Internap (INAPQ) 10-Q 2003 Q2 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 June 30, 2003

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
(State or Other Jurisdiction of
Incorporation or Organization)
91-2145721
(I.R.S. Employer
Identification Number)

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 is an accelerated filer (as defined in rule 12b-2 of the Securities Exchange Act of 1934). Yes o No x

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, which includes the as-converted common stock held by the holders of the Series A preferred stock, as of the latest practicable date: 224,846,571 shares of common stock, $0.001 par value, outstanding as of August 8, 2003, which includes 61,868,485 shares of common stock issuable upon conversion by the holders of the Series A preferred stock.

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INTERNAP NETWORK SERVICES CORPORATION
FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 2003

TABLE OF CONTENTS

			Pages
PART I.	FINANCIAL INFORMATION
	Item 1.	Financial Statements	3
		Condensed Consolidated Balance Sheets as of June 30, 2003 and December 31, 2002	3
		Condensed Consolidated Statements of Operations for the three- and six- months ended June 30, 2003 and 2002	4
		Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2003 and 2002	5
		Condensed Consolidated Statement of Stockholders’ Equity (Deficit) and Comprehensive Loss for the six months ended June 30, 2003	6
		Notes to Condensed Consolidated Financial Statements	7 - 11
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	12 - 28
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	31
	Item 4.	Controls and Procedures	31
PART II.	OTHER INFORMATION
	Item 1.	Legal Proceedings	32
	Item 2.	Changes in Securities and Use of Proceeds	32
	Item 3.	Defaults upon Senior Securities	32
	Item 4.	Submission of Matters to a Vote of Security Holders	32
	Item 5.	Other Information	33
	Item 6.	Exhibits and Reports on Form 8-K	33

SIGNATURES 34

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PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

INTERNAP NETWORK SERVICES CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts)

	June30, 2003			December31, 2002
	(Unaudited)			(Audited)
ASSETS
Current assets:
Cash and cash equivalents	$	10,281		$	25,219
Accounts receivable, net of allowance of $1,534 and $1,595, respectively		15,474			15,232
Prepaid expenses and other assets		3,633			5,632
Total current assets		29,388			46,083
Property and equipment, net of accumulated depreciation of $125,669 and $105,347 respectively		70,547			88,394
Restricted cash		2,088			2,053
Investments		2,571			3,047
Goodwill and other intangible assets, net of accumulated amortization of $40,608 and $37,755, respectively		27,384			30,579
Deposits and other assets		2,521			2,813
Total assets	$	134,499		$	172,969
LIABILITIES, CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS’ EQUITY (DEFICIT)
Current liabilities:
Accounts payable	$	11,598		$	13,247
Accrued liabilities		8,966			11,020
Deferred revenues		4,998			6,850
Notes payable, current portion		3,324			4,514
Revolving credit facility		9,209			10,000
Capital lease obligations, current portion		2,359			2,831
Restructuring liability, current portion		3,761			6,574
Total current liabilities		44,215			55,036
Deferred revenues		210			1,317
Notes payable, less current portion		3,691			5,196
Capital lease obligations, less current portion		21,167			22,717
Restructuring liability, less current portion		5,249			7,078
Total liabilities		74,532			91,344
Series A convertible preferred stock, $0.001 par value, 3,500 shares authorized; 2,888 and 2,931 issued and outstanding, respectively, with a liquidation preference of $92,405 and $93,792, respectively		78,589			79,790
Stockholders’ equity (deficit):
Common stock, $0.001 par value, 600,000 shares authorized; 162,184 and 160,094 shares issued and outstanding, respectively		162			160
Additional paid in capital		799,845			798,344
Deferred stock compensation		—			(396	)
Accumulated deficit		(818,827	)		(796,422	)
Accumulated items of other comprehensive income		198			149
Total stockholders’ equity (deficit)		(18,622	)		1,835
Total liabilities, convertible preferred stock and stockholders’ equity (deficit)	$	134,499		$	172,969

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

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INTERNAP NETWORK SERVICES CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited, in thousands, except per share amounts)

