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EX-31.1 - EXHIBIT 31.1 - INTERNAP NETWORK SERVICES CORPex31-1.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
 
 
FORM 10-Q
 
 
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended June 30, 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: 000-27265
 
 
INTERNAP NETWORK SERVICES CORPORATION
(Exact Name of Registrant as Specified in Its Charter)
 
DELAWARE
91-2145721
(State or Other Jurisdiction of
(I.R.S. Employer
Incorporation or Organization)
Identification No.)
 
250 Williams Street
Atlanta, Georgia 30303
(Address of Principal Executive Offices, Including Zip Code)
 
(404) 302-9700
(Registrant’s Telephone Number, Including Area Code)
 
 
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
o
Accelerated filer
x
Non-accelerated filer
o
Smaller reporting company
o
(Do not check if a smaller reporting company)
   
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
 
As of July 21, 2011, 52,401,143 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, 2011
TABLE OF CONTENTS
         
       
Pages
         
  PART I. FINANCIAL INFORMATION    
         
ITEM 1.
 
FINANCIAL STATEMENTS
   
         
   
Unaudited Condensed Consolidated Statements of Operations
    1
         
   
Unaudited Condensed Consolidated Balance Sheets
   2
         
   
Unaudited Condensed Consolidated Statements of Stockholders’ Equity and Comprehensive Loss
    3
         
   
Unaudited Condensed Consolidated Statements of Cash Flows
   4
         
   
Unaudited Condensed Notes to Consolidated Financial Statements
  5
         
ITEM 2.
 
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
  11
         
ITEM 3.
 
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
  17
         
ITEM 4.
 
CONTROLS AND PROCEDURES
  18
         
  PART II. OTHER INFORMATION    
         
ITEM 1.
 
LEGAL PROCEEDINGS
  18
         
ITEM 1A.
 
RISK FACTORS
  18
         
ITEM 2.
 
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
  18
         
ITEM 6.
 
EXHIBITS
  19
         
  SIGNATURES   20

 
i

 
 

PART I. FINANCIAL INFORMATION
 
ITEM 1. FINANCIAL STATEMENTS
 
INTERNAP NETWORK SERVICES CORPORATION AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
                         
   
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
   
2011
   
2010
   
2011
   
2010
 
Revenues:
                       
Data center services
  $ 32,481     $ 31,197     $ 64,023     $ 64,918  
Internet protocol (IP) services
    27,929       29,328       55,791       58,971  
Total revenues
    60,410       60,525       119,814       123,889  
                                 
Operating costs and expenses:
                               
Direct costs of network, sales and services, exclusive of depreciation and amortization, shown below:
                               
Data center services
    19,733       19,784       38,263       42,827  
IP services
    10,836       11,479       21,336       22,521  
Direct costs of customer support
    5,374       4,606       10,485       9,545  
Direct costs of amortization of acquired technologies
    875       979       1,750       1,958  
Sales and marketing
    7,731       7,002       15,564       14,126  
General and administrative
    7,449       9,174       16,577       17,505  
Depreciation and amortization
    8,768       7,013       16,822       14,787  
Loss on disposal of property and equipment, net
    11       18       84       19  
Restructuring
    1,304       1,183       1,492       1,201  
Total operating costs and expenses
    62,081       61,238       122,373       124,489  
Loss from operations
    (1,671 )     (713 )     (2,559 )     (600 )
                                 
Non-operating expense (income):
                               
Interest income
          (33 )           (62 )
Interest expense
    875       518       1,522       821  
Other, net
    48       6       87       36  
Total non-operating expense (income)
    923       491       1,609       795  
                                 
Loss before income taxes and equity in (earnings) of equity method investment
    (2,594 )     (1,204 )     (4,168 )     (1,395 )
Provision for income taxes
    106       129       179       285  
Equity in (earnings) of equity-method investment, net of taxes
    (88 )     (62 )     (235 )     (149 )
                                 
Net loss
  $ (2,612 )   $ (1,271 )   $ (4,112 )   $ (1,531 )
                                 
Basic and diluted net loss per share
  $ (0.05 )   $ (0.03 )   $ (0.08 )   $ (0.03 )
                                 
Weighted average shares outstanding used in computing basic and diluted net loss per share
    50,174       50,013       50,251       50,264  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
- 1 -

 
 
INTERNAP NETWORK SERVICES CORPORATION AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except par value amounts)
             
   
June 30,
2011
   
December 31,
2010
 
             
ASSETS
           
Current assets:
           
Cash and cash equivalents
  $ 40,098     $ 59,582  
Accounts receivable, net of allowance for doubtful accounts of $1,831 and $1,883, respectively
    18,409       17,588  
Prepaid expenses and other assets
    11,533       11,217  
Total current assets
    70,040       88,387  
                 
Property and equipment, net
    158,211       142,289  
Investment
    2,601       2,265  
Intangible assets, net
    12,943       14,698  
Goodwill
    39,464       39,464  
Deposits and other assets
    4,548       3,600  
Deferred tax asset,  net
    2,417       2,439  
Total assets
  $ 290,224     $ 293,142  
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
Current liabilities:
               
Accounts payable
  $ 18,254     $ 25,383  
Accrued liabilities
    6,870       8,975  
Deferred revenues
    2,699       3,268  
Capital lease obligations
    191       1,071  
Term loan, less discount of $118 and $116, respectively
    883       884  
Restructuring liability
    2,691       2,691  
Other current liabilities
    140       135  
Total current liabilities
    31,728       42,407  
                 
Deferred revenues
    2,152       2,134  
Capital lease obligations
    29,032       19,139  
Term loan, less discount of $267 and $328, respectively
    17,983       18,422  
Restructuring liability
    5,445       5,273  
Deferred rent
    16,440       16,655  
Other long-term liabilities
    430       501  
Total liabilities
    103,210       104,531  
Commitments and contingencies
               
Stockholders’ equity:
               
Preferred stock, $0.001 par value; 20,000 shares authorized; no shares issued or outstanding
           
Common stock, $0.001 par value; 120,000 shares authorized; 52,401 and 52,017 shares outstanding, respectively
    53       52  
Additional paid-in capital
    1,232,650       1,229,684  
Treasury stock, at cost; 217 and 115 shares, respectively
    (1,192 )     (520 )
Accumulated deficit
    (1,044,282 )     (1,040,170 )
Accumulated items of other comprehensive loss
    (215 )     (435 )
Total stockholders’ equity
    187,014       188,611  
Total liabilities and stockholders’ equity
  $ 290,224     $ 293,142  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
- 2 -

