Internap (INAPQ) 10-Q 2012 Q3 Quarterly report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2012
OR
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______ to ______
Commission File Number: 000-27265
INTERNAP NETWORK SERVICES CORPORATION
(Exact Name of Registrant as Specified in Its Charter)

DELAWARE	91-2145721
(State or Other Jurisdiction of	(I.R.S. Employer
Incorporation or Organization)	Identification No.)
One Ravinia Drive, Suite 1300
Atlanta, Georgia 30346
(Address of Principal Executive Offices, Including Zip Code)
(404) 302-9700
(Registrant’s Telephone Number, Including Area Code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer	o	Accelerated filer	x
Non-accelerated filer	o	Smaller reporting company	o
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
As of October 18, 2012, 53,455,807 shares of the registrant’s outstanding common stock, $0.001 par value per share, were outstanding.

 INTERNAP NETWORK SERVICES CORPORATION

FORM 10-Q

FOR THE QUARTER ENDED SEPTEMBER 30, 2012

TABLE OF CONTENTS

	PART I. FINANCIAL INFORMATION
ITEM 1.	FINANCIAL STATEMENTS
	Unaudited Condensed Consolidated Statements of Operations and Comprehensive Loss	1
	Unaudited Condensed Consolidated Balance Sheets	2
	Unaudited Condensed Consolidated Statements of Stockholders’ Equity	3
	Unaudited Condensed Consolidated Statements of Cash Flows	4
	Unaudited Condensed Notes to Consolidated Financial Statements	5
ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	11
ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	18
ITEM 4.	CONTROLS AND PROCEDURES	19
	PART II. OTHER INFORMATION
ITEM 1.	LEGAL PROCEEDINGS	19
ITEM 1A.	RISK FACTORS	19
ITEM 2.	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	19
ITEM 6.	EXHIBITS	20
	SIGNATURES

i

INTERNAP NETWORK SERVICES CORPORATION AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

AND COMPREHENSIVE LOSS

(In thousands, except per share amounts)

	Three Months Ended September 30,						Nine Months Ended September 30,
	2012			2011			2012			2011
Revenues:
Data center services	$	42,139		$	34,114		$	123,570		$	98,137
Internet protocol (IP) services		25,990			27,900			80,274			83,691
Total revenues		68,129			62,014			203,844			181,828
Operating costs and expenses:
Direct costs of network, sales and services, exclusive of depreciation
and amortization, shown below:
Data center services		23,539			20,480			67,158			58,743
IP services		10,034			10,307			30,210			31,643
Direct costs of customer support		6,898			5,407			20,108			15,892
Direct costs of amortization of acquired technologies		1,179			875			3,538			2,625
Sales and marketing		7,569			7,314			23,973			22,878
General and administrative		8,985			8,333			29,886			24,911
Depreciation and amortization		9,885			9,647			26,463			26,468
(Gain) loss on disposal of property and equipment, net		—			(47	)		(19	)		37
Restructuring and impairments		124			123			812			1,615
Total operating costs and expenses		68,213			62,439			202,129			184,812
(Loss) income from operations		(84	)		(425	)		1,715			(2,984	)
Non-operating expenses:
Interest expense		1,996			1,166			5,335			2,688
Other, net		118			20			413			107
Total non-operating expenses		2,114			1,186			5,748			2,795
Loss before income taxes and equity in (earnings) of equity-method investment		(2,198	)		(1,611	)		(4,033	)		(5,779	)
Provision for income taxes		289			275			503			454
Equity in (earnings) of equity-method investment, net of taxes		(37	)		(98	)		(197	)		(333	)
Net loss		(2,450	)		(1,788	)		(4,339	)		(5,900	)
Other comprehensive income:
Foreign currency translation adjustment, net of taxes		221			12			192			232
Comprehensive loss	$	(2,229	)	$	(1,776	)	$	(4,147	)	$	(5,668	)
Basic and diluted net loss per share	$	(0.05	)	$	(0.04	)	$	(0.09	)	$	(0.12	)
Weighted average shares outstanding used in computing basic and diluted net loss per share		50,572			50,217			50,656			50,360

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)

	September 30, 2012			December 31, 2011
ASSETS
Current assets:
Cash and cash equivalents	$	26,375		$	29,772
Accounts receivable, net of allowance for doubtful accounts of $1,963 and $1,668, respectively		21,002			18,539
Prepaid expenses and other assets		13,204			13,270
Total current assets		60,581			61,581
Property and equipment, net		247,305			198,369
Investment in joint venture		3,137			2,936
Intangible assets, net		22,728			26,886
Goodwill		59,605			59,471
Deposits and other assets		5,653			5,371
Deferred tax asset, net		1,821			2,096
Total assets	$	400,830		$	356,710
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	26,285		$	21,746
Accrued liabilities		9,907			9,152
Deferred revenues		2,801			2,475
Revolving credit facility		—			100
Capital lease obligations		4,294			2,154
Term loan, less discount of $240 and $206, respectively		3,461			2,794
Restructuring liability		2,567			2,709
Accrued contingent consideration		4,945			—
Other current liabilities		166			151
Total current liabilities		54,426			41,281
Deferred revenues		2,662			2,323
Capital lease obligations		45,193			38,923
Revolving credit facility		22,329			—
Term loan, less discount of $446 and $367, respectively		62,353			55,383
Accrued contingent consideration		—			4,626
Restructuring liability		3,540			4,884
Deferred rent		15,372			16,100
Other long-term liabilities		933			1,020
Total liabilities		206,808			164,540
Commitments and contingencies (Note 8)
Stockholders’ equity:
Preferred stock, $0.001 par value; 20,000 shares authorized; no shares issued or outstanding		—			—
Common stock, $0.001 par value; 120,000 shares authorized; 53,436 and 52,528 shares outstanding, respectively		54			53
Additional paid-in capital		1,242,003			1,235,554
Treasury stock, at cost; 248 and 231 shares, respectively		(1,717	)		(1,266	)
Accumulated deficit		(1,046,211	)		(1,041,872	)
Accumulated items of other comprehensive loss		(107	)		(299	)
Total stockholders’ equity		194,022			192,170
Total liabilities and stockholders’ equity	$	400,830		$	356,710

The accompanying notes are an integral part of these consolidated financial statements.