	Three months ended June 30,						Six months ended June 30,
	2003			2002			2003			2002
Revenues	$	34,240		$	33,030		$	68,417		$	65,644
Costs and expenses:
Direct cost of network		18,669			22,627			37,337			46,732
Customer support		2,257			3,669			4,621			7,495
Product development		1,701			1,977			3,385			3,934
Sales and marketing		5,048			5,801			10,225			11,858
General and administrative		4,054			5,047			8,529			11,539
Depreciation and amortization		9,779			13,504			20,362			26,316
Amortization of intangible assets		1,428			1,606			2,856			3,033
Amortization of deferred stock compensation		—			(11	)		390			341
Restructuring costs		198			—			952			(4,954	)
Loss on sales and retirements of property and equipment		—			841			—			1,139
Total operating costs and expenses		43,134			55,061			88,657			107,433
Loss from operations		(8,894	)		(22,031	)		(20,240	)		(41,789	)
Other income (expense):
Interest income (expense), net		(943	)		(464	)		(1,694	)		(695	)
Loss from equity method investment		(194	)		(313	)		(471	)		(662	)
Total other income (expense)		(1,137	)		(777	)		(2,165	)		(1,357	)
Net loss	$	(10,031	)	$	(22,808	)	$	(22,405	)	$	(43,146	)
Basic and diluted net loss per share	$	(0.06	)	$	(0.15	)	$	(0.14	)	$	(0.28	)
Weighted average shares used in computing basic and diluted net loss per share		162,058			153,537			161,639			152,780

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

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INTERNAP NETWORK SERVICES CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, in thousands)

	Six months endedJune30,
	2003			2002
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss	$	(22,405	)	$	(43,146	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		23,218			29,349
Non-cash restructuring costs / (adjustments)		—			(4,954	)
Non-cash interest expense on capital lease obligations		641			427
Provision for doubtful accounts		812			845
Non-cash compensation and warrant expense		390			341
Loss on disposal of property and equipment		—			1,139
Loss from equity method investment		471			662
Changes in operating assets and liabilities:
Accounts receivable		(1,054	)		1,076
Prepaid expenses, deposits and other assets		2,125			1,626
Accounts payable		(1,649	)		(291	)
Accrued restructuring charge		(4,642	)		(9,421	)
Deferred revenues		(2,959	)		(1,379	)
Accrued liabilities		(2,054	)		(2,505	)
Net cash used in operating activities		(7,106	)		(26,231	)
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property and equipment		(2,176	)		(7,499	)
Proceeds from disposal of property and equipment		—			407
(Increase in) reduction of restricted cash		(35	)		490
Purchase of investments		(27	)		(1,347	)
Proceeds from investments		247			—
Redemption of investments		—			18,748
Net cash (used in) provided by investing activities		(1,991	)		10,799
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from revolving credit facility		369			5,000
Payment on revolving credit facility		(1,160	)		—
Principal payments on notes payable		(2,695	)		(1,101	)
Payments on capital lease obligations		(2,663	)		(10,449	)
Proceeds from exercise of stock options and warrants		308			315
Proceeds from issuance of common stock		—			569
Net cash used in financing activities		(5,841	)		(5,666	)
Net decrease in cash and cash equivalents		(14,938	)		(21,098	)
Cash and cash equivalents at beginning of period		25,219			63,551
Cash and cash equivalents at end of period	$	10,281		$	42,453
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for interest	$	1,144		$	1,529

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

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INTERNAP NETWORK SERVICES CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY (DEFICIT)
AND COMPREHENSIVE LOSS
SIX MONTHS ENDED JUNE 30, 2003
(Unaudited, in thousands)