 
 
INTERNAP NETWORK SERVICES CORPORATION AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF
STOCKHOLDERS’ EQUITY AND COMPREHENSIVE LOSS
(In thousands)
                                           
   
Common Stock
                               
   
Shares
   
Par
Value
   
Additional
Paid-In
Capital
   
Treasury
Stock
   
Accumulated
Deficit
   
Accumulated
Other
Comprehensive
Loss
   
Total
Stockholders’
Equity
 
                                           
SIX MONTHS ENDED JUNE 30, 2011:
                                         
Balance, December 31, 2010
    52,017     $ 52     $ 1,229,684     $ (520 )   $ (1,040,170 )   $ (435 )   $ 188,611  
Net loss
                            (4,112 )           (4,112 )
Foreign currency translation adjustment
                                  220       220  
Total comprehensive loss
                                                    184,719  
Stock compensation plans activity and stock-based compensation expense
    384       1       2,966       (672 )                 2,295  
Balance, June 30, 2011
    52,401     $ 53     $ 1,232,650     $ (1,192 )   $ (1,044,282 )   $ (215 )   $ 187,014  
                                                         
SIX MONTHS ENDED JUNE 30, 2010:
                                                       
Balance, December 31, 2009
    50,763     $ 51     $ 1,221,456     $ (127 )   $ (1,036,548 )   $ (430 )   $ 184,402  
Net loss
                            (1,531 )           (1,531 )
Foreign currency translation adjustment
                                  (286 )     (286 )
Total comprehensive loss
                                                    182,585  
Stock compensation plans activity and stock-based compensation expense
    1,161       1       5,598       (308 )                 5,291  
Balance, June 30, 2010
    51,924     $ 52     $ 1,227,054     $ (435 )   $ (1,038,079 )   $ (716 )   $ 187,876  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
- 3 -

 

INTERNAP NETWORK SERVICES CORPORATION AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
             
   
Six Months Ended
June 30,
 
   
2011
   
2010
 
Cash Flows From Operating Activities:
           
Net loss
  $ (4,112 )   $ (1,531 )
Adjustments to reconcile net loss to net cash provided by operating activities:
               
Depreciation and amortization
    18,572       16,745  
Loss on disposal of property and equipment, net
    84       19  
Provision for doubtful accounts
    480       773  
Equity in (earnings) from equity-method investment
    (235 )     (149 )
Non-cash changes in deferred rent
    (215 )     179  
Stock-based compensation expense
    1,900       2,436  
Deferred income taxes
    22       352  
Other, net
    445       337  
Changes in operating assets and liabilities:
               
Accounts receivable
    (1,301 )     (639 )
Prepaid expenses, deposits and other assets
    (1,333 )     (1,291 )
Accounts payable
    (7,129 )     9,069  
Accrued and other liabilities
    (2,105 )     (1,831 )
Deferred revenues
    (551 )     (832 )
Accrued restructuring liability
    172       26  
Net cash flows provided by operating activities
    4,694       23,663  
                 
Cash Flows From Investing Activities:
               
Purchases of property and equipment
    (23,177 )     (28,494 )
Maturities of investments in marketable securities
          4,300  
Net cash flows used in investing activities
    (23,177 )     (24,194 )
                 
Cash Flows From Financing Activities:
               
Proceeds from credit agreements
          39,000  
Principal payments on credit agreements
    (500 )     (39,000 )
Payments on capital lease obligations
    (622 )     (62 )
Stock-based compensation plans
    162       2,845  
Other, net
    (66 )     (61 )
Net cash flows (used in) provided by financing activities
    (1,026 )     2,722  
Effect of exchange rates on cash and cash equivalents
    25       (42 )
Net (decrease) increase in cash and cash equivalents
    (19,484 )     2,149  
Cash and cash equivalents at beginning of period
    59,582       73,926  
Cash and cash equivalents at end of period
  $ 40,098     $ 76,075  
                 
Supplemental disclosure of cash flow information:
               
Cash paid for interest, net of amounts capitalized
  $ 1,904     $ 821  
Cash paid for income taxes
    243       138  
Non-cash acquisition of property and equipment under capital leases
    9,258       16,757  
Capitalized stock-based compensation
    232       9  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
- 4 -

 
 
INTERNAP NETWORK SERVICES CORPORATION AND SUBSIDIARIES
UNAUDITED CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
  
1.           NATURE OF OPERATIONS AND BASIS OF PRESENTATION
 
Internap Network Services Corporation (“Internap,” “we,” “us” or “our”) 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 managed hosting solutions are differentiated by superior performance, availability and support.
 
We provide services at 37 data centers across North America, Europe and the Asia-Pacific region and through 76 Internet Protocol (“IP”) service points, which include 18 content delivery network (“CDN”) points of presence (“POPs”) and one additional standalone CDN POP.
 
We prepare our unaudited condensed consolidated financial statements pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) which include all of our accounts and those of our wholly owned subsidiaries. As permitted by such rules and regulations, we have condensed or omitted certain information and note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The unaudited condensed consolidated financial statements reflect all adjustments, which consist of normal recurring adjustments, necessary for a fair statement of our financial position as of June 30, 2011 and our operating results, cash flows and changes in stockholders’ equity for the interim periods presented. We derived the balance sheet at December 31, 2010 from our audited financial statements as of that date. You should read these financial statements and the related notes in conjunction with our financial statements and notes thereto contained in our Annual Report on Form 10-K for the year ended December 31, 2010 filed with the SEC.
 
The preparation of financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to revenue recognition, doubtful accounts, goodwill and intangible assets, accruals, stock-based compensation, income taxes, restructuring charges, leases, long-term service contracts, contingencies and litigation. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ materially from these estimates.
 
The results of operations for the six months ended June 30, 2011 are not necessarily indicative of the results that may be expected for any future periods or for the year ending December 31, 2011 or subsequent years.
 
Certain prior period information has been reclassified to conform to the current period presentation.
 
2.           REVENUE RECOGNITION
 
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 (a) vendor-specific objective evidence, if available, (b) third-party evidence, if vendor-specific objective evidence is not available, and (c) 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 a median 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.
 
 
- 5 -

 
 
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.
 
