incurred during the application development stage. We amortize capitalized software once the software is ready for its intended use and we compute it based on the straight-line method over the economic life of the software product. Judgment is required in determining which software projects are capitalized and the estimated economic life.
 
Recent Accounting Pronouncements
 
Recent accounting pronouncements are summarized in note 2 to the accompanying consolidated financial statements. Currently, we do not expect any recent accounting pronouncements that we have not yet adopted to have a material impact on our consolidated financial statements.
 
Results of Operations
 
Revenues
 
We generate revenues primarily from the sale of data center services and IP services.
 
Direct Costs of Network, Sales and Services
 
Direct costs of network, sales and services are comprised primarily of:
 
 
costs for connecting to and accessing ISPs 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 ISP, we may incur additional local loop charges on a recurring basis. Connectivity costs vary depending on customer demands and pricing variables while network access point facility costs are generally fixed. 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, direct costs of customer support include facilities costs associated with the network operations centers, including costs related to servicing our data center customers.
 
 
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Direct Costs of Amortization of Acquired Technologies
 
Direct costs of amortization of acquired technologies are for technologies acquired through business combinations that are an integral part of the services and products we sell. We amortize the cost of the acquired technologies over original lives of three to eight years. The carrying value of acquired technologies at December 31, 2011 was $18. 8 million and the weighted average remaining life was approximately six years . These direct costs during the year ended December 31, 2009 also included impairment of the CDN advertising technology we obtained in the VitalStream acquisition.
 
Sales and Marketing
 
Sales and marketing costs consist of compensation, commissions and other costs for personnel engaged in marketing, sales and field service support functions, and advertising, online marketing, tradeshows, direct response programs, facility open houses, management of our external website and other promotional costs.
 
General and Administrative
 
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. We capitalize costs associated with internal-use software when the software enters the application development stage until the software is ready for its intended use. We expense all other product development costs as incurred.
 
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):
 
   
Year Ended December 31,
   
Increase (decrease)
from 2010 to 2011
   
Increase (decrease)
from 2009 to 2010
 
   
2011
   
2010
   
2009
   
Amount
   
Percent
   
Amount
   
Percent
 
Revenues:
                                         
Data center services
  $ 133,453     $ 128,200     $ 130,711     $ 5,253       4 %   $ (2,511 )     (2 )%
IP services
    111,175       115,964       125,548       (4,789 )     (4 )     (9,584 )     (8 )
Total revenues
    244,628       244,164       256,259       464             (12,095 )     (5 )
                                                         
Operating costs and expenses:
                                                       
Direct costs of network, sales and services, exclusive of depreciation and amortization, shown below:
                                                       
Data center services
    78,907       82,761       94,961       (3,854 )     (5 )     (12,200 )     (13 )
IP services
    41,403       44,662       48,055       (3,259 )     (7 )     (3,393 )     (7 )
Direct costs of customer support
    21,278       19,861       18,034       1,417       7       1,827       10  
Direct costs of amortization of acquired technologies
    3,500       3,811       8,349       (311 )     (8 )     (4,538 )     (54 )
Sales and marketing
    29,715       29,232       28,131       483       2       1,101       4  
General and administrative
    33,952       33,048       44,645       904       3       (11,597 )     (26 )
Depreciation and amortization
    36,926       30,158       28,282       6,768       22       1,876       7  
Loss on disposals of property and equipment, net
    37       116       26       (79 )     (68 )     90       346  
Restructuring and impairments
    2,833       1,411       54,698       1,422       101       (53,287 )     (97 )
Total operating costs and expenses
    248,551       245,060       325,181       3,491       1       (80,121 )     (25 )
Loss from operations
  $ (3,923 )   $ (896 )   $ (68,922 )   $ 3,027       338     $ 68,026       99  
                                                         
Interest expense
  $ 3,701     $ 2,170     $ 720     $ 1,531       71     $ 1,450       201  
(Benefit) provision for income taxes
  $ (5,612 )   $ 952     $ 357     $ (6,564 )     (689 )%   $ 595       167 %
 
 
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Segment Information
 
We operate in two business segments: data center services and IP services. Segment results for each of the three years ended December 31, 2011 are summarized as follows (in thousands):
 
   
Year Ended December 31,
 
   
2011
   
2010
   
2009
 
Revenues:
                 
Data center services
  $ 133,453     $ 128,200     $ 130,711  
IP services
    111,175       115,964       125,548  
Total revenues
    244,628       244,164       256,259  
                         
Direct costs of network, sales and services, exclusive of depreciation and amortization:
                       
Data center services
    78,907       82,761       94,961  
IP services
    41,403       44,662       48,055  
Total direct costs of network, sales and services, exclusive of depreciation and amortization
    120,310       127,423       143,016  
                         
Segment profit:
                       
