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Internap Network Services 10-Q 2008 UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
WASHINGTON,
DC 20549
FORM
10-Q
(Mark
One)
For the quarterly period ended
June 30, 2008>
OR
For the transition period from
to
Commission
File Number: 000-27265
INTERNAP
NETWORK SERVICES CORPORATION
(Exact
Name of Registrant as Specified in Its Charter)
250
Williams Street
Atlanta,
Georgia 30303
(Address
of Principal Executive Offices, Including Zip Code)
(404)
302-9700
(Registrant’s
Telephone Number, Including Area Code)
Indicate
by check mark whether the registrant: (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days. Yes x
No ¨
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
definitions of “accelerated filer,” “large accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.
(Check
one):
(Do not
check if a smaller reporting company)
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). Yes o
No x
As of
July 31, 2008, 50,225,433 shares of the registrant’s outstanding common stock,
$0.001 par value per share, were outstanding.
INTERNAP
NETWORK SERVICES CORPORATION
FORM
10-Q
FOR
THE QUARTER ENDED JUNE 30, 2008
TABLE
OF CONTENTS
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This
Quarterly Report on Form 10-Q contains “forward-looking statements” within the
meaning of Section 21E of the Securities Exchange Act of 1934, as amended.
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 set forth in this quarterly report under “Item 1A. Risk
Factors.” We undertake no obligation to update any forward-looking
statements as a result of new information, future events or
otherwise.
As used
herein, except as otherwise indicated by context, references to “we,” “us,”
“our,” or the “Company” refer to Internap Network Services
Corporation.
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UNAUDITED
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In
thousands, except per share amounts)
The
accompanying notes are an integral part of these condensed consolidated
financial statements.
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UNAUDITED
CONDENSED CONSOLIDATED BALANCE SHEETS
(In
thousands, except per share amounts)
The
accompanying notes are an integral part of these condensed consolidated
financial statements.
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UNAUDITED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In
thousands)
The
accompanying notes are an integral part of these condensed consolidated
financial statements.
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UNAUDITED
CONDENSED CONSOLIDATED STATEMENTS OF
STOCKHOLDERS'
EQUITY AND COMPREHENSIVE LOSS
(In
thousands)
*Total
comprehensive loss was $(3,412) and $(1,502) for the three months ended June 30,
2008 and 2007, respectively.
The
accompanying notes are an integral part of these condensed consolidated
financial statements.
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UNAUDITED
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Internap
Network Services Corporation (“Internap,” “we,” “us,” “our,” or the “Company”)
delivers high performance and reliable Internet solutions through a suite of
network optimization and delivery products and services. These solutions,
combined with progressive and proactive technical support, enable companies to
confidently migrate business-critical applications, including audio and video
streaming and monetization services, to the Internet. Our suite of products and
services support a broad range of Internet applications. We serve both domestic
and international customers in the financial services, healthcare, technology,
retail, travel, media/entertainment, and other markets. Our product and service
offerings are complemented by Internet Protocol, or IP, access solutions such as
data center services, content delivery networks, or CDN, and managed security.
We deliver services through our 53 service points across North America, Europe
and the Asia-Pacific region. Our Private Network Access Points, or P-NAPs,
feature multiple direct high-speed connections to major Internet networks
including AT&T Inc., Sprint Nextel Corporation, Verizon Communications
Inc., Savvis, Inc., Global Crossing Limited, and Level 3 Communications, Inc. We
operate and manage the Company in three business segments: IP services, data
center services and CDN services.
Our
unaudited condensed consolidated financial statements have been prepared
pursuant to the rules and regulations of the Securities and Exchange Commission,
or SEC, and include all the accounts of the Company and its wholly owned
subsidiaries. Certain information and note disclosures, normally included in
financial statements prepared in accordance with accounting principles generally
accepted in the United States, have been condensed or omitted pursuant to such
rules and regulations. The unaudited condensed consolidated financial statements
reflect all adjustments, consisting only of normal recurring adjustments,
necessary for a fair statement of our financial position as of June 30, 2008 and
our operating results, cash flows, and changes in stockholders’ equity for the
interim periods presented. The balance sheet at December 31, 2007 has been
derived from our audited financial statements as of that date. These financial
statements and the related notes should be read in conjunction with our
financial statements and notes thereto contained in our Annual Report on Form
10-K/A for the year ended December 31, 2007 filed with the SEC.
The
preparation of financial statements in accordance with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities and revenues and expenses in the
financial statements. Examples of estimates subject to possible revision based
upon the outcome of future events include, among others, the provision for
doubtful accounts, network cost accruals, sales, use and other taxes,
recoverability of long-lived assets and goodwill, depreciation of property and
equipment, restructuring allowances and stock-based compensation. Actual results
could differ from those estimates.