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: (a) the delivered item or items have value to the customer on a standalone basis and (b) 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.
     
For additional information regarding our revenue recognition accounting policies, see our Annual Report on Form 10-K for the year ended December 31, 2010 and the consolidated financial statements contained therein.
 
3.           OPERATING SEGMENTS
 
We operate in two business segments: data center services and IP services. The data center services segment includes colocation services, which involves providing physical space within our data centers, as well as associated services such as redundant power, interconnection, environmental controls and security. 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.  The IP services segment includes our patented Performance IP™ service, XIP™ Acceleration-as-a-Service solution, CDN services and flow control platform (“FCP”) products.
 
The following table shows operating results for our business segments, along with reconciliations from segment profit to loss before income taxes and equity in (earnings) of equity-method investment:
                         
   
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
   
2011
   
2010
   
2011
   
2010
 
Revenues:
                       
Data center services
  $ 32,481     $ 31,197     $ 64,023     $ 64,918  
IP services
    27,929       29,328       55,791       58,971  
Total revenues
    60,410       60,525       119,814       123,889  
                                 
Operating costs and expenses:
                               
Direct costs of network, sales and services, exclusive of depreciation and amortization:
                               
Data center services
    19,733       19,784       38,263       42,827  
IP services
    10,836       11,479       21,336       22,521  
Total direct costs of network, sales and services, exclusive of depreciation and amortization
    30,569       31,263       59,599       65,348  
                                 
Segment profit:
                               
Data center services
    12,748       11,413       25,760       22,091  
IP services
    17,093       17,849       34,455       36,450  
Total segment profit
    29,841       29,262       60,215       58,541  
                                 
Restructuring
    1,304       1,183       1,492       1,201  
Other operating expenses, including direct costs of customer support, depreciation and amortization
    30,208       28,792       61,282       57,940  
Loss from operations
    (1,671 )     (713 )     (2,559 )     (600 )
Non-operating expense
    923       491       1,609       795  
Loss before income taxes and equity in (earnings) of equity-method investment
  $ (2,594 )   $ (1,204 )   $ (4,168 )   $ (1,395 )
 
 
- 6 -

 
 
4.           RESTRUCTURING
 
In prior years, we implemented significant restructuring plans that resulted in substantial charges for our real estate obligations.  In addition, during the six months ended June 30, 2011, we recorded initial restructuring charges related to the ceased use of an office facility, as well as subsequent plan adjustments in sublease income assumptions for certain properties included in our previously-disclosed restructuring plans. We include these initial restructuring charges and subsequent plan adjustments in “Restructuring” on the accompanying consolidated statements of operations.
 
The following table displays the restructuring activity and balances during the six months ended June 30, 2011 (in thousands):
                               
   
December 31, 2010
Restructuring
Liability
   
Initial
Restructuring
Charges
   
Subsequent
Plan
Adjustments
   
Cash
Payments
   
June 30, 2011
Restructuring
Liability
 
Activity for 2011
restructuring charge:
                             
Real estate obligations
  $     $ 318     $     $ (17 )   $ 301  
Activity for 2010
restructuring charge:
                                       
Real estate obligations
    12                   (12 )      
Activity for 2007
restructuring charge:
                                       
Real estate obligations
    5,635             720       (833 )     5,522  
Activity for 2001
restructuring charge:
                                       
Real estate obligations
    2,317             353       (357 )     2,313  
                                         
Total
  $ 7,964     $ 318     $ 1,073     $ (1,219 )   $ 8,136  
 
5.           INCOME TAXES
 
At the end of each quarterly reporting period, we estimate the effective income tax rate we expect to be applicable for the full year. We use the expected effective income tax rate to provide for income taxes on a year-to-date basis. We reflect the tax effect of any tax law changes and certain other discrete events in the period in which they occur.
 
Our overall effective income tax rate, as a percentage of pre-tax ordinary income, for the six months ended June 30, 2011 and 2010 was (4%) and (23%), respectively. The fluctuation in the effective income tax rate was due to recognition of income taxes in the United Kingdom (“U.K.”), permanent tax adjustment items, a change in valuation allowance and state income taxes.
 
The annual effective tax rate for 2011 could change due to a number of factors including, but not limited to, our geographic profit mix between the United States (“U.S.”), the U.K. and other foreign jurisdictions, new tax laws, new interpretations of existing tax law and rulings by and settlements with taxing authorities.
 
We continue to maintain a valuation allowance of $139.0 million against our deferred tax assets. The total deferred tax assets primarily consist of net operating loss carryforwards. We may recognize U.S. deferred tax assets in future periods when we estimate them to be realizable. Based on an analysis of our historic and projected future U.S. pre-tax income, we do not have sufficient positive evidence to expect a release of our valuation allowance against our U.S. deferred tax assets currently or within the next 12 months. Accordingly, we continue to maintain the full valuation allowance in the U.S. and all foreign jurisdictions, other than the U.K.
 
For the six months ended June 30, 2011, there were no new material uncertain tax positions. Also, we do not expect the total amount of unrecognized tax benefits to significantly increase or decrease within the next 12 months.
 
 
- 7 -

 
 
6.           LOSS PER SHARE
 
We calculated basic and diluted net loss per share as follows (in thousands, except per share amounts):
                         
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
 
2011
 
2010
 
2011
 
2010
 
Net loss available to common stockholders
  $ (2,612 )   $ (1,271 )   $ (4,112 )   $ (1,531 )
Weighted average shares outstanding, basic and diluted
    50,174       50,013       50,251       50,264  
Net loss per share, basic and diluted
  $ (0.05 )   $ (0.03 )   $ (0.08 )   $ (0.03 )
                                 
Anti-dilutive securities excluded from diluted net loss per share calculation for stock-based compensation plans
    6,447       6,061       6,447       6,061  
 
 7.           FAIR VALUE MEASUREMENTS
 
We account for certain assets and liabilities at fair value. The hierarchy below lists three levels of fair value based on the extent to which inputs used in measuring fair value are observable in the market. We categorize each of our fair value measurements in one of these three levels based on the lowest level input that is significant to the fair value measurement in its entirety. These levels are:
 
 
Level 1: Quoted prices in active markets for identical assets or liabilities;
 
Level 2: Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities; and
 
Level 3: Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
 
The following table represents the fair value hierarchy for our financial assets (cash equivalents, investments in marketable securities and other related assets) measured at fair value on a recurring basis (in thousands):
 
   
Level 1
   
Level 2
   
Level 3
   
Total
 
                         
June 30, 2011:
                       
Available for sale securities:
                       
Money market funds(1)
 
$
33,282
   
$
   
$
   
$
33,282
 
   
$
33,282
   
$
   
$
   
$
33,282
 
 
   
Level 1
   
Level 2
   
Level 3
   
Total
 
                         
December 31, 2010:
                       
Available for sale securities:
                       
Money market funds(1)
 
$
39,283
   
$
   
$
   
$
39,283
 
   
$
39,283
   
$
   
$
   
$
39,283
 
 
   
 
(1)
Included in “Cash and cash equivalents” in the consolidated balance sheets as of June 30, 2011 and December 31, 2010 in addition to $6.8 million and $20.3 million, respectively, of cash. Unrealized gains and losses on money market funds were nominal due to the short-term nature of the investments.
 