	CommonStock
	Shares	Par Value		Additional Paid-In Capital			Deferred Stock Compensation			Accumulated Deficit			Accumulated Items of Other Comprehensive Income(Loss)		Total Stockholders’ Equity(Deficit)			Comprehensive Loss
Balance, December 31, 2002	160,094	$	160	$	798,344		$	(396	)	$	(796,422	)	$	149	$	1,835
Conversion of Series A convertible preferred stock into common stock	953		1		1,201			—			—			—		1,202
Amortization of deferred stock compensation and reversal for terminated employees	—		—		(5	)		396			—			—		391
Exercise of options to purchase common stock	281		—		139			—			—			—		139
Issuance of employee stock purchase plan shares	856		1		166			—			—			—		167
Net loss	—		—		—			—			(22,405	)		—		(22,405	)	$	(22,405	)
Unrealized foreign currency translation gain	—		—		—			—			—			49		49			49
Total Comprehensive loss																		$	(22,356	)
Balance, June 30, 2003	162,184	$	162	$	799,845		$	—		$	(818,827	)	$	198		($18,622	)

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

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INTERNAP NETWORK SERVICES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. BASIS OF PRESENTATION

The unaudited condensed consolidated financial statements of Internap Network Services Corporation (“Internap,” “we,” “us,” “our” or the “Company”) have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission and include all the accounts of Internap Network Services Corporation and its wholly owned subsidiaries. Certain information and footnote disclosures, normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States, have been condensed or omitted pursuant to such rules and regulations. The unaudited condensed consolidated financial statements reflect all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of our financial position as of June 30, 2003 and our operating results, cash flows, and changes in stockholders’ equity (deficit) for the interim periods presented. The balance sheet at December 31, 2002 has been derived from our audited financial statements as of that date. These financial statements and the related notes should be read in conjunction with our financial statements and notes thereto contained in our annual report on Form 10-K for the year ended December 31, 2002 filed with the Securities and Exchange Commission.

The preparation of financial statements in accordance with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities and revenues and expenses in the financial statements. Examples of estimates subject to possible revision based upon the outcome of future events include, among others, recoverability of long-lived assets and goodwill, depreciation of property and equipment, restructuring allowances, amortization of deferred stock compensation, and the allowance for doubtful accounts. Actual results could differ from those estimates.

Certain prior year balances have been reclassified to conform to current year presentation. These reclassifications have not affected our financial position, results of operations, or net cash flows.

The results of operations for the three and six months ended June 30, 2003 are not necessarily indicative of the results that may be expected for the future periods.

2. RISKS AND UNCERTAINTIES

We have a limited operating history and our operations are subject to certain risks and uncertainties frequently encountered by companies in rapidly evolving markets. These risks include the failure to develop or supply technology or services, the ability to obtain adequate financing, the ability to manage rapid growth or expansion, competition within the industry, and technology trends.

We have experienced significant net operating losses since inception. During fiscal 2002, we incurred net losses of $72.3 million and used $40.3 million of cash in our operating activities. Management expects operating losses will continue through December 31, 2003. During 2002, we decreased the size of our workforce by 216 employees, or 40%, as compared to the number of employees at December 31, 2001, and terminated certain real estate leases and commitments in order to control costs. Our plans indicate our existing cash and investments are adequate to fund our operations through December 31, 2003. However, our capital requirements depend on several factors, including the rate of market acceptance of our services, the ability to expand and retain our customer base, and other factors. If we fail to realize our planned revenues or costs, management believes it has the ability to curtail capital spending and reduce expenses to ensure cash and investments will be sufficient to meet our cash requirements and our loan covenants through December 31, 2003. If, however, our cash requirements vary materially from those currently planned, or if we fail to generate sufficient cash flow from the sales of our services, we may require additional financing sooner than anticipated. We cannot assure such financing will be available on acceptable terms, if at all.

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3. RESTRUCTURING CHARGES

2001 Restructuring charge

During 2001, due to the decline and uncertainty of the telecommunications market, we announced two separate restructurings of our business. Under the restructuring programs, management decided to exit certain non-strategic real estate lease and license arrangements, consolidate and exit redundant network connections, and streamline the operating cost structure. The total charges include restructuring costs of $71.6 million. During 2001, we incurred cash restructuring expenditures totaling $19.9 million, non-cash restructuring expenditures of $4.7 million, and reduced the original restructuring cost estimate by $7.7 million primarily as a result of favorable lease obligation settlements, leaving a balance of $39.3 million as of December 31, 2001. During the first and third quarters of 2002, we further reduced our restructuring liability by $5.0 million and $7.2 million, respectively. The first quarter 2002 reduction was primarily due to favorable settlements to terminate and restructure certain colocation lease obligations on terms favorable to our original restructuring estimates. The third quarter 2002 reduction was primarily due to returning the previously restructured Atlanta, Georgia facility into service as the site of the new corporate headquarters. Pursuant to the original restructuring plans, the Atlanta facility was not to be used by us in the future. However, due to changes in management, corporate direction, and other factors, that could not be foreseen at the time of the original restructuring plans, the Atlanta facility was selected as the location for the new corporate headquarters.