The
results of operations for the three and six months ended June 30, 2008 are not
necessarily indicative of the results that may be expected for any future
periods or for the year ending December 31, 2008.
Reclassifications
For the
three and six months ended June 30, 2007, we have classified all revenues and
direct costs of network, sales and services previously reported in other,
non-segmented results, except for third party CDN services, in the most closely
related business segments to provide a more accurate view of the results of
operations of the business segments. Financial information for 2007
has also been reclassified to conform to the current period
presentation. None of the reclassifications had any effect on
previously reported total revenues, total direct costs of network, sales and
services, exclusive of depreciation and amortization, or net loss.
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INTERNAP
NETWORK SERVICES CORPORATION
UNAUDITED
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
The
effect of these reclassifications is shown below (in thousands):
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INTERNAP
NETWORK SERVICES CORPORATION
UNAUDITED
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -
(continued)
On
February 20, 2007, we completed the acquisition of VitalStream Holdings, Inc.,
or VitalStream, for approximately $214.0 million, whereby VitalStream became a
wholly owned subsidiary of Internap. VitalStream provides products and services
for storing and delivering digital media to large audiences over the Internet
and advertisement insertion and related advertising services to companies that
stream digital media over the Internet. We accounted for the transaction using
the purchase method of accounting in accordance with SFAS No. 141,
“Business Combinations.” Our results of operations include the activities of
VitalStream from February 21, 2007.
The
following unaudited pro forma consolidated financial information reflects our
results of operations for the six months ended June 30, 2007 as if the
acquisition of VitalStream had occurred at the beginning of the period. Pro
forma net loss and net loss per share for the six months ended June 30, 2007
include non-recurring charges for restructuring and asset impairment of $11.4
million and acquired in-process research and development of $0.5 million. These
pro forma results are not necessarily indicative of what our operating results
would have been had the acquisition actually taken place at the beginning of the
period (in thousands, except per share amounts):
The
following tables show operating results for our reportable segments, along with
reconciliations from segment profit to loss before income taxes and equity in
earnings of equity-method investment:
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INTERNAP
NETWORK SERVICES CORPORATION
UNAUDITED
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -
(continued)
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INTERNAP
NETWORK SERVICES CORPORATION
UNAUDITED
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
On March
20, 2008, we granted 0.2 million shares of restricted common stock with
performance-based vesting. The awards will vest in increments of
one-third beginning on the first anniversary of the grant date if the Company
achieves revenue and adjusted earnings levels established by the board of
directors. The term adjusted earnings is defined in the long-term
incentive plan. The Company will either meet or not meet both goals
in a given year. With respect to all shares of performance-based
restricted stock that do not vest during any of the three years, 50% of such
shares will vest on the fourth anniversary of the date of grant. For
the performance-based restricted stock awards, we recognize compensation expense
based on management’s assessment of the probability that the performance
conditions will be achieved. Management must use its judgment to make the
probability assessment and, as of June 30, 2008, believes the performance
conditions will not be met.
We have
also recorded a $0.3 million liability classified as performance based awards to
be issued in lieu of cash bonuses to certain members of senior management if
performance targets are achieved. If actual results differ from
management’s assumptions, future results related to these performance based
awards could be materially different.
Total
stock-based compensation was $2.1 million and $2.8 million for the three months
ended June 30, 2008 and 2007, respectively, and $4.4 million for the six months
ended June 30, 2008 and 2007. These amounts include $0.1 million of capitalized
stock-based compensation during the six months ended June 30, 2008. We use the
Black-Scholes option valuation model to determine stock-based compensation
expense.
As
reported in our Annual Report on Form 10-K/A for the year ended December 31,
2007, we incurred a restructuring and impairment charge of $10.3 million during
the three months ended March 31, 2007. The charge was the result of a review of
our business, particularly in light of our acquisition of VitalStream and our
plan to finalize the overall integration and implementation plan before March
31, 2007. The charge to expense included $7.8 million for leased facilities,
representing both the costs less anticipated sublease recoveries that will
continue to be incurred without economic benefit to us and costs to terminate
leases before the end of their term. The charge also included severance payments
of $1.1 million for the termination of certain employees and $1.4 million for
impairment of assets. Net related expenditures were estimated to be $10.7
million, of which $3.5 million has been paid through June 30, 2008, and the
balance continuing through December 2016, the last date of the longest lease
term. These expenditures are expected to be paid out of operating
cash flows. The impairment charge of $1.3 million was related to the leases
referenced above and less than $0.1 million for other assets. Cost savings from
the restructuring were estimated to be approximately $0.8 million per year
through 2016, primarily for rent expense.