8.           CONTINGENCIES AND LITIGATION
 
Securities Class Action Litigation. On November 12, 2008, a putative securities fraud class action lawsuit was filed against us and our former chief executive officer in the United States District Court for the Northern District of Georgia, captioned Catherine Anastasio and Stephen Anastasio v. Internap Network Services Corp. and James P. DeBlasio, Civil Action No. 1:08-CV-3462-JOF. The complaint alleges that we and the individual defendant violated Section 10(b) of the Securities Exchange Act of 1934 (the “Exchange Act”) and that the individual defendant also violated Section 20(a) of the Exchange Act as a “control person” of Internap. Plaintiffs purport to bring these claims on behalf of a class of our investors who purchased our common stock between March 28, 2007 and March 18, 2008.
 
 
- 8 -

 
 
Plaintiffs allege generally that, during the putative class period, we made misleading statements and omitted material information regarding (a) integration of VitalStream, which we acquired in 2007, (b) customer issues and related credits due to services outages and (c) our previously reported 2007 revenue that we subsequently reduced in 2008 as announced on March 18, 2008. Plaintiffs assert that we and the individual defendant made these misstatements and omissions to maintain our share price. Plaintiffs seek unspecified damages and other relief.
 
On August 12, 2009, the Court granted plaintiffs leave to file an Amended Class Action Complaint (“Amended Complaint”). The Amended Complaint added a claim for violation of Section 14(a) of the Exchange Act based on alleged misrepresentations in our proxy statement in connection with our acquisition of VitalStream. The Amended Complaint also added our former chief financial officer as a defendant and lengthened the putative class period.
 
On September 11, 2009, we and the individual defendants filed motions to dismiss. On November 6, 2009, plaintiffs filed a Corrected Amended Class Action Complaint. On December 7, 2009, plaintiffs filed a motion for leave to file a Second Amended Class Action Complaint to add allegations regarding, inter alia, an alleged failure to conduct due diligence in connection with the VitalStream acquisition and additional statements from purported confidential witnesses.
 
On September 15, 2010, the Court granted our motion to dismiss and denied the individual defendants’ motion to dismiss. The Court dismissed plaintiffs’ claims under Section 14(a) of the Exchange Act. With respect to plaintiffs’ claims under Section 10(b) of the Exchange Act, the Court held that the Amended Complaint failed to satisfy the pleading requirements of the Private Securities Litigation Reform Act, but allowed plaintiffs’ one final opportunity to amend the complaint. On October 26, 2010, plaintiffs filed their Third Amended Class Action Complaint. On December 10, 2010, we filed a motion to dismiss this complaint, which is currently pending before the Court.
 
Derivative Action Litigation. On November 12, 2009, stockholder Walter M. Unick filed a putative derivative action purportedly on behalf of Internap against certain of our directors and officers in the Superior Court of Fulton County, Georgia, captioned Unick v. Eidenberg, et al., Case No. 2009cv177627. This action is based upon substantially the same facts alleged in the securities class action litigation described above. The complaint seeks to recover damages in an unspecified amount. On January 28, 2010, the Court entered the parties’ agreed order staying the matter until the motions to dismiss are resolved in the securities class action litigation.
 
While we will vigorously contest these lawsuits, we cannot determine the final resolution of the lawsuits or when they might be resolved. In addition to the expenses incurred in defending this litigation and any damages that may be awarded in the event of an adverse ruling, our management’s efforts and attention may be diverted from the ordinary business operations to address these claims. Regardless of the outcome, this litigation described above may have a material adverse impact on our financial results because of defense costs, including costs related to our indemnification obligations, diversion of resources and other factors.
 
We are subject to other legal proceedings, claims and litigation arising in the ordinary course of business. Although the outcome of these matters is currently not determinable, we do not expect that the ultimate costs to resolve these matters will have a material adverse impact on our financial condition, results of operations or cash flows.
 
9.           CAPITAL LEASE OBLIGATIONS
 
We record capital lease obligations and leased property and equipment at the time of entering into the respective lease at the lesser of the present value of future lease payments based upon the terms of the related lease agreement or the fair value of the assets held under capital leases. As of June 30, 2011, our capital leases had expiration dates ranging from 2013 to 2023.
 
During the six months ended June 30, 2011, we entered into a lease for new company-controlled data center space in Dallas, Texas.  As a result, property and equipment and corresponding capital lease obligations increased by $9.3 million.
 
Future minimum capital lease payments and the present value of the minimum lease payments for all capital leases as of June 30, 2011, are as follows (in thousands):
 
2011
 
$
1,491
 
2012
   
3,637
 
2013
   
4,568
 
2014
   
4,629
 
2015
   
4,758
 
Thereafter
   
29,261
 
Remaining capital lease payments
   
48,344
 
Less: amounts representing imputed interest
   
(19,121
)
Present value of minimum lease payments
   
29,223
 
Less: current portion
   
(191
)
   
$
29,032
 
 
 
- 9 -

 
 
Also during the six months ended June 30, 2011, we entered into a lease for new company-controlled data center space in Los Angeles, California.  However, we did not take possession of the space until July 2011 when the space was available according to terms of the lease, and as a result, we recorded related property and equipment and corresponding capital lease obligations of $8.0 million subsequent to June 30, 2011.
 