Data center services
    54,546       45,439       35,750  
IP services
    69,772       71,302       77,493  
Total segment profit
    124,318       116,741       113,243  
                         
Restructuring and impairments
    2,833       1,411       54,698  
Other operating expenses, including direct costs of customer support,   depreciation and amortization
    125,408       116,226       127,467  
Loss from operations
    (3,923 )     (896 )     (68,922 )
Non-operating expense
    3,866       2,170       461  
Loss before income taxes and equity in (earnings) of equity-method investment
  $ (7,789 )   $ (3,066 )   $ (69,383 )
 
Segment 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. Segment profit is a supplemental financial measure that is not prepared in accordance with GAAP. We view direct costs of network, sales and services as generally less-controllable, external costs and we regularly monitor the margin of revenues in excess of these direct costs. Similarly, we view the costs of customer support to also be an important component of costs of revenues but believe that the costs of customer support are more within our control and, to some degree, discretionary in that we can adjust those costs by managing personnel needs. We also have excluded depreciation and amortization from segment profit because they are based on estimated useful lives of tangible and intangible assets. Further, we base depreciation and amortization on historical costs incurred to build out our deployed network and the historical costs of these assets may not be indicative of current or future capital expenditures. Although we believe, for the foregoing reasons, that our presentation of segment profit non-GAAP financial measures provides useful supplemental information to investors regarding our results of operations, our non-GAAP financial measures should only be considered in addition to, and not as a substitute for, or superior to, any measure of financial performance prepared in accordance with GAAP.
 
Years Ended December 31, 2011 and 2010

Data Center Services
 
Revenues for data center services increased $5.3 million, or 4%, to $133.5 million during the year ended December 31, 2011, compared to $128.2 million during the same period in 2010. The increase in revenue was primarily due to net revenue growth in company-controlled colocation and hosting services. 
 
Direct costs of data center services, exclusive of depreciation and amortization, decreased $3.9 million, or 5%, to $78.9 million during the year ended December 31, 2011, compared to $82.8 during the same period in 2010. The decrease was primarily the result of the termination of partner leases related to our proactive churn program.
 
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.
 
 
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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 59% during the year ended December 31, 2011, compared to 65% during the same period in 2010.
 
IP Services
 
Revenues for IP services decreased $4.8 million, or 4%, to $111.2 million during the year ended December 31, 2011, compared to $116.0 million during the same period in 2010. 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 19% during the year ended December 31, 2011, compared to the same period in 2010, calculated based on an average over the number of months in the respective periods.
 
IP services revenues included FCP product sales of  $1.6 million and $1.4 million and FCP-related services and  subscription revenue of $1.0 million and $1.1 million during December 31, 2011 and 2010, respectively.

Direct costs of IP services, exclusive of depreciation and amortization, decreased $3.3 million, or 7%, to $41.4 million during the year ended December 31, 2011, compared to $44.7 million during the same period in 2010. This decrease was due to lower connectivity costs, which vary based upon demand-based pricing variables. Costs for IP services are subject to ongoing negotiations for pricing and minimum commitments. 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.
 
There have been ongoing industry-wide pricing declines over the last several years and this trend continued during the years ended December 31, 2011 and 2010. 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. We believe we remain well-positioned to benefit from an increasing reliance on the Internet as the medium for business applications, media distribution, communication and entertainment.
 
Other Operating Costs and Expenses
 
Compensation. Total compensation and benefits, including stock-based compensation, were $56.7 million and $56.2 million during the years ended December 31, 2011 and 2010, respectively.
 
Cash-based compensation and benefits increased $1.1 million to $52.7 million during the year ended December 31, 2011 from $51.6 million during the same period in 2010. The increase was primarily due to a $3.8 million increase in cash-based compensation and payroll taxes related to a higher employee headcount and increased salary levels, a $0.6 million increase in severance and a $0.8 million increase attributable to credits we recorded in 2010 related to prior years’ Georgia Headquarters Tax Credit (“HQC”), partially offset by a $3.3 million decrease due to capitalized payroll costs and benefits related to software development in 2011 and a $0.5 million decrease in insurance expense. The HQC is sponsored by the state of Georgia to incentivize companies 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 state payroll liability.
 
Stock-based compensation decreased $0.6 million to $4.0 million during the year ended December 31, 2011 from $4.6 million during the same period in 2010.  The decrease was primarily due to $0.4 million related to differences in vesting terms for grants in 2010 as compared to those in 2011 and $0.3 million for capitalized costs related to software development in 2011.  The following table summarizes the amount of stock-based compensation, net of estimated forfeitures, included in the accompanying consolidated statements of operations during 2011 and 2010 (in thousands):

   
2011
   
2010
 
Direct costs of customer support
 
$
659
   
$
755
 
Sales and marketing
   
835
     
944
 
General and administrative
   
2,489
     
2,932
 
   
$
3,983
   
$
4,631
 
 
Direct Costs of Customer Support . Direct costs of customer support increased 7% to $21.3 million during the year ended December 31, 2011 from $19.9 million during the same period in 2010. The increase was primarily due to a $1.3 million increase in cash-based compensation costs and a $0.4 million increase in professional services, offset by a $0.3 million decrease due to capitalized payroll costs related to software development in the year ended December 31, 2011.