In 2001,
we implemented significant restructuring plans that resulted in substantial
charges for real estate and network infrastructure obligations, personnel and
other charges. Additional related charges have subsequently been incurred as we
continued to evaluate our restructuring reserve.
The
following table displays the activity and balances for the restructuring
activity for the six months ended June 30, 2008 (in thousands):
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INTERNAP
NETWORK SERVICES CORPORATION
UNAUDITED
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
We also
recorded a $1.1 million impairment charge during the six months ended June 30,
2007 for our sales order-through-billing system. This impairment charge was not
related to any specific segment.
As disclosed in our Annual Report on
Form 10-K/A for the fiscal year ended December 31, 2007, we perform our annual
impairment analysis of goodwill as of August 1 of each year in accordance with
Statement of Financial Accounting Standard, or SFAS, No. 142, “Goodwill and
Other Intangible Assets.” Under SFAS No. 142, the impairment analysis
of goodwill and other intangible assets not subject to amortization must be
based on estimated fair values. The valuation of intangible assets
requires assumptions and estimates of many critical factors, including revenue
and market growth, operating cash flows, market multiples, and discount
rates. We have experienced declines in our consolidated operating
results during the first two quarters of 2008 as compared to our
projections. Adverse changes in expected operating results and/or
unfavorable changes in other economic factors used to estimate fair values could
result in a non-cash impairment charge in the future under SFAS No.
142. An
impairment of goodwill may also lead us to record an impairment of other
intangible assets.
At the
end of each interim reporting period, we estimate the effective income tax rate
expected to be applicable for the full year as required by Accounting Principals
Board Opinion No. 28, “Interim Financial Reporting.” The effective income tax
rate determined is used to provide for income taxes on a year-to-date basis. The
tax effect of any tax law changes and certain other discrete events are
reflected in the period in which they occur.
Our
effective income tax rate, as a percentage of pre-tax net income, for the six
months ended June 30, 2008 and 2007 was (13%) and (1%),
respectively. The fluctuation in the effective income tax rate is
attributable to discrete events including the creation of a deferred tax
liability related to the tax amortization of goodwill from the acquisition of
VitalStream in February 2007. Movement in the deferred tax asset caused a
corresponding movement in the provision for income taxes during the six months
ended June 30, 2008. The effective income tax rate for the year
ending December 31, 2008 could further change due to number of factors
including, but not limited to, our geographic profit mix between the U.K. and
the United States, enactments of new tax laws, new interpretations of existing
tax laws and rulings by taxing authorities.
We
continue to maintain a full valuation allowance against our non-U.K. unrealized
deferred tax assets of approximately $185.0 million, consisting primarily of net
operating loss carryforwards. We may recognize deferred tax assets in
future periods when they are estimated to be realizable, such as establishing
expected continuing profitability on a consolidated basis or by certain of our
foreign subsidiaries. To the extent we may owe income taxes in future periods,
we intend to use our net operating loss carryforwards to the extent available to
offset taxable income and reduce cash outflows for income
taxes. Based on an analysis of our projected 2008 and 2009 domestic
income, we may have sufficient positive evidence within the next twelve months
to begin releasing the valuation allowance against our domestic deferred tax
assets.
Tax years
2005 through 2007 remain open to examination by United States
Department of Treasury. Currently in the U.K., the tax years which remain open
to examination include 2004 through 2007. Additionally, other state
and foreign jurisdictions remain open to examination. Net operating losses
carryforwards remain subject to examination for the corresponding jurisdiction's
statutory period following the period which the net operating loss is fully
utilized.
We
computed basic and diluted net loss per share using the weighted average number
of shares of common stock outstanding during the period. We have excluded all
outstanding options and warrants to purchase common stock and unvested
restricted stock as such securities are anti-dilutive for all periods
presented.
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INTERNAP
NETWORK SERVICES CORPORATION
UNAUDITED
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
Basic and
diluted net loss per share for the three and six months ended June 30, 2008, and
2007 are calculated as follows (in thousands, except per share
amounts):
Fair
Value
Effective
January 1, 2008, we adopted SFAS No. 157, “Fair Value Measurements.” The
standard describes a fair value hierarchy based on three levels of inputs, of
which the first two are considered observable and the last unobservable, that
may be used to measure fair value. See note 10 for further a further
description of this standard. The fair value hierarchy is summarized as
follows:
The
following table represents the fair value hierarchy for our financial assets
(cash equivalents and investments in marketable securities) measured at fair
value on a recurring basis as of June 30, 2008 (in thousands):
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