10.           RECENT ACCOUNTING PRONOUNCEMENTS
 
In June 2011, the Financial Accounting Standards Board (“FASB”) issued new accounting guidance related to the presentation of comprehensive income. The new guidance will require the presentation of components of net income and other comprehensive income either as one continuous statement or as two consecutive statements and eliminates the option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity. There is no change to the items that we must report in other comprehensive income or when we must reclassify an item of other comprehensive income to net income.  The guidance is effective for interim and annual periods beginning after December 15, 2011. Because the guidance impacts presentation only, it will have no effect on our financial condition, results of operations or cash flows.
 
In May 2011, the FASB issued new accounting guidance related to convergence between U.S. GAAP and International Financial Reporting Standards (“IFRS”).  The new guidance changes the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements to ensure consistency between U.S. GAAP and IFRS.  The new guidance also expands the disclosures for fair value measurements that are estimated using significant unobservable (Level 3) inputs.  The guidance is effective for interim and annual periods beginning after December 15, 2011. The adoption is not expected to have a material impact on our fair value measurements, financial condition, results of operations or cash flows.
 
 
- 10 -

 
 
INTERNAP NETWORK SERVICES CORPORATION AND SUBSIDIARIES
 
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include statements regarding industry trends, our future financial position and performance, business strategy, revenues and expenses in future periods, projected levels of growth, impairments, levels of cash, utilization of borrowings and financing needs, performance of and demand for our information technology (“IT”) infrastructure services, results of litigation and other matters that do not relate strictly to historical facts. These statements are often identified by the use of words such as “may,” “will,” “seeks,” “anticipates,” “believes,” “estimates,” “expects,” “projects,” “forecasts,” “plans,” “intends,” “continue,” “could,” “should” or similar expressions or variations. These statements are based on the beliefs and expectations of our management team based on information currently available. Such forward-looking statements are not guarantees of future performance and are subject to risks and uncertainties that could cause actual results to differ materially from those contemplated by forward-looking statements. Important factors currently known to our management that could cause or contribute to such differences include, but are not limited to, those referenced in this Quarterly Report on Form 10-Q under Part II Item 1A “Risk Factors.” We undertake no obligation to update any forward-looking statements as a result of new information, future events or otherwise.
 
As used herein, except as otherwise indicated by context, references to “we,” “us,” “our” or “Internap” refer to Internap Network Services Corporation.
 
Overview
 
Internap provides high-performance IT infrastructure services that enable our customers to focus on their core business, improve service levels and lower the cost of IT operations. Our colocation, connectivity and hosting solutions are differentiated by superior performance, availability and support.
     
We currently have approximately 2,700 customers across 28 metropolitan markets, serving a variety of industries, such as entertainment and media, including gaming; financial services; business services; software, including software-as-a-service; hosting and information technology infrastructure; and telecommunications. For the six months ended June 30, 2011, revenues generated and long-lived assets located outside the United States (“U.S.”) were each less than 10% of our total revenues and assets.
 
Operating Segments
 
Data Center Services
 
Our data center services segment includes colocation services, which involves providing physical space within our data centers, as well as 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 our secure data centers. The segment also includes hosting services in which customers own and manage their software applications and content, while we provide and maintain the hardware, operating system, data center infrastructure and interconnection.  Hosting services include our managed hosting offering in which customers receive dedicated environments.  These services also include our emerging cloud computing and storage business.
 
Our data center services enable us to have a broader product offering that provides customer flexibility and the ability to bundle these services with our high performance Internet Protocol (“IP”) connectivity and content delivery network (“CDN”) services, along with hosting customers’ infrastructure, data and applications. Our data center services provide a single source for network infrastructure, IP connectivity and security, all of which are designed to maximize solution performance while providing a more stable, dependable infrastructure, and are backed by service level agreements (“SLAs”) and our team of dedicated support professionals.
 
We sell our colocation and/or hosting services at 37 data centers across North America, Europe and the Asia-Pacific region. We refer to nine 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, during the six months ended June 30, 2011, we began to build out a new company-controlled data center in Dallas, Texas and subsequent to June 30, 2011, we began to build out a new company-controlled data center in Los Angeles, California. We expect these expansions to increase the footprint of our company-controlled data centers by 110,000 net sellable square feet over time.
 
 
- 11 -

 
 
As a service provider in today’s global economy, we must demonstrate that we have adequate controls and safeguards in place to protect our customers’ infrastructure in our data centers. To do this, we utilize a third-party service auditor (an independent accounting firm) to perform an examination in accordance with Statement on Auditing Standards No. 70 and issue a Type II report which includes a description of our controls, along with detailed testing of the design and operation of these controls.  We have such audits performed at our company-controlled data centers every six months. Additionally, the underlying providers for several of our partner sites also have these audits performed and we have obtained and reviewed these reports to our satisfaction.  Effective for periods ending after June 15, 2011, Service Organization Controls (“SOC”) reports covering such audits will be issued under Statement on Standards for Attestation Engagements No. 16.
 
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 76 Internet Protocol (“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 information technology delivery models, in a reliable and predictable manner. Our services and products take into account the unique performance requirements of each business application to ensure performance as designed, without unnecessary cost. Our fees for IP services are based on a fixed fee, usage or a combination of both.
 
Our CDN services enable our customers to quickly and securely stream and distribute rich media and content, such as video, audio software and applications, to audiences across the globe through strategically located data POPs. Providing capacity-on-demand to handle large events and unanticipated traffic spikes, we deliver scalable high-quality content distribution and the analytic tools to allow our customers to refine their marketing programs.
 
Recent Accounting Pronouncements
 
We summarize recent accounting pronouncements in note 10 to the accompanying financial statements.
 
Critical Accounting Policies and Estimates
 
Effective January 1, 2011, we adopted new accounting guidance related to the accounting and disclosure for revenue recognition. This guidance modifies the criteria for recognizing revenue in multiple element arrangements and the scope of what constitutes a non-software deliverable. Adoption of this new guidance did not have a material impact on our consolidated financial statements.
 
We summarize our revenue recognition policies related to this new guidance in note 2 to the accompanying financial statements. For additional information regarding all of our revenue recognition accounting policies, see our Annual Report on Form 10-K for the year ended December 31, 2010 and the consolidated financial statements contained therein.
 