 
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Direct Costs of Amortization of Acquired Technologies . Direct costs of amortization of acquired technologies were $3.5 million and $3.8 million during the years ended December 31, 2011 and 2010, respectively.
 
Sales and Marketing . Sales and marketing costs increased 2% to $29.7 million during the year ended December 31, 2011 from $29.2 million during the same period in 2010. The increase was primarily due to a $0.9 million increase in cash-based compensation costs and a $0.5 million increase in sales training and conference costs, partially offset by a $0.4 million decrease in commissions and a $0.6 million decrease in professional services.
 
General and Administrative . General and administrative costs increased 3% to $34.0 million during the year ended December 31, 2011 from $33.0 million during the same period in 2010. The increase was primarily due to (i) a $1.3 million increase in cash-based compensation costs, (ii) a $0.5 million increase attributable to credits we recorded in 2010 related to prior years’ HQC, (iii) a $0.6 million increase in severance, (iv) a $0.6 million increase in non-capitalized software and support and (v ) a $1.3 million increase in professional services, which included $0.6 million of Voxel acquisition costs, partially offset by (x) a $2.6 million decrease due to capitalized payroll costs related to software development during the year ended December 31, 2011, (y) a $0.4 million decrease in stock-based compensation  and (z) a $0.3 million decrease in taxes, licenses and fees.

Depreciation and Amortization . Depreciation and amortization increased 22% to $36.9 million during the year ended December 31, 2011, compared to $30.2 million during the same period in 2010. The increase was primarily due to the effects of our expansion of company-controlled data centers and network infrastructure.

Restructuring and Impairments . Restructuring and impairments were $2.8 million during the year ended December 31, 2011, compared to $1.4 million during the same period in 2010.
 
Restructuring charges were $2.3 million and $1.4 million during the years ended December 31, 2011 and 2010, respectively.  The charges in both years primarily related to subsequent plan adjustments we made 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.
 
Impairment charges were $0.5 million and $0 during the years ended December 31, 2011 and 2010, respectively. While Voxel’s products are complementary to our existing IT Infrastructure services, we will not use certain of our assets in the same manner as we would have used them had the acquisition not taken place.  As such, we evaluated our suite of IT Infrastructure services for impairment. The evaluation resulted in an impairment charge of $0.5 million to developed software related to our Cloud portal functionality, included in the data center services segment.

Interest Expense . Interest expense increased to $3.7 million during the year ended December 31, 2011, compared to $2.2 million during the same period in 2010. The increase in interest expense was primarily due to new capital lease obligations related to our expansion of company-controlled data centers.

  Provision for Income Taxes . The benefit for income taxes was $5.6 million during the year ended December 31, 2011, compared to an expense of $1.0 million during the same period in 2010. The variance was primarily due to a $6.1 million deferred tax benefit resulting from Voxel purchase accounting that offset our existing income tax expense of $0.5 million. The $6.1 million deferred tax benefit lowered our consolidated net deferred tax asset and required a release of valuation allowance. Our effective income tax rate, as a percentage of pre-tax income, for the years ended December 31, 2011 and 2010 was (72%) and 31%, 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 $123.4 million. The total deferred tax assets primarily consist of net operating loss carryforwards and basis difference in fixed assets. 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.
 
Years Ended December 31, 2010 and 2009
 
Data Center Services
 
Revenues for data center services decreased $2.5 million, or 2%, to $128.2 million during the year ended December 31, 2010, compared to $130.7 million during the same period in 2009. The decrease in revenue during 2010 was primarily due to our proactive churn program in the amount of $10.5 million, which was partially offset by underlying revenue growth of $8.0 million.
 
 
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Direct costs of data center services, exclusive of depreciation and amortization, decreased $12.2 million, or 13%, to $82.8 million during the year ended December 31, 2010, compared to $95.0 million during the same period in 2009. The decrease was also the result of our efforts in 2010 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.
 
Direct costs of data center services as a percentage of corresponding revenues improved to 65% during the year ended December 31, 2010, compared to 73% during during the same period in 2009.
 
IP Services
 
Revenues for IP services decreased $9.6 million, or 8%, to $116.0 million duirng the year ended December 31, 2010, compared to $125.6 million during  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 32% during the year ended December 31, 2010, compared to the same period in 2009, calculated based on an average over the number of months in the respective periods.
 