2002 Restructuring charge

With the continuing decline and uncertainty in the telecommunications market during 2002, we implemented additional restructuring actions to align our business with market opportunities. As a result, we recorded a business restructuring charge and asset impairments of $7.6 million in the three months ended September 30, 2002. The charges were primarily comprised of real estate obligations related to a decision to relocate the corporate headquarters from Seattle, Washington to an existing leased facility in Atlanta, Georgia, net asset write-downs related to the departure from the Seattle office, and costs associated with further personnel reductions. The restructuring and asset impairment charge of $7.6 million during 2002 was offset by a $7.2 million adjustment, described above, resulting from the decision to utilize the Atlanta facility as our corporate headquarters. The previously unused space in the Atlanta location had been accrued as part of the restructuring liability established during fiscal year 2001.

Included in the $7.6 million 2002 restructuring charge are $1.1 million of personnel costs related to a reduction in force of approximately 145 employees. This represents employee severance payments made during 2002. We expect that there will be additional restructuring costs in the future as additional payments are made to employees who are subject to deferred compensation arrangements payable at the completion of interim employment agreements. We expect these costs to total less than $1.0 million. Additionally, we continue to evaluate the restructuring reserve as plans are being executed, which could result in additional charges or adjustments.

Real Estate Obligations. Both the 2001 and 2002 restructuring plans require us to abandon certain leased properties not currently in use or that will not be utilized by us in the future. Also included in real estate obligations is the abandonment of certain colocation license obligations. Accordingly, we recorded real estate related restructuring costs of $40.8 million, net of non-cash plan adjustments, which are estimates of losses in excess of estimated sublease revenues or termination fees to be incurred on these real estate obligations over the remaining lease terms expiring through 2015. This cost was determined based upon our estimate of anticipated sublease rates and time to sublease the facility. If rental rates decrease in these markets or if it takes longer than expected to sublease these properties, the actual loss could exceed this estimate.

Network Infrastructure Obligations. The changes to our network infrastructure require that we decommission certain network ports we do not currently use and will not use in the future pursuant to the restructuring plan. These costs have been accrued as components of the restructuring charge because they represent amounts to be incurred under contractual obligations in existence at the time the restructuring plan was initiated. These contractual obligations will continue in the future with no economic benefit, or they contain penalties that will be incurred if the obligations are cancelled.

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The following table displays the activity and balances for restructuring activity during 2003 (in millions):

	December 31, 2002 Restructuring Liability		Cash Reductions			June 30, 2003 Restructuring Liability
Restructuring costs activity for 2001 restructuring charge:
Real estate obligations	$	9.6	$	(3.3	)	$	6.3
Network infrastructure obligations		1.3		(0.1	)		1.2
Other		1.1		(0.2	)		0.9
Restructuring costs activity for 2002 restructuring charge:
Real estate obligations		1.7		(1.1	)		0.6
Total restructuring costs	$	13.7	$	(4.7	)	$	9.0

4. NET LOSS PER SHARE

Basic and diluted net loss per share has been computed using the weighted average number of shares of common stock outstanding during the period, less the weighted average number of unvested shares of common stock issued that are subject to repurchase. We have excluded all convertible preferred stock, warrants, outstanding options to purchase common stock and shares subject to repurchase from the calculation of diluted net loss per share, as such securities are antidilutive for all periods presented.