 
- 12 -

 
 
Results of Operations
 
The following table sets forth selected consolidated statements of operations data during the periods presented, including comparative information between the periods (dollars in thousands):
 
   
Three Months Ended
June 30,
   
Increase (Decrease)
from June 30, 2010
to June 30, 2011
   
Six Months Ended
June 30,
   
Increase (Decrease)
from June 30, 2010
to June 30, 2011
 
   
2011
   
2010
   
Amount
   
Percent
   
2011
   
2010
   
Amount
   
Percent
 
Revenues:
                                               
Data center services
  $ 32,481     $ 31,197     $ 1,284       4 %   $ 64,023     $ 64,918     $ (895 )     (1 )%
IP services
    27,929       29,328       (1,399 )     (5 )     55,791       58,971       (3,180 )     (5 )
Total revenues
    60,410       60,525       (115 )           119,814       123,889       (4,075 )     (3 )
                                                                 
Operating costs and expenses:
                                                               
  Direct costs of network, sales and services, exclusive of depreciation and amortization, shown below:
                                                               
Data center services
    19,733       19,784       (51 )           38,263       42,827       (4,564 )     (11 )
IP services
    10,836       11,479       (643 )     (6 )     21,336       22,521       (1,185 )     (5 )
  Direct costs of customer support
    5,374       4,606       768       17       10,485       9,545       940       10  
  Direct costs of amortization of acquired technologies
    875       979       (104 )     (11 )     1,750       1,958       (208 )     (11 )
  Sales and marketing
    7,731       7,002       729       10       15,564       14,126       1,438       10  
  General and administrative
    7,449       9,174       (1,725 )     (19 )     16,577       17,505       (928 )     (5 )
  Depreciation and amortization
    8,768       7,013       1,755       25       16,822       14,787       2,035       14  
  Loss on disposal of property and equipment, net
    11       18       (7 )           84       19       65        
  Restructuring
    1,304       1,183       121       10       1,492       1,201       291       24  
Total operating costs and expenses
    62,081       61,238       843       1       122,373       124,489       (2,116 )     (2 )
  Loss from operations
  $ (1,671 )   $ (713 )   $ 958       134     $ (2,559 )   $ (600 )   $ 1,959       327  
                                                                 
Interest expense
  $ 875     $ 518     $ 357       69     $ 1,522     $ 821     $ 701       85  
Provision for income taxes
  $ 106     $ 129     $ (23 )     (18 )%   $ 179     $ 285     $ (106 )     (37 )%
 
Three Months Ended June 30, 2011 and 2010
 
Data Center Services
 
Revenues for data center services increased $1.3 million, or 4%, to $32.5 million for the three months ended June 30, 2011, compared to $31.2 million for the same period in 2010. The increase in revenue in the three months ended June 30, 2011 was primarily due to net revenue growth of $2.7 million, offset by our proactive churn program in the amount of $1.4 million.
 
Direct costs of data center services, exclusive of depreciation and amortization, were $19.7 million for the three months ended June 30, 2011, compared to $19.8 million for the same period in 2010.
 
Direct costs of data center services, exclusive of depreciation and amortization, have substantial fixed cost components, primarily for rent, but also significant demand-based pricing variables, such as utilities due 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, as well as the utilization of total available space. While we recognize some of the initial operating costs of company-controlled data centers in advance of revenues, these sites are more profitable at certain levels of utilization than are partner sites. Conversely, costs in partner sites are more demand-based and therefore are more closely associated with the recognition of revenues.
 
 
- 13 -

 
 
IP Services
 
Revenues for IP services decreased $1.4 million, or 5%, to $27.9 million for the three months ended June 30, 2011, compared to $29.3 million for 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 16% for the three months ended June 30, 2011, compared to the three months ended June 30, 2010, calculated based on an average over the sum of the months in the respective periods.
 
Direct costs of IP services, exclusive of depreciation and amortization, decreased $0.6 million, or 6%, to $10.8 million for the three months ended June 30, 2011, compared to $11.5 million for the same period in 2010. This decrease was due to lower connectivity costs, which vary based upon customer traffic volume and other 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.
 
Other Operating Costs and Expenses
 
Compensation. Total compensation and benefits, including stock-based compensation, was $13.7 million during each of the three months ended June 30, 2011 and 2010.
 
Cash-based compensation and benefits increased $0.4 million to $12.7 million during the three months ended June 30, 2011 from $12.3 million during the same period in 2010. The increase was primarily due to a $1.1 million increase in cash-based compensation and payroll taxes related to a higher employee headcount and increased salary levels, a $1.1 million increase attributable to credits we recorded in 2010 related to prior years’ Georgia Headquarters Tax Credit (“HQC”), offset by a $1.2 million decrease due to capitalized payroll and benefit costs related to software development in 2011 and a $0.4 million decrease in insurance costs.
 
Stock-based compensation decreased $0.4 million to $1.0 million during the three months ended June 30, 2011 from $1.4 million during the same period in 2010.  The decrease was primarily due to differences in vesting terms for grants in the three months ended June 30, 2010, compared to those in the same period 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 the three months ended June 30, 2011 and 2010 (in thousands):
 
   
2011
   
2010
 
Direct costs of customer support
 
$
179
   
$
198
 
Sales and marketing
   
262
     
271
 
General and administrative
   
548
     
975
 
   
$
989
   
$
1,444
 
 
Direct Costs of Customer Support. Direct costs of customer support increased 17% to $5.4 million during the three months ended June 30, 2011 from $4.6 million during the same period in 2010. The increase was primarily due to a $0.6 million increase in cash-based compensation costs.
 
Direct Costs of Amortization of Acquired Technologies. Direct costs of amortization of acquired technologies were $0.9 million and $1.0 million during the three months ended June 30, 2011 and 2010, respectively.
 
Sales and Marketing. Sales and marketing costs during the three months ended June 30, 2011 increased 10% to $7.7 million from $7.0 million during the same period in 2010. The increase was primarily due to a $0.6 million increase in cash-based compensation costs.
 
General and Administrative. General and administrative costs during the three months ended June 30, 2011 decreased 19% to $7.4 million from $9.2 million during the same period in 2010. The decrease was primarily due to a $0.4 million decrease in stock-based compensation, a $0.5 million decrease related to the pass-through of taxes and the capitalization of use tax on equipment purchases, a $0.3 million decrease in professional services, a $1.1 million decrease due to capitalized payroll and benefit costs related to software development in 2011 and a $0.2 million decrease in insurance costs, partially offset by a $1.1 million increase in cash-based compensation costs.
 