IP services revenues included FCP product sales of $1.4 million and $0.9 million and FCP-related services and subscription revenue of $1.1 million and $0.9 million during the years ended December 31, 2010 and 2009, respectively.
 
Direct costs of IP services, exclusive of depreciation and amortization, decreased $3.4 million, or 7%, to $44.7 million during the year ended December 31, 2010, compared to $48.1 million during the same period in 2009. This decrease was 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 ISPs.
 
Other Operating Costs and Expenses
 
Other than direct costs of network, sales and services, compensation has the most pervasive impact on operating costs and expenses. We discuss compensation on an aggregate basis below followed by discussion of functional costs and expenses.
 
Compensation. Total compensation and benefits, including stock-based compensation, were $56.2 million and $59.3 million during the years ended December 31, 2010 and 2009, respectively.
 
Cash-based compensation and benefits decreased $2.1 million to $51.6 million during the year ended December 31, 2010 from $53.7 million during the same period in 2009. The decrease was primarily due to (i) a $0.7 million decrease in cash-based compensation related to reduced employee headcount, (ii) a $1.3 million decrease due to capitalized payroll costs related to software development in 2010, (iii) a $0.8 million decrease in severance incurred in 2009 and $0.9 million related to the transition of our former president and chief executive officer incurred in 2009 and (iv) a benefit of $0.4 million related to the reversal of a bonus accrual for the year ended December 31, 2009, offset by (w) a $0.4 million increase in the 2010 bonus accrual, (x) a $1.1 million in merit pay increases, (y) a $0.3 million increase in insurance costs and (z) a $1.7 million increase in commissions related to incentives for customer retention.
 
Additionally, we did not record a HQC for the year ended December 31, 2009 compared to a $1.6 million credit recorded for the year ended December 31, 2010, which included credits for three years.
 
Stock-based compensation decreased $1.0 million to $4.6 million during the year ended December 2010 from $5.6 million during the same period in 2009. The decrease was primarily due to a reduction of stock-based compensation expense of $0.8 million related to the transition of our former president and chief executive officer incurred during the year ended December 31, 2009. The following table summarizes the amount of stock-based compensation, net of estimated forfeitures, included in the accompanying consolidated statements of operations during the years ended December 31, 2010 and 2009 (in thousands):

   
2010
   
2009
 
Direct costs of customer support
  $ 755     $ 974  
Sales and marketing
    944       1,395  
General and administrative
    2,932       3,244  
    $ 4,631     $ 5,613  
 
Total unrecognized compensation costs related to unvested stock-based compensation as of December 31, 2010 was $8.5 million with a weighted-average remaining recognition period of 2.7 years.
 
Direct Costs of Customer Support . Direct costs of customer support increased 10% to $19.9 million during the year ended December 31, 2010 from $18.0 million during the same period in 2009. The increase was primarily due to a $2.1 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 the year ended December 31, 2009 and the 2010 HQC benefit of $0.5 million.
 
 
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Direct Costs of Amortization of Acquired Technologies . Direct costs of amortization of acquired technologies were $3.8 million and $8.3 million during the years ended December 31, 2010 and 2009, respectively. The decrease was due to impairment charges that occurred during the year ended December 31, 2009. In conjunction with consolidating our business segments in 2009, we performed an analysis of the potential impairment and reassessed the remaining asset lives of other identifiable intangible assets. The analysis and reassessment of other identifiable intangible assets resulted in an impairment charge of $4.1 million in acquired CDN advertising technology during the year ended December 31, 2009 due to a strategic change in market focus.
 
Sales and Marketing . Sales and marketing costs during the year ended December 31, 2010 increased 4% to $29.2 million from $28.1 million during the sameperiod in 2009. The increase was primarily due to (i) a $1.9 million increase in commissions paid to employees related to incentives for customer retention and commissions paid to agents, (ii) a $0.7 million increase in marketing and (iii) a $0.3 million increase in professional services related to recruiting, partially offset by (x) a $0.4 million decrease in non-essential sales facilities cost, (y) a $0.4 million decrease in stock-based compensation and (z) a $1.3 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 during the year ended December 31, 2010 decreased 26% to $33.0 million from $44.6 million during the same period in 2009. The decrease was primarily due to (i) a $0.6 million decrease in severance incurred in 2009, (ii) a benefit of $1.7 million related to cash-based and stock-based compensation for the transition of our former president and chief executive officer incurred in 2009, (iii) a $1.3 million decrease due to capitalized payroll costs related to software development in 2010, (iv) a $0.9 million HQC that we recorded in 2010, (v) a $1.5 million decrease in the provision for doubtful accounts, (vi) a $0.5 million decrease in taxes and licenses and (vii) a $4.7 million decrease in professional services. Professional services costs were higher in the year ended December 31, 2009 due primarily to the use of consultants for finance and temporary information technology, personnel recruiting services and higher accounting and audit fees.
 