Basic and diluted net loss per share for the three and six months ended June 30, 2003 and 2002 are calculated as follows (in thousands, except per share amounts):

	Three months ended June 30,						Six months ended June 30,
	2003			2002			2003			2002
	(Unaudited)			(Unaudited)			(Unaudited)			(Unaudited)
Net loss	$	(10,031	)	$	(22,808	)	$	(22,405	)	$	(43,146	)
Weighted-average shares of common stock outstanding used in computing basic and diluted net loss per share		162,058			153,537			161,639			152,780
Basic and diluted net loss per share	$	(0.06	)	$	(0.15	)	$	(0.14	)	$	(0.28	)
Antidilutive securities not included in diluted net loss per share calculation:
Convertible preferred stock		62,328			68,455			62,328			68,455
Options to purchase common stock		29,750			25,329			29,750			25,329
Warrants to purchase common stock		17,326			17,326			17,326			17,326
		109,404			111,110			109,404			111,110

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5. CAPITAL LEASE OBLIGATIONS

Capital lease obligations and the leased property and equipment are recorded at acquisition at the present value of future lease payments based upon the terms of the lease agreement. On April 14, 2003, we entered into an agreement to amend our equipment lease obligations with Cisco Systems Capital Corporation. Specifically, this lease amendment provides for adjustments to our required minimum quarterly revenue levels and minimum quarterly EBITDA (earnings before interest, taxes, depreciation and amortization) levels. The lease amendment also required a payment that was made on April 15, 2003 for $2.2 million (representing advance payment of our lease payments due in March and April 2004).

6. REVOLVING CREDIT FACILITY AND NOTES PAYABLE

The Company has a loan and security agreement with a $15.0 million revolving credit facility (“Revolver”) and a $5.0 million term loan. Availability under the Revolver and term loan is based on 80% of eligible accounts receivable plus 50% of unrestricted cash and investments. In addition, the loan and security agreement will make available to us an additional $5.0 million under a term loan if we meet certain debt coverage ratios. The balance outstanding under the term loan was $4.2 million at June 30, 2003, while the balance under the Revolver was $9.2 million.

7. STOCK-BASED COMPENSATION PLANS

On June 30, 2003, we had eight stock-based employee compensation plans, which the company accounts for under the recognition and measurement principles of Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. During the three month period ended March 31, 2003, we fully amortized our deferred stock compensation to expense for $0.4 million.

The Company accounts for stock-based compensation based on the provisions of APB Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB No. 25”), which states that no compensation expense is recorded for stock options or other stock-based awards to employees that are granted with an exercise price equal to or above the estimated fair value per share of the Company’s common stock on the grant date. In the event that stock options are granted at a price lower than the fair market value at that date, the difference between the fair market value of the Company’s common stock and the exercise price of the stock option is recorded as unearned compensation. Unearned compensation is amortized to compensation expense over the vesting period of the stock option. The Company has adopted the disclosure requirements of Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”), as it relates to stock options granted to employees, which requires pro forma net losses be disclosed based on the fair value of the options granted at the date of the grant.

Fair Value Disclosures

The Company calculated the fair value of each option on the date of grant using the Black-Scholes option-pricing model as prescribed by SFAS No. 123 using the following weighted average assumptions:

	June 30, 2002		June 30, 2003
Risk-free interest rate	3.52	%	3.77	%
Expected life	4 years		4 years
Dividend yield	None		None
Expected volatility	100	%	100	%

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Had compensation cost for the Company’s stock-based compensation plans been determined as prescribed by SFAS No. 123, the Company’s net pro forma loss would have been as follows

	Three months ended June 30,						Six months ended June 30,
	2003			2002			2003			2002
Net loss:
As reported	$	(10,031	)	$	(22,808	)	$	(22,405	)	$	(43,146	)
Add compensation expense		—			(11	)		390			341
Deduct total stock-based employee compensation expense determined     under fair value based method for all awards.		(1,122	)		9,400			(1,392	)		18,790
Pro forma net loss	$	(11,153	)	$	(13,419	)	$	(23,407	)	$	(24,015	)
Basic and diluted net loss per share:
As reported	$	(0.06	)	$	(0.15	)	$	(0.14	)	$	(0.28	)
Proforma	$	(0.07	)	$	(0.09	)	$	(0.14	)	$	(0.16	)

8. SERIES A CONVERTIBLE PREFERRED STOCK

During the six months ended June 30, 2003, Series A convertible preferred stockholders converted 44,140 shares of convertible preferred stock at a recorded value of $1.2 million into 952,733 shares of common stock. As of June 30, 2003, the Company had 2,887,661 shares of Series A convertible preferred stock outstanding with a recorded value of $78.6 million.