Depreciation and Amortization. Depreciation and amortization increased 25% to $8.8 million during the three months ended June 30, 2011, compared to $7.0 million during the same period in 2010. The increase was primarily due to the effects of our expansion of company-controlled data centers and private network access points (“P-NAP”) infrastructure.
 
Interest Expense. Interest expense increased to $0.9 million during the three months ended June 30, 2011, compared to $0.5 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.
 
 
- 14 -

 
 
Provision for Income Taxes. The provision for income taxes was $0.1 million during the three months ended June 30, 2011 and 2010. Our effective income tax rate, as a percentage of pre-tax income, for the three months ended June 30, 2011 and 2010 was (4%) and (11%), 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 of $139.0 million against our deferred tax assets. The total deferred tax assets primarily consist of net operating loss carryforwards. We may recognize U.S. deferred tax assets in future periods when we estimate them to be realizable. Based on an analysis of our historic and projected future U.S. pre-tax income, we do not have sufficient positive evidence to expect a release of our valuation allowance against our U.S. deferred tax assets currently or within the next 12 months. Accordingly, we continue to maintain the full valuation allowance in the U.S. and all foreign jurisdictions, other than the U.K.
 
Six Months Ended June 30, 2011 and 2010
 
Data Center Services
 
Revenues for data center services decreased $0.9 million, or 1%, to $64.0 million for the six months ended June 30, 2011, compared to $64.9 million for the same period in 2010. The decrease in revenue in the six months ended June 30, 2011 was primarily due to our proactive churn program in the amount of $4.6 million, which was offset by underlying net revenue growth of $3.7 million.
 
Direct costs of data center services, exclusive of depreciation and amortization, decreased $4.6 million, or 11%, to $38.3 million for the six months ended June 30, 2011, compared to $42.8 million for the same period in 2010. The decrease was primarily the result of our proactive churn program.
 
IP Services
 
Revenues for IP services decreased $3.2 million, or 5%, to $55.8 million for the six months ended June 30, 2011, compared to $59.0 million for 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 21% for the six months ended June 30, 2011, compared to the six months ended June 30, 2010, calculated based on an average over the sum of the months in the respective periods.
 
Direct costs of IP services, exclusive of depreciation and amortization, decreased $1.2 million, or 5%, to $21.3 million for the six months ended June 30, 2011, compared to $22.5 million for the same period in 2010. This decrease was due to lower connectivity costs, which vary based upon customer traffic volume and other demand-based pricing variables.
 
Other Operating Costs and Expenses
 
Compensation. Total compensation and benefits, including stock-based compensation, was $28.5 million and $27.4 million during the six months ended June 30, 2011 and 2010, respectively.
 
Cash-based compensation and benefits increased $1.6 million to $26.6 million during the six months ended June 30, 2011 from $25.0 million during the same period in 2010. The increase was primarily due to a $2.4 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 $1.1 million increase attributable to credits we recorded in 2010 related to prior years’ HQC, offset by a $2.1 million decrease due to capitalized payroll and benefit costs related to software development in 2011 and a $0.4 million decrease in insurance costs.
 
Stock-based compensation decreased $0.5 million to $1.9 million during the six months ended June 30, 2011 from $2.4 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 $0.2 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 the six months ended June 30, 2011 and 2010 (in thousands):
 
   
2011
   
2010
 
Direct costs of customer support
 
$
358
   
$
374
 
Sales and marketing
   
490
     
527
 
General and administrative
   
1,052
     
1,535
 
   
$
1,900
   
$
2,436
 
 
Direct Costs of Customer Support. Direct costs of customer support increased 10% to $10.5 million during the six months ended June 30, 2011 from $9.5 million during the same period in 2010. The increase was primarily due to a $0.8 million increase in cash-based compensation costs.
 
 
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Direct Costs of Amortization of Acquired Technologies. Direct costs of amortization of acquired technologies were $1.8 million and $2.0 million during the six months ended June 30, 2011 and 2010, respectively.
 
Sales and Marketing. Sales and marketing costs during the six months ended June 30, 2011 increased 10% to $15.6 million from $14.1 million during the same period in 2010. The increase was primarily due to a $1.0 million increase in cash-based compensation costs, a $0.2 million increase in commissions and a $0.5 million increase in sales training and conference costs, partially offset by a $0.4 million decrease in professional services.
 
General and Administrative. General and administrative costs during the six months ended June 30, 2011 decreased 5% to $16.6 million from $17.5 million during the same period in 2010. The decrease was primarily due to a $0.5 million decrease in stock-based compensation, a $1.0 million decrease related to the pass-through of taxes and the capitalization of use tax on equipment purchases and a $2.0 million decrease due to capitalized payroll and benefit costs related to software development in 2011, partially offset by a $1.6 million increase in cash-based compensation costs, a $0.6 million increase in severance and a $0.5 million increase in professional services.
 
Depreciation and Amortization. Depreciation and amortization increased 14% to $16.8 million during the six months ended June 30, 2011, compared to $14.8 million during the same period in 2010. The increase was primarily due to the effects of our expansion of company-controlled data centers and P-NAP infrastructure.
 
Interest Expense. Interest expense increased to $1.5 million during the six months ended June 30, 2011, compared to $0.8 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 provision for income taxes was $0.2 million during the six months ended June 30, 2011, compared to $0.3 million during the same period in 2010. Our effective income tax rate, as a percentage of pre-tax income, for the six months ended June 30, 2011 and 2010 was (4%) and (23%), 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
 
At June 30, 2011, we had $40.1 million in cash and cash equivalents and $48.5 million in debt obligations, which included $29.2 million in capital leases and $19.3 million borrowed under our term loan.  Net cash flows provided by operations were $4.7 million for the six months ended June 30, 2011.
 
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 agreement 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 credit facility limit our ability to incur additional indebtedness. We believe we have sufficient cash to operate our business for the next 12 months.
 
We monitor and review our performance and operations in light of global economic conditions. The current economic environment may impact the ability of our customers to meet their obligations to us, which could result in delayed collection of accounts receivable and an increase in our provision for doubtful accounts.
 
We have experienced significant impairments and operational restructurings in recent years, which included substantial changes in our senior management team, streamlining our cost structure, consolidation of network access points and termination of certain non-strategic real estate leases and license arrangements. We have a history of quarterly and annual period net losses. During the six months ended June 30, 2011, we had a net loss of $4.1 million. As of June 30, 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.
 