Depreciation and Amortization . Depreciation and amortization, including other intangible assets but excluding acquired technologies, increased 7% to $30.2 million during the year ended December 31, 2010, compared to $28.3 million during 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, partially offset by a decrease in amortization expense of $2.5 million related to certain other intangibles becoming fully amortized during 2010. Capital expenditures were $62.2 million during the year ended December 31, 2010 compared to $17.3 million during the same period in 2009.
 
Restructuring and Impairments.   Total restructuring charges during the year ended December 31, 2010 were $1.4 million, which primarily related to subsequent plan adjustments we made in sublease income assumptions for certain properties included in our previously-disclosed restructuring plans. Due to economic conditions, these adjustments extended the period during which we diddo not anticipate receiving sublease income from those properties given our expectation that it would take longer to find sublease tenants and the increased availability of space in each of these markets where we had unused space.
 
Total restructuring charges during the year ended December 31, 2009 were $3.2 million, including $2.1 million for adjustments in sublease income assumptions for certain properties included in our previously-disclosed 2007 and 2001 restructuring plans, $0.9 million for a workforce reduction in March 2009 and $0.2 million for cessation of use of four smaller office and partner data center sites.
 
We did not record any impairments during the year ended December 31, 2010. The goodwill impairments during the year ended December 31, 2009 related to our IP services segment and included $48.0 million for goodwill related to our former CDN services segment and $3.5 million to adjust goodwill of our FCP products Similarly, the $4.1 million of impairments of acquired technology, included in direct costs of amortization, were related to advertising technology of our former CDN services segment. The CDN services goodwill and technology arose from our acquisition of VitalStream in February 2007.
 
Interest Expense . Interest expense increased to $2.2 million during the year ended December 31, 2010, compared to $0.7 million during the same period in 2009. The increase in interest expense was primarily due to the $16.7 million in new capital lease obligations related to our expansion of company-controlled data center in Santa Clara and expansion of our data center in Seattle during 2010.
 
Provision for Income Taxes . The provision for income taxes was $1.0 million during the year ended December 31, 2010, compared to $0.4 million during the same period in 2009. Our effective income tax rate, as a percentage of pre-tax income, for the years ended December 31, 2010 and 2009 was 31% 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.
 
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.
 
 
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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 “—Capital Resources—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 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 selling 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. 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, 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. During the year ended December 31, 2011, we had a net loss of $1.7 million. As of December 31, 2011, 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.
 
Capital Resources
 
Credit Agreement.   In December 2011 , we amended our credit agreement (the “Amendment”). The Amendment increased the revolving credit facility of the credit agreement by $20.0 million, for a total revolving credit facility of $60.0 million. The Amendment also increased the term loan facility by $20.0 million, for a total term loan facility of $59.0 million.
 
The Amendment modifies certain interest rates and definitions, adds a senior leverage ratio covenant and reallocates certain lender commitments. In addition, the Amendment approved our acquisition of Voxel which we completed concurrently with the effective date and funding of the Amendment.  Following the Amendment and the Voxel acquisition, we had fully drawn the term loan.
 
As of December 31, 2011, the $60.0 million revolving credit facility had an outstanding principal amount of $0.1  million. In addition, we issued $11.1 million letters of credit, resulting in $48.8 million in borrowing capacity. The term loan had an outstanding principal amount of $58.8 million, which is to be repaid in $750,000 quarterly installments on the last day of each fiscal quarter commencing December 31, 2011, with the remaining unpaid balance due on November 2, 2014. As of December 31, 2011, the interest rates on the revolving credit facility and term loan were 5.0% and 3.8%, respectively.
 
The credit agreement, as amended, 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 December 31, 2011, we were in compliance with these covenants. We summarize the credit agreement in note 11 to the accompanying consolidated financial statements.
 
Capital Leases. Our future minimum lease payments on remaining capital lease obligations at December 31, 2011 were $41.1 million. We summarize our existing capital lease obligations in note 12 to the accompanying consolidated financial statements.
 
In addition, 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 existing corporate office space. We will take possession of the space in 2012 when the space is available according to terms of the lease. We will record related property and equipment and corresponding capital lease obligations of $7.4 million when we take possession.
 
Commitments and Other Obligations. We have commitments and other obligations that are contractual in nature and will represent a use of cash in the future unless the agreements are modified. Service and purchase 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 purchase and service commitments with corresponding revenue growth.
 