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 INTERNAP NETWORK SERVICES CORPORATION AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF

STOCKHOLDERS’ EQUITY

(In thousands)

	Common Stock
	Shares		Par Value		Additional Paid-In Capital		Treasury Stock			Accumulated Deficit			Accumulated Other Comprehensive Loss			Total Stockholders’ Equity
NINE MONTHS ENDED SEPTEMBER 30, 2012:
Balance, December 31, 2011		52,528	$	53	$	1,235,554	$	(1,266	)	$	(1,041,872	)	$	(299	)	$	192,170
Net loss		—		—		—		—			(4,339	)		—			(4,339	)
Foreign currency translation		—		—		—		—			—			192			192
Stock-based compensation		—		—		4,710		—			—			—			4,710
Other activity of stock compensation plans		908		1		1,739		(451	)		—			—			1,289
Balance, September 30, 2012		53,436	$	54	$	1,242,003	$	(1,717	)	$	(1,046,211	)	$	(107	)	$	194,022
NINE MONTHS ENDED SEPTEMBER 30, 2011:
Balance, December 31, 2010		52,017	$	52	$	1,229,684	$	(520	)	$	(1,040,170	)	$	(435	)	$	188,611
Net loss		—		—		—		—			(5,900	)		—			(5,900	)
Foreign currency translation		—		—		—		—			—			232			232
Stock-based compensation		—		—		3,373		—			—			—			3,373
Other activity of stock compensation plans		466		1		1,062		(692	)		—			—			371
Balance, September 30, 2011		52,483	$	53	$	1,234,119	$	(1,212	)	$	(1,046,070	)	$	(203	)	$	186,687

The accompanying notes are an integral part of these consolidated financial statements.

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INTERNAP NETWORK SERVICES CORPORATION AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

	Nine Months Ended September 30,
	2012			2011
Cash Flows From Operating Activities:
Net loss	$	(4,339	)	$	(5,900	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization		30,001			29,093
Loss on disposal of property and equipment, net		—			37
Impairment of capitalized software		258			—
Stock-based compensation expense, net of capitalized amount		4,382			2,990
Equity in (earnings) of equity-method investment		(197	)		(333	)
Provision for doubtful accounts		833			793
Non-cash changes in capital lease obligations		669			624
Non-cash change in accrued contingent consideration		319			—
Non-cash changes in deferred rent		(727	)		(345	)
Deferred income taxes		292			334
Other, net		440			224
Changes in operating assets and liabilities:
Accounts receivable		(3,296	)		(2,103	)
Prepaid expenses, deposits and other assets		(297	)		(1,338	)
Accounts payable		4,540			5,206
Accrued and other liabilities		826			(1,106	)
Deferred revenues		664			(775	)
Restructuring liability		(1,486	)		(364	)
Net cash flows provided by operating activities		32,882			27,037
Cash Flows From Investing Activities:
Purchases of property and equipment		(64,614	)		(50,909	)
Net cash flows used in investing activities		(64,614	)		(50,909	)
Cash Flows From Financing Activities:
Principal payments on term loan		(2,375	)		(750	)
Proceeds from term loan		10,000			—
Proceeds from revolving credit facility		22,229			—
Payment of debt issuance costs		(543	)		—
Payments on capital lease obligations		(2,296	)		(903	)
Proceeds from exercise of stock options		2,245			1,062
Tax withholdings related to net share settlements of restricted stock awards		(956	)		(691	)
Other, net		(90	)		(100	)
Net cash flows provided by (used in) financing activities		28,214			(1,382	)
Effect of exchange rates on cash and cash equivalents		121			(39	)
Net decrease in cash and cash equivalents		(3,397	)		(25,293	)
Cash and cash equivalents at beginning of period		29,772			59,582
Cash and cash equivalents at end of period	$	26,375		$	34,289
Supplemental disclosure of cash flow information:
Cash paid for interest	$	5,342		$	2,550
Cash paid for income taxes		177			253
Non-cash acquisition of property and equipment under capital leases		10,079			17,210
Capitalized stock-based compensation		329			384

The accompanying notes are an integral part of these consolidated financial statements.

4

 INTERNAP NETWORK SERVICES CORPORATION AND SUBSIDIARIES

UNAUDITED CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.           NATURE OF OPERATIONS AND BASIS OF PRESENTATION

Internap Network Services Corporation (“we,” “us,” “our” or “Internap”) provides intelligent information technology (“IT”) Infrastructure services that combine superior performance and platform flexibility to enable our customers to focus on their core business, improve service levels and lower the cost of IT operations. We provide services at 43 data centers across North America, Europe and the Asia-Pacific region and through 83 Internet Protocol (“IP”) service points, which include 25 content delivery network (“CDN”) points of presence (“POPs”).

We have prepared the accompanying unaudited condensed consolidated financial statements in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information. These financial statements include all of our accounts and those of our wholly-owned subsidiaries. We have eliminated all intercompany transactions and balances in the accompanying financial statements.

We have condensed or omitted certain information and note disclosures normally included in financial statements prepared in accordance with GAAP. In the opinion of management, the accompanying financial statements reflect all adjustments, which consist of normal recurring adjustments, necessary for a fair statement of our financial position as of September 30, 2012 and our operating results, cash flows and changes in stockholders’ equity for the interim periods presented. The balance sheet at December 31, 2011 was derived from our audited financial statements, but does not include all disclosures required by GAAP. You should read the accompanying financial statements and the related notes in conjunction with our financial statements and notes thereto contained in our Annual Report on Form 10-K for the year ended December 31, 2011 filed with the Securities and Exchange Commission.

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. Actual results may differ materially from these estimates.

The results of operations for the nine months ended September 30, 2012 are not necessarily indicative of the results that may be expected for any future periods.

2.           OPERATING SEGMENTS

We operate in two business segments: data center services and IP services. The data center services segment includes colocation services, which involves providing physical space within our data centers, as well as associated services such as power, interconnection, environmental controls and security. This segment also includes hosting and cloud 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, CDN services and flow control platform (“FCP”) products.