 
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Cash Flows for the Six Months Ended June 30, 2011 and 2010
 
Operating Activities. Net cash provided by operating activities for the six months ended June 30, 2011 was $4.7 million. Our net loss, after adjustments for non-cash items, generated cash from operations of $16.9 million, while changes in operating assets and liabilities used cash from operations of $12.2 million. We expect to use cash flows from operating activities to fund a portion of our capital expenditures and other requirements and to meet our other commitments and obligations, including outstanding debt, as they become due.
 
The primary non-cash adjustment for the six months ended June 30, 2011 was $18.6 million for depreciation and amortization, which included the effects of the expansion of our company-controlled data centers and P-NAP facilities. Non-cash adjustments also included $1.9 million for stock-based compensation expense. The changes in operating assets and liabilities included a $7.1 million decrease in accounts payable and a $2.1 million decrease in accrued liabilities.
 
Days sales outstanding at June 30, 2011 was 27 days, down from 28 days at June 30, 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.
 
Investing Activities. Net cash used in investing activities for the six months ended June 30, 2011 was $23.2 million for capital expenditures, which related to the continued expansion and upgrade of our company-controlled data centers and network infrastructure.
 
Financing Activities. Net cash used in financing activities for the six months June 30, 2011 was $1.0 million primarily due to principal payments on our credit agreement and capital lease obligations.
 
Capital Resources
 
Credit Agreement. We have an $80.0 million credit agreement (the “Credit Agreement”), which provides for a four-year revolving credit facility up to $40.0 million, which includes a $10.0 million sub-limit for letters of credit. The Credit Agreement also provides for a four-year term loan up to $40.0 million (the “Term Loan”). We borrowed $20.0 million under the Term Loan at the closing of the Credit Agreement, and we have a one-time option to borrow an additional $20.0 million until November 2012.
 
As of June 30, 2011, the Term Loan had an outstanding principal amount of $19.3 million (due in quarterly installments with the remaining balance due November 2014), we have issued $5.5 million of letters of credit and we had an additional $54.5 million in borrowing capacity under the Credit Agreement. As of June 30, 2011, the interest rate on the Term Loan was 3.5%.
 
We made customary representations, warranties, negative and affirmative covenants, including certain financial covenants relating to minimum liquidity and fixed charge coverage ratio, as well as customary events of default and certain default provisions that could result in acceleration of amounts owed, if any, under the Credit Agreement. As of June 30, 2011, we were in compliance with these covenants.
 
Capital Leases. During the six months ended June 30, 2011, we entered into leases for new company-controlled data center space in Dallas, Texas and Los Angeles, California. As a result, property and equipment and corresponding capital lease obligations increased by $9.3 million for the Dallas facility.  Subsequent to June 30, 2011, property and equipment and corresponding capital lease obligations increased by $8.0 million for the Los Angeles facility when we took possession of the space in July 2011.
 
We summarize our capital lease obligations in note 9 to the accompanying consolidated financial statements.
 
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
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 we have recognized $2.4 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.
 
 
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Interest Rate Risk
 
Our objective in managing interest rate risk is to maintain favorable long-term fixed rate or a balance of fixed and variable rate debt that will lower our overall borrowing costs within reasonable risk parameters. Currently, our strategy for managing interest rate risk does not include the use of derivative securities. As of June 30, 2011, our long-term debt consisted of $19.3 million borrowed under our Term Loan with a current interest rate of 3.5%. We estimate that an interest rate change of 100 basis points would change our interest expense and payments by $0.2 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.
 
ITEM 4. CONTROLS AND PROCEDURES
 
Disclosure Controls and Procedures
 
Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of June 30, 2011.
 
Changes in Internal Control over Financial Reporting
 
There was no change in our internal control over financial reporting that occurred during the quarter ended June 30, 2011 that has materially affected, or that is reasonably likely to materially affect, our internal control over financial reporting.
  
PART II.  OTHER INFORMATION
 
ITEM 1. LEGAL PROCEEDINGS
 
We are subject to legal proceedings, claims and litigation arising in the ordinary course of business. Although the outcome of these matters is currently not determinable, we do not expect that the ultimate costs to resolve these matters will have a material adverse impact on our financial condition, results of operations or cash flows.
 
ITEM 1A. RISK FACTORS
 
There have been no material changes from the Risk Factors we previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2010 filed with the Securities and Exchange Commission on February 24, 2011.
 
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
 
The following table sets forth information regarding our repurchases of securities for each calendar month in the quarter ended June 30, 2011:
 
ISSUER PURCHASES OF EQUITY SECURITIES
 
Period
 
Total
Number
of Shares
Purchased*
   
Average
Price
Paid per
Share
   
Total
Number of
Shares
Purchased as
Part of
Publicly
Announced
Plans or
Programs
   
Maximum
Number
(or
 Approximate
Dollar Value) of
Shares That
May Yet Be
Purchased
Under the Plans
or Programs
 
 
    April 1 to 30, 2011
    16,353     $ 7.01              
 
    May 1 to 31, 2011
    1,603       7.49              
 
    June 1 to 30, 2011
    7,833       7.39              
 
    Total
    25,789     $ 7.16              
 

*           These shares were surrendered to us to satisfy tax withholding obligations in connection with the vesting of shares of restricted stock previously issued to employees.
 
 
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ITEM 6. EXHIBITS
       
Exhibit
Number
 
Description
 
     
31.1
 
Rule 13a-14(a)/15d-14(a) Certification, executed by J. Eric Cooney, President, Chief Executive Officer and Director of Internap.
     
31.2
 
Rule 13a-14(a)/15d-14(a) Certification, executed by George E. Kilguss, III, Chief Financial Officer of Internap.
     
32.1
 
Section 1350 Certification, executed by J. Eric Cooney, President, Chief Executive Officer and Director of Internap.
     
32.2
 
Section 1350 Certification, executed by George E. Kilguss, III, Chief Financial Officer of Internap.
 

 
 
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INTERNAP NETWORK SERVICES CORPORATION AND SUBSIDIARIES
 
SIGNATURE
 
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized
       
 
INTERNAP NETWORK SERVICES
CORPORATION
 
       
 
By:
/s/ George E. Kilguss, III
 
   
George E. Kilguss, III
 
   
Chief Financial Officer
 
   
(Principal Accounting Officer)
 
       
   
Date: July 28, 2011
 
 
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