9. RECENT ACCOUNTING PRONOUNCEMENTS

In January 2003, the Financial Accounting Standards Board (“ASB”) FASB issued Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities,” which clarifies the application of Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” relating to consolidation of certain entities. First, FIN 46 will require identification of the Company’s participation in variable interests entities (“VIE”), which are defined as entities with a level of invested equity that is not sufficient to fund future activities to permit them to operate on a stand-alone basis, or whose equity holders lack certain characteristics of a controlling financial interest. Then, for entities identified as VIE, FIN 46 sets forth a model to evaluate potential consolidation based on an assessment of which party to the VIE, if any, bears a majority of the exposure to its expected losses, or stands to gain from a majority of its expected returns. FIN 46 also sets forth certain disclosures regarding interests in VIE that are deemed significant, even if consolidation is not required. The Company evaluated its investments and concluded that none qualify as a “variable interest” as defined in FIN 46.

In February 2003, the Emerging Issues Task Force (“EITF”) issued an abstract, Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables.” This Issue addresses certain aspects of the accounting by a vendor for arrangements under which it will perform multiple revenue-generating activities. Specifically, this Issue addresses how to determine whether an arrangement involving multiple deliverables contains more than one unit of accounting. The Company is currently assessing the impact of EITF No. 00-21 as it relates to revenue arrangements with multiple deliverables.

On May 15, 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity”. This statement establishes standards for classifying and measuring as liabilities certain financial instruments that embody obligations of the issuer and have characteristics of both liabilities and equity. This statement represents a significant change in practice in the accounting for a number of financial instruments, including mandatorily redeemable equity instruments and certain equity derivatives that are frequently used in connection with share repurchase programs. This statement is effective for all financial instruments created or modified after May 31, 2003, and to other instruments as of September 1, 2003. We have had no newly created or modified financial instruments since May 31, 2003. However, we currently have preferred stock on our balance sheet that is reported as a mandatorily redeemable financial instrument. The Company is currently assessing the impact of changes to rights of the preferred stock affected in July 2003 to evaluate whether these rights change the designation of the preferred stock from being a mandatorily redeemable financial instrument. This assessment will be made and will be reported beginning with the Company’s reporting for the quarter ended September 30, 2003.

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

Certain statements in this Quarterly Report on Form 10-Q, including, without limitation, statements containing the words “believes,” “anticipates,” “estimates,” “expects” and words of similar import, constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. You should not place undue reliance on these forward-looking statements. Our actual results could differ materially from those anticipated in these forward-looking statements for many reasons, including the risks faced by us described below and elsewhere in this Form 10-Q, and in other documents we file with the Securities and Exchange Commission.

The forward-looking information set forth in this Quarterly Report on Form 10-Q is as of June 30, 2003, and Internap undertakes no duty to update this information. Should events occur subsequent to June 30, 2003, that make it necessary to update the forward-looking information contained in this Form 10-Q, the updated forward-looking information will be filed with the SEC in a subsequent Quarterly Report on Form 10-Q or as a press release included as an exhibit to a Form 8-K, each of which will be available at the SEC’s website at www.sec.gov. More information about potential factors that could affect our business and financial results is included in the section entitled “Risk Factors” of this Form 10-Q.

OVERVIEW

Internap Network Services Corporation (“Internap,” “we,” “us,” “our” or the “Company”) is a leading provider of Internet Protocol (IP)-based connectivity solutions to businesses that need assured network availability for mission-critical applications. Customers connected to the Internet through one of our service points have their data intelligently routed to and from destinations on the Internet using our overlay network, which analyzes the traffic situation on the major networks that comprise the Internet and delivers mission-critical information and communications quickly and reliably. Use of our overlay network usually results in lower instances of data loss and greater quality of service than services offered by conventional Internet connectivity providers. In addition to IP connectivity, we offer colocation services and virtual private networking (“VPN”) services. We also complement our service offerings as resellers of VPN, content delivery network (“CDN”), managed security and managed storage services. The majority of our revenue is derived from high-performance Internet connectivity and related colocation services. As of June 30, 2003, we provided our services to 1,487 customers located throughout the United States and globally.