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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 September 30,							Nine Months Ended September 30,
	2012			2011				2012			2011
Revenues:
Data center services	$	42,139			$	34,114		$	123,570		$	98,137
IP services		25,990				27,900			80,274			83,691
Total revenues		68,129				62,014			203,844			181,828
Direct costs of network, sales and services, exclusive of depreciation and amortization:
Data center services		23,539				20,480			67,158			58,743
IP services		10,034				10,307			30,210			31,643
Total direct costs of network, sales and services, exclusive of depreciation and amortization		33,573				30,787			97,368			90,386
Segment profit:
Data center services		18,600				13,634			56,412			39,394
IP services		15,956				17,593			50,064			52,048
Total segment profit		34,556				31,227			106,476			91,442
Restructuring		124				123			812			1,615
Other operating expenses, including direct costs of customer support, depreciation and amortization		34,516				31,529			103,949			92,811
(Loss) income from operations		(84	)			(425	)		1,715			(2,984	)
Non-operating expense		2,114				1,186			5,748			2,795
Loss before income taxes and equity in (earnings) of equity-method investment	$	(2,198	)		$	(1,611	)	$	(4,033	)	$	(5,779	)

 3.           PROPERTY AND EQUIPMENT

During January 2012, we reassessed the estimated useful lives of certain assets included in our property and equipment, as we determined we were generally using these assets longer than originally anticipated. As a result, the estimated useful lives of these assets were affected as follows:

	Estimated Useful Life (in years)
	Original	Revised
Network equipment	3	5
Capitalized software	3	5
Leasehold improvements	7	10-25

Effective January 1, 2012, we accounted for the change in estimated useful lives as a change in accounting estimate on a prospective basis. For the nine months ended September 30, 2012, depreciation and amortization expense was $10.5 million less than it would have been under the previous estimated useful lives.

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

4.           GOODWILL AND OTHER INTANGIBLE ASSETS

For purposes of valuing our goodwill and other intangible assets, we have the following three reporting units: IP products, IP services and data center services, all of which have goodwill. We performed our annual impairment review as of August 1, 2012 and concluded that goodwill attributed to each of our reporting units was not impaired as the fair value of each reporting unit exceeded the carrying value, including goodwill. None of our reporting units were at risk of failing step one.

To determine the fair value of our reporting units, we utilize the discounted cash flow and market methods. We have consistently utilized both methods in our goodwill impairment tests and weight both results equally because we believe both, in conjunction with each other, provide a reasonable estimate of the fair value of the reporting unit. The discounted cash flow method is specific to our anticipated future results of the reporting unit, while the market method is based on our market sector including our competitors.

6

We determined the assumptions supporting the discounted cash flow method, including the discount rate, using our best estimates as of the date of the impairment review. We have performed various sensitivity analyses on certain of the assumptions used in the discounted cash flow method, such as forecasted revenues and discount rate. We used reasonable judgment in developing our estimates and assumptions and there was no impairment indicated in our testing.

The assumptions, inputs and judgments used in performing the valuation analysis are inherently subjective and reflect estimates based on known facts and circumstances at the time we perform the valuation. These estimates and assumptions primarily include, but are not limited to, discount rates; terminal growth rates; projected revenues and costs; earnings before interest, taxes, depreciation and amortization for expected cash flows; market comparables and capital expenditure forecasts. The use of different assumptions, inputs and judgments, or changes in circumstances, could materially affect the results of the valuation. Due to inherent uncertainty involved in making these estimates, actual results could differ from our estimates and could result in additional non-cash impairment charges in the future.

In addition to our annual test, we also assess on a quarterly basis whether any events have occurred or circumstances have changed that would indicate an impairment could exist on our intangible and long-lived assets. We concluded that no impairment indicators existed to cause us to re-assess our intangible and long-lived assets during the three months ended September 30, 2012.

5.           ACCRUED CONTINGENT CONSIDERATION

In conjunction with our acquisition of Voxel Holdings, Inc. (“Voxel”) in December 2011, we recorded a liability for accrued contingent consideration of $5.0 million, at its fair value of $4.6 million, to be paid if we receive certain technology deliverables. At December 31, 2011, the liability was included as a long-term liability, as the expected delivery date was on or before December 30, 2013.  During June 2012, we revised the expected payment date to occur in early 2013.

At September 30, 2012, the fair value of the liability was $4.9 million, resulting in an adjustment to the liability of $0.3 million for the nine months ended September 30, 2012, which we include as a non-operating expense in “Other, net” on the accompanying statements of operations and comprehensive loss.

6.           FAIR VALUE MEASUREMENTS

We account for certain assets and liabilities at fair value. The hierarchy below lists three levels of fair value based on the extent to which inputs used in measuring fair value are observable in the market. We categorize each of our fair value measurements in one of these three levels based on the lowest level input that is significant to the fair value measurement in its entirety. These levels are:

● Level 1: Quoted prices in active markets for identical assets or liabilities;

● Level 2: Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities; and

● Level 3: Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

The following table represents the fair value hierarchy for our financial assets (cash equivalents and investments in marketable securities) measured at fair value on a recurring basis (in thousands):

	Level 1		Level 2		Level 3		Total
September 30, 2012:
Available for sale securities:
Money market funds	$	—	$	—	$	—	$	—
	$	—	$	—	$	—	$	—

		Level 1		Level 2		Level 3		Total
December 31, 2011:
Available for sale securities:
Money market funds(1)		$	9,237	$	—	$	—	$	9,237
		$	9,237	$	—	$	—	$	9,237
(1)	Included in “Cash and cash equivalents” in the consolidated balance sheets as of December 31, 2011 in addition to $20.6 million of cash. Unrealized gains and losses on money market funds were nominal due to the short-term nature of the investments.

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The fair value of our term loan and revolving credit facility, estimated using discounted cash flow analysis based on incremental borrowing rates for similar types of borrowing arrangements, is as follows (in thousands):

	September 30, 2012				December 31, 2011
	Fair Value		Carrying Amount		Fair Value		Carrying Amount
Term loan	$	66,155	$	66,500	$	58,571	$	58,750
Revolving credit facility		22,204		22,329		100		100

7.           LOSS PER SHARE

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

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

	Three Months Ended September 30,						Nine Months Ended September 30,
	2012			2011			2012			2011
Net loss available to common stockholders	$	(2,450	)	$	(1,788	)	$	(4,339	)	$	(5,900	)
Weighted average shares outstanding, basic and diluted		50,572			50,217			50,656			50,360
Net loss per share, basic and diluted	$	(0.05	)	$	(0.04	)	$	(0.09	)	$	(0.12	)
Anti-dilutive securities excluded from diluted net loss per share calculation for stock-based compensation plans		6,038			6,160			6,038			6,168

8.          COMMITMENTS, CONTINGENCIES AND LITIGATION 

Credit Agreement

In August 2012, we amended our credit agreement (the “Amendment”), which increased the revolving credit facility by $10.0 million, for a total revolving credit facility of $70.0 million, and increased the term loan by $10.0 million, for a total term loan of $67.3 million.  In addition, the quarterly payment amount on the term loan was increased from $750,000 to $875,000, the due date for the revolving credit facility and the term loan was extended to August 2015 and the minimum liquidity covenant was reduced from $30.0 million to $20.0 million.