 
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The following table summarizes our commitments and other obligations as of December 31, 2011 (in thousands):
 
      Payments Due by Period  
     
Total
     
Less than
1 year
     
1-3
Years
     
3-5
Years
   
More
than 5
years
 
                                         
Revolving credit facility (1)
  $ 101     $ 101     $     $     $  
Term loan (2)
    64,744       5,226       59,518              
Capital lease obligations
    63,407       5,845       13,556       13,067       30,939  
Accrued contingent consideration (3)
    5,000             5,000              
Operating lease commitments
    158,066       28,316       53,604       36,241       39,905  
Service and purchase commitments
    18,941       9,252       5,437       3,624       628  
                                         
    $ 310,259     $ 48,740     $ 137,115     $ 52,932     $ 71,472  
 

(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 December 31, 2011, 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 December 31, 2011, the interest rate was 3.8% 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 $4.6 million on the accompanying consolidated balance sheets. Payment date is expected to be on or before December 30, 2013. We summarize the Voxel acquisition in note 3 in the accompanying consolidated financials statements.
 
Cash Flows
 
Operating Activities
 
Year Ended December 31, 2011 . Net cash provided by operating activities during the year ended December 31, 2011 was $28.6 million. Our net loss, after adjustments for non-cash items, generated cash from operations of $38.9  million, while changes in operating assets and liabilities used cash from operations of $10.3 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 for the year ended December 31, 2011 was $40.4 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 $4.0 million for stock-based compensation expense. The changes in operating assets and liabilities included a $1.2 million increase in accounts receivable, a $2.3 million increase in prepaid expenses, deposits and other assets and a $5.2 million decrease in accounts payable. Days sales outstanding at December 31, 2011 were 27 days, up from 26 days at December 31, 2010. 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.
 
Year Ended December 31, 2010 . Net cash provided by operating activities during the year ended December 31, 2010 was $39.6 million. Our net loss, after adjustments for non-cash items, generated cash from operations of $37.3 million, while changes in operating assets and liabilities generated cash from operations of $2.3 million.
 
The primary non-cash adjustment for the year ended December 31, 2010 was $34.0 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 $4.6 million for stock-based compensation expense. The changes in operating assets and liabilities included a $8.1 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 $2.1 million decrease in accrued and other liabilities and deferred revenues and a $2.6 million increase in inventory, prepaid expenses, deposits and other assets. Days sales outstanding at December 31, 2010 were 26 days, down from 27 days at December 31, 2009.
 
Year Ended December 31, 2009 . Net cash provided by operating activities during the year ended December 31, 2009 was $37.5 million. Our net loss, after adjustments for non-cash items, generated cash from operations of $28.8 million, while changes in operating assets and liabilities generated cash from operations of $8.7 million.
 
 
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The primary non-cash adjustment during the year ended December 31, 2009 was $55.6 million for impairment of goodwill and other intangible assets further discussed above in the section “—Critical Accounting Policies and Estimates—Goodwill and Other Intangible Assets” and “—Results of Operations—Other Operating Costs and Expenses—Impairments and Restructuring—Impairments.” Non-cash adjustments also included $32.5 million for depreciation and amortization, which included the effects of the expansion of our network and data center facilities, and $5.6 million for stock-based compensation, which we discuss above in “—Results of Operations—Other Operating Costs and Expenses—Compensation.” Changes in operating assets and liabilities had a net favorable impact on cash provided by operations, particularly from accounts receivable. Net accounts receivable decreased $7.2 million, primarily as a result of our focus on credit and collections and a continued focus on mitigating default risk in our customer base. Quarterly days sales outstanding at December 31, 2009 decreased to 27 days from 40 days at December 31, 2008. Inventory, prepaid expenses, deposits and other assets decreased $2.2 million from December 31, 2008 to December 31, 2009, primarily from amortization of annual prepaid insurance premiums and lower prepaid colocation expenses at our partner sites as we concentrated on selling into company-controlled facilities. Accrued liabilities increased $1.4 million, mainly due to the accrual of $2.9 million representing a portion of targeted payments for annual performance bonuses and associated payroll taxes during the year ended December 31, 2009. We did not accrue any amounts for annual performance bonuses during the year ended December 31, 2008 given that we did not meet established performance goals. The increase in the annual performance bonus accrual and associated payroll taxes was partially offset by lower professional fees and commissions. Accounts payable decreased $2.4 million from December 31, 2008 to December 31, 2009, representing a use of cash.
 
Investing Activities
 
Year Ended December 31, 2011 . Net cash used in investing activites during the year ended December 31, 2011 was $96.3 million, due to capital expenditures of $68.6 million and the Voxel acquisition, net of cash received, of $27.7 million.  Capital expenditures related to the continued expansion and upgrade of our company-controlled data centers and network infrastructure.
 
Year Ended December 31, 2010 .   Net cash used in investing activities during the year ended December 31, 2010 was $55.2 million, due to capital expenditures of $62.2 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.
 
Year Ended December 31, 2009 . Net cash used in investing activities during the year ended December 31, 2009 was $9.9 million, primarily due to capital expenditures of $17.3 million, partially offset by proceeds from the maturities of investments in marketable securities of $7.4 million. Our capital expenditures related to the continued expansion and upgrade of our data center facilities and network infrastructure.
 