Our high-performance Internet connectivity services are available at speeds ranging from fractional T-1 (256 kbps) to OC-12 (622 mbps), and Ethernet Connectivity from 10 mbps to 1,000 mbps (Gigabit Ethernet) from Internap’s 30 service points to customers. We provide our connectivity services through the deployment of service points, which are redundant network infrastructure facilities coupled with our proprietary routing technology. Service points maintain high-speed, dedicated connections to major global Internet networks, commonly referred to as backbones. As of June 30, 2003, we operated 30 service points in 17 major metropolitan market areas.

The following discussion should be read in conjunction with the consolidated financial statements provided under Part I, Item 1 of this Quarterly Report on Form 10-Q. Certain statements contained herein may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements involve a number of risks, uncertainties and other factors that could cause actual results to differ materially, as discussed more fully herein.

RESULTS OF OPERATIONS

Our revenues are generated primarily from the sale of Internet connectivity services at fixed rates or usage-based pricing to our customers that desire a DS-3 or faster connection and other ancillary services, such as colocation, content distribution, server management and installation services, virtual private networking services, managed security services, data backup, remote storage and restoration services, and video conferencing services. We also offer T-1 and fractional DS-3 connections at fixed rates. We recognize revenues when persuasive evidence of an arrangement exists, the service has been provided, the fees for the service rendered are fixed or determinable and collectibility is probable. Customers are billed on the first day of each month either on a usage or a flat-rate basis. The usage based billing relates to the month prior to the

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month in which the billing occurs, whereas certain flat rate billings relate to the month in which the billing occurs. Deferred revenues consist of revenues for services to be delivered in the future and consist primarily of advance billings, which are amortized over the respective service period and billings for initial installation of customer network equipment, which are amortized over the estimated life of the customer relationship.

Direct cost of network is comprised primarily of the costs for connecting to and accessing Internet backbone providers and competitive local exchange providers, costs related to operating and maintaining service points and data centers and costs incurred for providing additional third-party services to our customers. To the extent a service point is located a distance from the respective Internet backbone providers, we may incur additional local loop charges on a recurring basis.

Customer support costs consist primarily of employee compensation costs for employees engaged in connecting customers to our network, installing customer equipment into service point facilities, and servicing customers through our network operation centers. In addition, facilities costs associated with the network operations center are included in customer support costs.

Product development costs consist principally of compensation and other personnel costs, consultant fees and prototype costs related to the design, development and testing of our proprietary technology, enhancement of our network management software and development of internal systems. Costs associated with internal use software are capitalized when the software enters the application development stage until implementation of the software has been completed. All other product development costs are expensed as incurred.

Sales and marketing costs consist of compensation, commissions and other costs for personnel engaged in marketing, sales and field service support functions, as well as advertising, tradeshows, direct response programs, new service point launch events, management of our web site and other promotional costs.

General and administrative costs consist primarily of compensation and other expenses for executive, finance, human resources and administrative personnel, professional fees and other general corporate costs.

Since inception, in connection with the grant of certain stock options to employees, we recorded deferred stock compensation totaling $25.0 million, representing the difference between the fair value of our common stock on the date options were granted and the exercise price. In connection with our acquisition of VPNX, we recorded deferred stock compensation totaling $5.1 million related to unvested options we assumed. These amounts are included as a component of stockholders’ equity (deficit) and are being amortized over the vesting period of the individual grants, generally four years, using an accelerated method as described in Financial Accounting Standards Board Interpretations No. 28. We recorded amortization of deferred stock compensation in the amount of  $0.3 million and $0.4 million for the six months ended June 30, 2002 and 2003, respectively. At June 30, 2003, the entire amount of deferred stock compensation had been fully amortized.