We recorded a debt discount of $0.3 million related to costs incurred for the amended term loan. In addition, since the recording of the Amendment was a modification of the credit agreement, we will continue to amortize the previously recorded debt discount over the new term.

Capital Leases

We record capital lease obligations and leased property and equipment at the lesser of the present value of future lease payments based upon the terms of the related lease agreement or the fair value of the assets held under capital leases. As of September 30, 2012, our capital leases had expiration dates ranging from 2013 to 2023.

During the nine months ended September 30, 2012, we entered into a capital lease for network equipment for $2.7 million.  During 2011, we entered into a capital lease for new corporate office space in Atlanta, Georgia due to our Atlanta data center expansion into our then-existing corporate office space. During March 2012, we took possession of the space when it was available according to terms of the lease and recorded the related property and corresponding capital lease obligation of $7.4 million.

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Future minimum capital lease payments and the present value of the minimum lease payments for all capital leases as of September 30, 2012, are as follows (in thousands):

2012	$	2,068
2013		8,723
2014		8,933
2015		9,366
2016		8,357
Thereafter		34,465
Remaining capital lease payments		71,912
Less: amounts representing imputed interest		(22,425	)
Present value of minimum lease payments		49,487
Less: current portion		(4,294	)
	$	45,193

Other Commitments

Our service and purchase commitments relate primarily related to IP, telecommunications and data center services.  As of September 30, 2012, future minimum payments under these commitments were as follows (in thousands):

2012	$	6,060
2013		4,130
2014		3,010
2015		2,381
2016		951
Thereafter		429
	$	16,961

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.

Plaintiffs allege generally that, during the putative class period, we made misleading statements and omitted material information regarding (a) integration of VitalStream, which we acquired in 2007, (b) customer issues and related credits due to services outages and (c) our previously reported 2007 revenue that we subsequently reduced in 2008 as announced on March 18, 2008. Plaintiffs assert that we and the individual defendant made these misstatements and omissions to maintain our share price. Plaintiffs seek unspecified damages and other relief.

On August 12, 2009, the Court granted plaintiffs leave to file an Amended Class Action Complaint (“Amended Complaint”). The Amended Complaint added a claim for violation of Section 14(a) of the Exchange Act based on alleged misrepresentations in our proxy statement in connection with our acquisition of VitalStream. The Amended Complaint also added our former chief financial officer as a defendant and lengthened the putative class period.

On September 11, 2009, we and the individual defendants filed motions to dismiss. On November 6, 2009, plaintiffs filed a Corrected Amended Class Action Complaint. On December 7, 2009, plaintiffs filed a motion for leave to file a Second Amended Class Action Complaint to add allegations regarding, inter alia, an alleged failure to conduct due diligence in connection with the VitalStream acquisition and additional statements from purported confidential witnesses.

On September 15, 2010, the Court granted our motion to dismiss and denied the individual defendants’ motion to dismiss. The Court dismissed plaintiffs’ claims under Section 14(a) of the Exchange Act. With respect to plaintiffs’ claims under Section 10(b) of the Exchange Act, the Court held that the Amended Complaint failed to satisfy the pleading requirements of the Private Securities Litigation Reform Act, but allowed plaintiffs’ one final opportunity to amend the complaint. On October 26, 2010, plaintiffs filed their Third Amended Class Action Complaint. On December 10, 2010, we filed a motion to dismiss this complaint. On September 30, 2011, the Court granted in large part the motion to dismiss. The two remaining claims involve certain alleged misstatements concerning the progress of the integration of VitalStream and the stability of our CDN platform.

Derivative Action Litigation. On November 12, 2009, stockholder Walter M. Unick filed a putative derivative action purportedly on behalf of Internap against certain of our directors and officers in the Superior Court of Fulton County, Georgia, captioned Unick v. Eidenberg, et al., Case No. 2009cv177627. This action is based upon substantially the same facts alleged in the securities class action litigation described above. The complaint seeks to recover damages in an unspecified amount. On January 28, 2010, the Court entered the parties’ agreed order staying the matter until the motions to dismiss are resolved in the securities class action litigation. Given the developments in the securities class action described above, we intend to move to dismiss the derivative complaint.

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While we will vigorously contest these lawsuits, we cannot determine the final resolution of the lawsuits or when they might be resolved. In addition to the expenses incurred in defending this litigation and any damages that may be awarded in the event of an adverse ruling, our management’s efforts and attention may be diverted from the ordinary business operations to address these claims. Regardless of the outcome, this litigation described above may have a material adverse impact on our financial results because of defense costs, including costs related to our indemnification obligations, diversion of resources and other factors.

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

9.          RECENT ACCOUNTING PRONOUNCEMENTS

During July 2012, the Financial Accounting Standards Board (“FASB”) issued new accounting guidance that allows an entity to first assess qualitative factors to determine whether it is more likely than not that an indefinite-lived asset is impaired for determining whether it is necessary to perform the quantitative impairment test. The guidance is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012, with early adoption permitted. We do not expect adoption to have an impact on our financial condition or results of operations. 

During January 2012, we adopted new accounting guidancerelated to convergence between GAAP and International Financial Reporting Standards (“IFRS”). The new guidance changes the wording used to describe many of the requirements in GAAP for measuring fair value and for disclosing information about fair value measurements to ensure consistency between GAAP and IFRS. The new guidance also expands the disclosures for fair value measurements that are estimated using significant unobservable (Level 3) inputs. The adoption had no impact on our financial condition or results of operations.

During January 2012, we adopted new accounting guidance related to the presentation of comprehensive income, which requires the presentation of components of net income and other comprehensive income either as one continuous statement or as two consecutive statements and eliminates the option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity. The new guidance also requires the presentation of reclassification adjustments out of accumulated other comprehensive income by component in both the statement in which net income is presented and the statement in which other comprehensive income is presented. However, in December 2011, the guidance related to the presentation of reclassification adjustments was indefinitely deferred. Because the guidance impacts presentation only, it had no effect on our financial condition or results of operations.

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

10.          SUBSEQUENT EVENTS

In October 2012, we entered into a lease for new company-controlled data center space to expand our existing services in the metro New York market. This long term lease will increase our company controlled data center footprint by approximately 55,000 net sellable square feet over time. We will take possession of the space in 2013 when it is available according to the lease and will record the related property and equipment and corresponding capital lease obligations at that time.