Financing Activities
 
Year Ended December 31, 2011 . Net cash provided by financing activities during the year ended December 31, 2011 was $37.9 million, primarily due to proceeds received on the credit agreement.  We had a balance of $58.9 million outstanding under our credit agreement at December 31, 2011.
 
Year Ended December 31, 2010 . Net cash provided by financing activities during the year ended December 31, 2010 was $1.2 million, primarily due to cash received upon the exercise of stock options. We also repaid $78.8 million and re-borrowed $78.0 million on our credit facilities. As a result of these activities, we had a balance of $19.8 million on our term loan at December 31, 2010.
 
Year Ended December 31, 2009 . Net cash used in financing activities during the year ended December 31, 2009 was $0.6 million, primarily due to payments on capital leases of $0.3 million and $0.2 million for the reacquisition of shares of treasury stock as payment of taxes due from employees for stock-based compensation, net of proceeds from employee ESPP purchases and option exercises. We also repaid and re-borrowed a cumulative $78.5 million under our credit facility to optimize liquidity and net interest income and expense; however, at no one time during the year did we borrow more than $20.0 million. As a result of these activities, we had balances of $20.0 million on our revolving credit facility and $3.2 million in capital lease obligations as of December 31, 2009.
 
Off-Balance Sheet Arrangements
 
As of December 31, 2011, 2010 and 2009, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. Other than our operating leases, we do not engage in off-balance sheet financial arrangements.
 
 
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Other Investments
 
We have 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 to date we have recognized $2.2 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 December 31, 2011, our long-term debt consisted of $58.8 million borrowed under our term loan and $0.1 million borrowed under our revolving credit facility. Interest on the term loan was 3.8% 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 BaserRate 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 $0.6 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.
 
 
Our accompanying consolidated financial statements, financial statement schedule and the report of our independent registered public accounting firm appear in Part IV of this Form 10-K. Our report on internal controls over financial reporting appears in Item 9A of this Form 10-K.
 
 
None.
 
 
Evaluation of Disclosure Controls and Procedures
 
Based on our management’s evaluation (with the participation of our Chief Executive Officer and Chief Financial Officer), as of the end of the period covered by this report, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, (the “Exchange Act”)) are effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms and is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
 
Report of Management on Internal Control Over Financial Reporting
 
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of our management, including our chief executive officer and chief financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, or COSO.
 
Based on our evaluation under the framework in Internal Control — Integrated Framework issued by COSO, our management concluded that our internal control over financial reporting was effective as of December 31, 2011. The effectiveness of our internal control over financial reporting as of December 31, 2011 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which is included herein.
 
Changes in Internal Control over Financial Reporting
 
There was no change in our internal control over financial reporting that occurred during the quarter ended December 31, 2011 that has materially affected, or that is reasonably likely to materially affect, our internal control over financial reporting.
 
 
None.
 
 
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We will include information regarding our directors and executive officers in our definitive proxy statement for our annual meeting of stockholders to be held in 2012, which we will file within 120 days after the end of the fiscal year covered by this Annual Report on Form 10-K. This information is incorporated herein by reference.
 
Code of Conduct
 
We have adopted a code of conduct that applies to our officers and all of our employees. A copy of the code of conduct is available on our website at www.internap.com . We will furnish copies without charge upon request at the following address: Internap Network Services Corporation, Attn: SVP, Legal Services, 250 Williams Street, Atlanta, Georgia 30303.
 
If we make any amendments to the code of conduct other than technical, administrative or other non-substantive amendments, or grant any waivers, including implicit waivers, from the addendum to this code, we will disclose the nature of the amendment or waiver, its effective date and to whom it applies on our website or in a current report on Form 8-K filed with the Securities and Exchange Commission.
 
 
We will include information regarding executive compensation in our definitive proxy statement for our annual meeting of stockholders to be held in 2012, which we will file within 120 days after the end of the fiscal year covered by this Annual Report on Form 10-K. This information is incorporated herein by reference.
 
 
The information under the caption “Security Ownership of Certain Beneficial Owners and Management” contained in our definitive proxy statement for our annual meeting of stockholders to be held in 2012, which we will file within 120 days after the end of the fiscal year covered by this Annual Report on Form 10-K, is incorporated herein by reference.
 
 
The information under the caption “Certain Relationships and Related Transactions” contained in our definitive proxy statement for our annual meeting of stockholders to be held in 2012, which we will file within 120 days after the end of the fiscal year covered by this Annual Report on Form 10-K, is incorporated herein by reference.
 
 
The information under the caption “Ratification of Appointment of Independent Registered Public Accounting Firm” in our definitive proxy statement for our annual meeting of stockholders to be held in 2012, which we will file within 120 days after the end of the fiscal year covered by this Annual Report on Form 10-K, is incorporated in this Form 10-K by reference.
 