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INTERNAP NETWORK SERVICES CORPORATION AND SUBSIDIARIES

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include statements regarding industry trends, our future financial position and performance, business strategy, revenues and expenses in future periods, projected levels of growth and other matters that do not relate strictly to historical facts. These statements are often identified by words such as “may,” “will,” “seeks,” “anticipates,” “believes,” “estimates,” “expects,” “projects,” “forecasts,” “plans,” “intends,” “continue,” “could,” “should” or similar expressions or variations. These statements are based on the beliefs and expectations of our management team based on information currently available. Such forward-looking statements are not guarantees of future performance and are subject to risks and uncertainties that could cause actual results to differ materially from those contemplated by forward-looking statements. Important factors currently known to our management that could cause or contribute to such differences include, but are not limited to, those referenced in our Annual Report on Form 10-K for the year ended December 31, 2011 under Item 1A “Risk Factors.” We undertake no obligation to update any forward-looking statements as a result of new information, future events or otherwise.

As used herein, except as otherwise indicated by context, references to “we,” “us,” “our” or “Internap” refer to Internap Network Services Corporation.

Overview

We provide intelligent information technology (“IT”) Infrastructure services that combine superior performance and platform flexibility to enable our customers to focus on their core business, improve service levels and lower the cost of IT operations.     

We currently have approximately 3,700 customers in 28 metropolitan markets, serving a variety of industries, such as entertainment and media, including gaming; financial services; business services; software, including software-as-a-service; hosting and IT infrastructure; and telecommunications. For the three months ended September 30, 2012, revenues generated and long-lived assets located outside the United States (“U.S.”) were each less than 10% of our total revenues and assets.

Operating Segments

Data Center Services

Our data center services segment includes colocation services, which involves providing physical space within data centers and associated services such as power, interconnection, environmental controls and security. Colocation allows our customers to deploy and manage their servers, storage and other equipment in our secure data centers. The segment also includes hosting and cloud 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.

Our data center services offer a broad spectrum of products which provide customers flexibility and the ability to bundle these services with our high performance IP 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 43 data centers across North America, Europe and the Asia-Pacific region. We refer to 11 of these facilities as “company-controlled,” meaning we control the data centers’ operations, staffing and infrastructure and have negotiated long term leases for the facilities. We refer to the remaining 32 data centers as “partner” sites. In these locations, we typically do not control operations and infrastructure and terms are shorter than those in company-controlled data centers. Our facilities feature our enhanced IP connectivity, are designed and operated to be fully-secure and provide best-in-class power and environmental reliability.

We believe the demand for data center services continues to outpace industry-wide supply. To address this demand, we continue to incur capital expenditures to build and expand company-controlled data centers. During the three months ended September 30, 2012, we opened a new company-controlled data center in Los Angeles, California and expanded our company-controlled data center in Atlanta, Georgia. In addition, in October 2012, we entered into a lease for new company-controlled data center space to expand our existing services in the metro New York market. This long term lease will increase our company-controlled data center footprint by approximately 55,000 net sellable feet over time.  We will take possession of the space in 2013 when it is available according to the lease.  All of these expansions will increase our company controlled data center footprint by approximately 141,000 net sellable square feet over time.

We include Voxel Holdings, Inc. (“Voxel”) operations in our data center services segment. We acquired Voxel, a global provider of scalable hosting and cloud services, on December 30, 2011.

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IP Services

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

Our patented and patent-pending network route optimization technologies address the inherent weaknesses of the Internet, allowing businesses to take advantage of the convenience, flexibility and reach of the Internet to connect to customers, suppliers and partners, and to adopt new IT delivery models, in a scalable, reliable and predictable manner. Our services and products take into account the unique performance requirements of each business application to ensure performance as designed, without unnecessary cost. Our fees for IP services are based on a fixed fee, usage or a combination of both.

Our CDN services enable our customers to quickly and securely stream and distribute rich media and content, such as video, audio software and applications, to audiences across the globe through strategically-located POPs. Providing capacity-on-demand to handle large events and unanticipated traffic spikes, we deliver scalable high-quality content distribution and audience-analytic tools.

Recent Accounting Pronouncements

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

Critical Accounting Policies and Estimates

Property and Equipment

During January 2012, we reassessed the estimated useful lives of certain assets included in our property and equipment, as we determined we were generally using these assets longer than originally anticipated. We summarize the reassessment in note 3 to the accompanying financial statements.

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

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

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Results of Operations

Three Months Ended September 30, 2012 and 2011

The following table sets forth selected consolidated statements of operations data during the periods presented, including comparative information between the periods (dollars in thousands):

	Three Months Ended September 30,						Increase (Decrease) from September 30, 2011 to September 30, 2012
	2012			2011			Amount			Percent
Revenues:
Data center services	$	42,139		$	34,114		$	8,025			24	%
IP services		25,990			27,900			(1,910	)		(7	)
Total revenues		68,129			62,014			6,115			10
Operating costs and expenses:
Direct costs of network, sales and services, exclusive of depreciation and amortization, shown below:
Data center services		23,539			20,480			3,059			15
IP services		10,034			10,307			(273	)		(3	)
Direct costs of customer support		6,898			5,407			1,491			28
Direct costs of amortization of acquired technologies		1,179			875			304			35
Sales and marketing		7,569			7,314			255			3
General and administrative		8,985			8,333			652			8
Depreciation and amortization		9,885			9,647			238			2
Gain on disposal of property and equipment, net		—			(47	)		47			—
Restructuring		124			123			1			—
Total operating costs and expenses		68,213			62,439			5,774			9
Loss  from operations	$	(84	)	$	(425	)	$	(341	)		(80	)%
Interest expense	$	1,996		$	1,166		$	830			71	%

 Data Center Services

Revenues for data center services increased $8.0 million, or 24%, to $42.1 million for the three months ended September 30, 2012, compared to $34.1 million for the same period in 2011. The increase in revenue was primarily due to revenue growth in company-controlled colocation and hosting services, which includes revenue attributable to Voxel.

Direct costs of data center services, exclusive of depreciation and amortization, were $23.5 million for the three months ended September 30, 2012, compared to $20.5 million for the same period in 2011. The increase in direct costs was primarily due to revenue growth in hosting services and increased costs related to the opening of our Los Angeles, California and the expansion of our Atlanta, Georgia data centers.

Direct costs of data center services, exclusive of depreciation and amortization, have substantial fixed cost components, primarily rent for operating leases, but also significant demand-based pricing variables, such as utilities attributable to seasonal costs and customers’ changing power requirements. Direct costs of data center services as a percentage of revenues vary with the mix of usage between company-controlled data centers and partner sites, and the utilization of total available space. While we recognize some of the initial operating costs of company-controlled data centers in advance of revenues, these sites are more profitable at certain levels of utilization than are partner sites. Conversely, costs in partner sites are more demand-based and therefore are more closely associated with the recognition of revenues.

We will continue to focus on increasing revenues from company-controlled facilities as compared to partner sites. We also expect direct costs of data center services as a percentage of corresponding revenues to decrease as our new and recently-expanded company-controlled data centers continue to contribute to revenue and become more fully occupied. This is evidenced by the improvement in direct costs of data center services as a percentage of corresponding revenues of 56% during the three months ended September 30, 2012, compared to 60% during the same period in 2011.

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IP Services

Revenues for IP services decreased $1.9 million, or 7%, to $26.0 million for the three months ended September 30, 2012, compared to $27.9 million for the same period in 2011. The decrease was driven by a decline in IP pricing for new and renewing customers and the loss of legacy contracts at higher effective prices, partially offset by an increase in overall traffic. IP traffic increased approximately 48.9% for the three months ended September 30, 2012, compared to the same period in 2011, calculated based on an average over the number of months in the respective periods.

Direct costs of IP services, exclusive of depreciation and amortization, decreased $0.3 million, or 3%, to $10.0 million for the three months ended September 30, 2012, compared to $10.3 million for the same period in 2011. This decrease was primarily due to renegotiation of vendor contracts and cost reduction efforts.

There have been ongoing industry-wide pricing declines over the last several years. Technological improvements and excess capacity have been the primary drivers for lower pricing of IP services. We also continue to experience increasing traffic volume, resulting from both new and existing customers using more applications and the nature of applications consuming greater amounts of bandwidth.

Other Operating Costs and Expenses

Compensation. Total compensation and benefits, including stock-based compensation, were $16.8 million and $14.7 million for the three months ended September 30, 2012 and 2011, respectively.

Cash-based compensation and benefits increased $1.9 million to $15.5 million during the three months ended September 30, 2012 from $13.6 million during the same period in 2011. The increase was primarily due to a $1.4 million increase related to a higher employee headcount and increased salary levels and a $0.3 million increase in accrued bonus compensation.

Stock-based compensation, net of amount capitalized, increased to $1.4 million during the three months ended September 30, 2012 from $1.1 million during the same period in 2011. The increase in the three months ended September 30, 2012 was primarily due to stock-based compensation awarded in connection with the Voxel acquisition. 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 September 30, 2012 and 2011 (in thousands):

	2012		2011
Direct costs of customer support	$	234	$	178
Sales and marketing		241		228
General and administrative		888		684
	$	1,363	$	1,090

Direct Costs of Customer Support. Direct costs of customer support increased 28% to $6.9 million during the three months ended September 30, 2012 from $5.4 million during the same period in 2011. The increase was primarily due to a $1.2 million increase in cash-based compensation and payroll taxes.

Direct Costs of Amortization of Acquired Technologies. Direct costs of amortization of acquired technologies increased 35% to $1.2 million during the three months ended September 30, 2012 from $0.9 million during the same period in 2011. The increase was primarily due to the amortization of intangible assets acquired from Voxel.

Sales and Marketing. Sales and marketing costs increased 3% to $7.6 million during the three months ended September 30, 2012 from $7.3 million during the same period in 2011. The increase was primarily due to a $0.3 million increase in cash-based compensation and payroll taxes.

General and Administrative. General and administrative costs increased 8% to $9.0 million during the three months ended September 30, 2012 from $8.3 million during the same period in 2011. The increase was primarily due to a $0.3 million increase in accrued bonus compensation.

Depreciation and Amortization. Depreciation and amortization increased 2% to $9.9 million for the three months ended September 30, 2012, compared to $9.6 million during the same period in 2011. The increase was primarily due to the effects of expanding our company-controlled data centers, private network access points (“P-NAP”) infrastructure and capitalized software, partially offset by our change in estimated useful lives resulting in $3.5 million less expense than it would have been under the previous estimated useful lives on assets held at December 31, 2011.

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Interest Expense. Interest expense increased to $2.0 million during the three months ended September 30, 2012, compared to $1.2 million during the same period in 2011. The increase in interest expense was primarily due to new capital lease obligations related to expanding our company-controlled data centers and the increase in our borrowings under our term loan and revolving credit facility.

Nine Months Ended September 30, 2012 and 2011

The following table sets forth selected consolidated statements of operations data during the periods presented, including comparative information between the periods (dollars in thousands):

	Nine Months Ended September 30,						Increase (Decrease) from September 30, 2011 to September 30, 2012
	2012			2011			Amount			Percent
Revenues:
Data center services	$	123,570		$	98,137		$	25,433			26	%
IP services		80,274			83,691			(3,417	)		(4	)
Total revenues		203,844			181,828			22,016			12
Operating costs and expenses:
Direct costs of network, sales and services, exclusive of depreciation and amortization, shown below:
Data center services		67,158			58,743			8,415			14
IP services		30,210			31,643			(1,433	)		(5	)
Direct costs of customer support		20,108			15,892			4,216			27
Direct costs of amortization of acquired technologies		3,538			2,625			913			35
Sales and marketing		23,973			22,878			1,095			5
General and administrative		29,886			24,911			4,975			20
Depreciation and amortization		26,463			26,468			(5	)		—
(Gain) loss on disposal of property and equipment, net		(19	)		37			(56	)		(151	)
Restructuring		812			1,615			(803	)		(50	)
Total operating costs and expenses		202,129			184,812			17,317			9
Income (loss) from operations	$	1,715		$	(2,984	)	$	4,699			157	%
Interest expense	$	5,335		$	2,688		$	2,647			98	%

Data Center Services

Revenues for data center services increased $25.4 million, or 26%, to $123.6 million for the nine months ended September 30, 2012, compared to $98.1 million for the same period in 2011. The increase in revenue was primarily due to revenue growth in company-controlled colocation and hosting services, which includes revenue attributable to Voxel.

Direct costs of data center services, exclusive of depreciation and amortization, were $67.2 million for the nine months ended September 30, 2012, compared to $58.7 million for the same period in 2011. The increase in direct costs was primarily due to the revenue growth in hosting services and increased costs related to the opening of our Los Angeles, California and the expansion of our Atlanta, Georgia data centers, partially offset by a $0.5 million nonrecurring settlement of past charges with a data center vendor.

Direct costs of data center services as a percentage of corresponding revenues was 54% during the nine months ended September 30, 2012, compared to 60% during the same period in 2011.