 
 
Item 15(a)(1). Financial Statements . The following consolidated financial statements are filed herewith:
 
Page
 
Report of Independent Registered Public Accounting Firm
F-2
 
Consolidated Statements of Operations
F-3
 
Consolidated Balance Sheets
F-4
 
Consolidated Statements of Stockholders’ Equity and Comprehensive Income (Loss)
F-5
 
Consolidated Statements of Cash Flows
F-6
 
Notes to Consolidated Financial Statements
F-7
 
 
Item 15(a)(2). Financial Statement Schedules . The following financial statement schedule is filed herewith:
 
Page
 
Schedule II - Valuation and Qualifying Accounts for the Three Years Ended December 31, 2011
S-1
 
 
Item 15(a)(3). Exhibits . The following exhibits are filed as part of this report:
 
 
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Exhibit
Number
  Description  
       
3.1
 
 
Certificate of Elimination of the Series B Preferred Stock (incorporated herein by reference to Exhibit 3.1 to the Company’s Annual Report on Form 10-K, filed March 2, 2010).
       
3.2
 
 
Restated Certificate of Incorporation of the Company (incorporated herein by reference to Exhibit 3.2 to the Company’s Annual Report on Form 10-K, filed March 2, 2010).
       
3.3
 
 
 
Certificate of Amendment of Restated Certificate of Incorporation of the Company (incorporated herein by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K, filed June 21, 2010).
       
3.4
 
 
Amended and Restated Bylaws of the Company (incorporated herein by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K, filed March 29, 2011).
       
10.1
 
 
 
Amended and Restated Internap Network Services Corporation 1998 Stock Option/Stock Issuance Plan (incorporated herein by reference to Exhibit 10.1 to the Company’s Annual Report on Form 10-K, filed March 13, 2009).+
       
10.2
 
 
 
Internap Network Services Corporation 1999 Non-Employee Directors’ Stock Option Plan (incorporated herein by reference to Exhibit 10.2 to the Company’s Annual Report on Form 10-K, filed March 13, 2009).+
       
10.3
 
 
 
First Amendment to the Internap Network Services Corporation 1999 Non-Employee Directors’ Stock Option Plan (incorporated herein by reference to Exhibit 10.3 to the Company’s Annual Report on Form 10-K, filed March 13, 2009).+
       
10.4
 
 
 
Amended and Restated Internap Network Services Corporation 1999 Stock Incentive Plan for Non-Officers (incorporated herein by reference to Exhibit 10.5 to the Company’s Annual Report on Form 10-K, filed March 13, 2009).+
       
10.5
 
 
 
Amended Internap Network Services Corporation 1999 Equity Incentive Plan (incorporated herein by reference to Exhibit 10.7 to the Company’s Registration Statement on Form S-1, File No. 333-95503 dated January 27, 2000).+
       
10.6
 
 
 
Form of 1999 Equity Incentive Plan Stock Option Agreement (incorporated herein by reference to Exhibit 10.8 to the Company’s Registration Statement on Form S-1, File No. 333-84035 dated July 29, 1999).+
       
10.7
 
 
 
Internap Network Services Corporation 2000 Non-Officer Equity Incentive Plan (incorporated herein by reference to Exhibit 99.1 to the Company’s Registration Statement on Form S-8, File No. 333-37400 dated May 19, 2000).+
       
10.8
 
 
 
Internap Network Services Corporation 2002 Stock Compensation Plan (incorporated herein by reference to Exhibit 10.9 to the Company’s Annual Report on Form 10-K, filed March 13, 2009).+
       
10.9
 
 
 
Form of Nonstatutory Stock Option Agreement under the Internap Network Services Corporation 2002 Stock Compensation Plan (incorporated herein by reference to Exhibit 10.10 to the Company’s Annual Report on Form 10-K, filed March 13, 2009).+
       
10.10
 
 
 
Amended and Restated 2005 Incentive Stock Plan, dated June 16, 2011 (incorporated herein by reference to Appendix A to the Company’s Definitive Proxy Statement, filed April 29, 2011).+
       
10.11
 
 
 
Amended and Restated 2004 Internap Network Services Corporation Employee Stock Purchase Plan, dated January 11, 2006 (incorporated herein by reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2006, filed May 10, 2006).+
       
10.12
 
 
 
Form of Stock Grant Certificate under the Amended and Restated Internap Network Services Corporation 2005 Incentive Stock Plan (incorporated herein by reference to Exhibit 10.14 to the Company’s Annual Report on Form 10-K, filed March 2, 2010).+
       
10.13
 
 
 
Form of Stock Option Certificate under the Amended and Restated Internap Network Services Corporation 2005 Incentive Stock Plan (incorporated herein by reference to Exhibit 10.15 to the Company’s Annual Report on Form 10-K, filed March 2, 2010).+