IP Services

Revenues for IP services decreased $3.4 million, or 4%, to $80.3 million for the nine months ended September 30, 2012, compared to $83.7 million for the same period in 2011. The decrease was driven by a decline in IP pricing for new and renewing customers and the loss of legacy contracts at higher effective prices, partially offset by an increase in overall traffic. IP traffic increased approximately 37.7% for the nine months ended September 30, 2012, compared to the same period in 2011, calculated based on an average over the number of months in the respective periods.

Direct costs of IP services, exclusive of depreciation and amortization, decreased $1.4 million, or 5%, to $30.2 million for the nine months ended September 30, 2012, compared to $31.6 million for the same period in 2011. This decrease was primarily due to renegotiation of vendor contracts and cost reduction efforts.

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Other Operating Costs and Expenses

Compensation. Total compensation and benefits, including stock-based compensation, were $51.0 million and $43.2 million for the nine months ended September 30, 2012 and 2011, respectively.

Cash-based compensation and benefits increased $6.4 million to $46.6 million during the nine months ended September 30, 2012 from $40.2 million during the same period in 2011. The increase was primarily due to a $4.9 million increase related to a higher employee headcount and increased salary levels, a $0.4 million increase attributable to credits we recorded in 2011 related to prior years’ Georgia Headquarters Tax Credit, a $0.9 million increase in insurance benefit costs and a $0.8 million increase in accrued bonus compensation, partially offset by a $0.5 million decrease in severance.

Stock-based compensation, net of amount capitalized, increased to $4.4 million during the nine months ended September 30, 2012 from $3.0 million during the same period in 2011. The increase in the nine months ended September 30, 2012 was primarily due to stock-based compensation awarded in connection with the Voxel acquisition and forfeitures upon terminations of employment in the nine months ended September 30, 2011.  The following table summarizes the amount of stock-based compensation, net of estimated forfeitures, included in the accompanying consolidated statements of operations during the nine months ended September 30, 2012 and 2011 (in thousands):

	2012		2011
Direct costs of customer support	$	689	$	535
Sales and marketing		664		718
General and administrative		3,029		1,737
	$	4,382	$	2,990

Direct Costs of Customer Support. Direct costs of customer support increased 27% to $20.1 million during the nine months ended September 30, 2012 from $15.9 million during the same period in 2011. The increase was primarily due to a $3.5 million increase in cash-based compensation and payroll taxes.

Direct Costs of Amortization of Acquired Technologies. Direct costs of amortization of acquired technologies increased 35% to $3.5 million during the nine months ended September 30, 2012 from $2.6 million during the same period in 2011. The increase was primarily due to the amortization of intangible assets acquired from Voxel.

Sales and Marketing. Sales and marketing costs increased 5% to $24.0 million during the nine months ended September 30, 2012 from $22.9 million during the same period in 2011. The increase was primarily due to a $0.7 million increase in cash-based compensation and payroll taxes and $0.3 million increase in commissions.

General and Administrative. General and administrative costs increased 20% to $29.9 million during the nine months ended September 30, 2012 from $24.9 million during the same period in 2011. The increase was primarily due to a $0.6 million increase in cash-based compensation costs and payroll taxes, a $0.8 million increase in accrued bonus compensation, a $1.3 million increase in stock-based compensation, a $0.4 million increase in insurance costs, a $0.8 million increase in taxes and licenses and a $0.8 million increase in outside professional fees primarily for recruiting and labor, partially offset by a $0.4 million decrease in severance.

Depreciation and Amortization. Depreciation and amortization was $26.5 million during each of the nine months ended September 30, 2012 and 2011. The net change of zero was primarily due to our change in estimated useful lives resulting in $10.5 million less expense than it would have been under the previous estimated useful lives on assets held at December 31, 2011, partially offset by the effects of expanding our company-controlled data centers, P-NAP infrastructure and capitalized software.

Restructuring and Impairments.  For the nine months ended September 30, 2012, restructuring and impairments included $0.4 million for adjustments to previously implemented restructuring plans and $0.3 million for impairment on capitalized software.

Interest Expense. Interest expense increased to $5.3 million during the nine months ended September 30, 2012, compared to $2.7 million during the same period in 2011. The increase in interest expense was primarily due to new capital lease obligations related to expanding our company-controlled data centers and the increase in our borrowings under our term loan and revolving credit facility.

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Liquidity and Capital Resources

Liquidity

We monitor and review our performance and operations in light of global economic conditions. The current economic environment may impact the ability of our customers to meet their obligations to us, which could result in delayed collection of accounts receivable and an increase in our provision for doubtful accounts.

We expect to meet our cash requirements for the next 12 months through a combination of net cash provided by operating activities, existing cash on hand and utilizing additional borrowings under our credit facility described below in “—Credit Agreement”. Our capital requirements depend on a number of factors, including the continued market acceptance of our IT Infrastructure services and the ability to expand and retain our customer base. If our cash requirements vary materially from what we expect or if we fail to generate sufficient cash flows from selling our IT Infrastructure services, we may require 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 agreement limit our ability to incur additional indebtedness. Our anticipated uses of cash include capital expenditures, working capital needs and required payments on our credit agreement and other commitments.

We have a history of quarterly and annual period net losses. During the nine months ended September 30, 2012, we had a net loss of $4.3 million. As of September 30, 2012, our accumulated deficit was $1.0 billion. We continue to see signs of cautious behavior from our customers given economic conditions. We continue to analyze our business to control our costs, principally through making process enhancements and renegotiating network contracts for more favorable pricing and terms. We may not be able to sustain or increase profitability on a quarterly basis, and our failure to do so may adversely affect our business, including our ability to raise additional funds.

Credit Agreement

In August 2012, we amended our credit agreement (the “Amendment”), which increased the revolving credit facility by $10.0 million, for a total revolving credit facility of $70.0 million, and increased the term loan by $10.0 million, for a total term loan of $67.3 million.  In addition, the quarterly payment amount on the term loan was increased from $750,000 to $875,000, the due date for the revolving credit facility and the term loan was extended to August 2015 and the minimum liquidity covenant was reduced from $30.0 million to $20.0 million.

As of September 30, 2012, the revolving credit facility had an outstanding balance of $22.3 million and we issued $13.6 million letters of credit, resulting in $34.1 million in borrowing capacity. The term loan had an outstanding principal amount of $66.5 million, which is to be repaid in $875,000 quarterly installments on the last day of each fiscal quarter, with the remaining unpaid balance due on August 30, 2015. As of September 30, 2012, the interest rate on the revolving credit facility and term loan was 3.7%.

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

Capital Leases

During the nine months ended September 30, 2012, we entered into a lease for network equipment for $2.7 million. During 2011, we entered into a capital lease for new corporate office space in Atlanta, Georgia due to our Atlanta data center expansion into our then-existing corporate office space. During March 2012, we took possession of the space when it was available according to terms of the lease and recorded the related property and equipment and corresponding capital lease obligation of $7.4 million.

Our future minimum lease payments on all capital lease obligations at September 30, 2012 were $49.5 million. We summarize our existing capital lease obligations in note 8 to the accompanying consolidated financial statements.

In addition, in October 2012, we entered into a lease for new company-controlled data center space to expand our existing services in the metro New York area. This long term lease will increase our company-controlled data center footprint by approximately 55,000 net sellable square feet over time. We will take possession of it in 2013 when the space is available according to the lease and will record related property and equipment and corresponding capital lease obligations at that time.

Commitments and Other Obligations

We have commitments and other obligations that are contractual in nature and represent a future use of cash. Service commitments primarily relate to IP, telecommunications and data center services. Our ability to improve cash provided by operations in the future would be negatively impacted if we do not grow our business at a rate that would allow us to offset the service commitments with corresponding revenue growth.

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The following table summarizes our commitments and other obligations as of September 30, 2012 (in thousands):

	Total		Less than 1 year		1-3 Years		3-5 Years		More than 5 years
Revolving credit facility(1)	$	24,853	$	842	$	24,011	$	—	$	—
Term loan(1)		73,298		5,959		67,339		—		—
Capital lease obligations		71,912		2,068		17,656		17,723		34,465
Accrued contingent consideration(2)		5,000		5,000		—		—		—
Operating lease commitments		136,830		27,976		46,423		28,512		33,919
Service and purchase commitments		16,961		6,060		7,140		3,332		429
Total	$	328,854	$	47,905	$	162,569	$	49,567	$	68,813

(1) As of September 30, 2012, the interest rate was 3.7% and the projected interest included in the debt payments above incorporates this rate.

(2) Amount to be paid upon receipt of certain Voxel technology deliverables. The liability is shown at present value of $4.9 million on the accompanying consolidated balance sheets. We expect to pay the consideration in early 2013.

Cash Flows for the Nine Months Ended September 30, 2012 and 2011

Operating Activities. Net cash provided by operating activities for the nine months ended September 30, 2012 was $32.9 million. Our net loss, after adjustments for non-cash items, generated cash from operations of $31.9 million, while changes in operating assets and liabilities provided cash from operations of $1.0 million. We expect to use cash flows from operating activities to fund a portion of our capital expenditures and other requirements and to meet our other commitments and obligations, including outstanding debt.

The primary non-cash adjustment for the nine months ended September 30, 2012 was $30.0 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 $4.4 million for stock-based compensation expense. The changes in operating assets and liabilities included a $3.3 million increase in accounts receivable, a $4.5 million increase in accounts payable and a $1.5 million decrease in restructuring liability.

Days sales outstanding at September 30, 2012 was 28 days, up from 27 days at September 30, 2011. Days sales outstanding are measured as of a point in time and may fluctuate based on a number of factors, including, among other things, changes in revenues, cash collections, allowance for doubtful accounts and the amount of revenues billed in advance.

Investing Activities. Net cash used in investing activities for the nine months ended September 30, 2012 was $64.6 million for capital expenditures, which related to the continued expansion and upgrade of our company-controlled data centers and network infrastructure.

Financing Activities. Net cash provided by financing activities for the nine months September 30, 2012 was $28.2 million primarily due to proceeds from the term loan and revolving credit facility, offset by principal payments on the term loan and capital leases.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Other Investments

Prior to 2012, we invested $4.1 million in Internap Japan Co., Ltd., our joint venture with NTT-ME Corporation and NTT Holdings. We account for this investment using the equity method and we have recognized $2.0 million in equity-method losses over the life of the investment, representing our proportionate share of the aggregate joint venture losses and income. The joint venture investment is subject to foreign currency exchange rate risk.

Interest Rate Risk

Our objective in managing interest rate risk is to maintain favorable long-term fixed rate or a balance of fixed and variable rate debt within reasonable risk parameters. Although our current strategy for managing interest rate risk does not include the use of derivative securities, in the future we may utilize these securities solely for the management of interest rate risk. As of September 30, 2012, our long-term debt consisted of $66.5 million borrowed under our term loan and $22.3 million borrowed under our revolving credit facility. Interest on the term loan was 3.7% based on either (i) the Base Rate (as defined in the agreement) plus 3.50 percentage points, or (ii) the LIBOR Rate plus 3.50 percentage points, as we elect from time to time. Interest on the revolving credit facility was 3.7% based on either (x) the Base Rate plus 1.75 percentage points or (y) the LIBOR Rate plus 3.50 percentage points, as we elect from time to time. We estimate that a change in the interest rate of 100 basis points would change our interest expense and payments by $0.9 million per year, assuming we do not increase our amount outstanding.

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Foreign Currency Risk

Substantially all of our revenue is 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 September 30, 2012.

Changes in Internal Control over Financial Reporting

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

PART II.  OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

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

ITEM 1A. RISK FACTORS

There have been no material changes from the Risk Factors we previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2011 filed with the Securities and Exchange Commission on February 23, 2012.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

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

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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
July 1 to 31, 2012	646	$	7.00	—	—
August 1 to 31, 2012	3,766		7.01	—	—
September 1 to 30, 2012	3,207		7.37	—	—
Total	7,619	$	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 and directors.

ITEM 6. EXHIBITS

Exhibit Number		Description
10.1	Fourth Amendment to Credit Agreement dated August 30, 2012 by and among Internap and Wells Fargo Capital Finance, LLC, as agent for the Lenders (incorporated herein by reference to Exhibit 10.1 of Internap’s Current Report on Form 8-K, filed September 4, 2012).
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 Kevin M. Dotts, 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 Kevin M. Dotts, Chief Financial Officer of Internap.
101.INS	XBRL Instance Document.
101.SCH	XBRL Taxonomy Extension Schema Document.
101.CAL	XBRL Taxonomy Extension Calculation Linkbase Document.
101.DEF	XBRL Taxonomy Extension Definition Linkbase Document.
101.LAB	XBRL Taxonomy Extension Label Linkbase Document.
101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document.

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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/ Kevin M. Dotts
	Kevin M. Dotts
	Chief Financial Officer
	(Principal Accounting Officer) Date: October 25, 2012

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