The revenue and income potential of our business and market is unproven, and our limited operating history makes it difficult to evaluate its prospects. We have only been in existence since 1996, and our services are only offered in limited regions. We have incurred net losses in each quarterly and annual period since our inception, and as of June 30, 2003, our accumulated deficit was $818.8 million.

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The following table sets forth, as a percentage of total revenues, selected statement of operations data for the periods indicated:

	Three months ended June30,				Six months ended June30,
	2003		2002		2003		2002
Revenues	100	%	100	%	100	%	100	%
Costs and expenses:
Direct cost of network	55	%	69	%	55	%	71	%
Customer support	7	%	11	%	7	%	11	%
Product development	5	%	6	%	5	%	6	%
Sales and marketing	15	%	18	%	15	%	18	%
General and administrative	12	%	15	%	12	%	18	%
Depreciation and amortization	28	%	41	%	30	%	40	%
Amortization of intangible assets	4	%	5	%	4	%	5	%
Amortization of deferred stock compensation	—		—		1	%	1	%
Restructuring costs	—		—		1	%	(8	%)
Loss on sales and retirements of property and equipment	—		2	%	—		2	%
Total operating costs and expenses	126	%	167	%	130	%	164	%
Loss from operations	(26	%)	(67	%)	(30	%)	(64	%)
Other income (expense):
Interest income (expense), net	(3	%)	(1	%)	(2	%)	(1	%)
Loss on investments	—		(1	%)	(1	%)	(1	%)
Total other income (expense)	(3	%)	(2	%)	(3	%)	(2	%)
Net loss	(29	%)	(69	%)	(33	%)	(66	%)

Three Months Ended June 30, 2003 and 2002

Net Loss. Net loss for the three months ended June 30, 2003 was $10.0 million, or a net loss of $0.06 per share, as compared to a net loss of $22.8 million, or a net loss of $0.15 per share, for the same period during the preceding year. The $12.8 million decrease in net loss was primarily due to an $11.9 million decrease in operating expenses and a $1.2 million increase in revenue. The decrease in operating expenses was comprised primarily of decreases in direct cost of network, customer support, general and administration expense, depreciation and amortization expense, loss on sales and retirements of property and equipment, which declined $3.9 million, $1.4 million, $0.9 million, $3.7 million and $0.8 million respectively.

Revenues. Revenues increased 4% from $33.0 million for the three months ended June 30, 2002 to $34.2 million for the three months ended June 30, 2003. The increase of $1.2 million was attributable to increased sales at our existing service points resulting in a customer base of 1,487 at June 30, 2003 up from a customer base of 1,134 at June 30, 2002 and sales of complimentary services such as content distribution. We expect quarterly revenues to modestly increase for the remainder of 2003.

Direct cost of network. Direct cost of network decreased 17% from $22.6 million for the three months ended June 30, 2002 to $18.7 million for the three months ended June 30, 2003. This decrease of $3.9 million was primarily due to decreased costs related to renegotiated terms with Internet backbone and local exchange providers at each service point, which decreased $3.5 million, and service point facility cost of $0.7 million offset by increased content distribution costs as well as other costs of $0.3 million. We anticipate direct cost of network to continue to decline for the remainder of 2003.

Customer support. Customer support expenses decreased 38% from $3.7 million for the three months ended June 30, 2002 to $2.3 million for the three months ended June 30, 2003. This decrease of $1.4 million was primarily due to decreased compensation and benefits costs from the reduction in headcount and facility costs that decreased $1.1 million and $0.3 million, respectively. Customer support costs are expected to remain consistent with those noted during the current quarter.

Product Development. Product development costs decreased 14% from $2.0 million for the three months ended June 30, 2002 to $1.7 million for the three months ended June 30, 2003. This decrease of $0.3 million was due primarily to decreased facility costs. Product development costs are expected to remain consistent with those noted during the current quarter.

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Sales and Marketing. Sales and marketing costs decreased 13% from $5.8 million for the three months ended June 30, 2002 to $5.0 million for the three months ended June 30, 2003. This decrease of $0.8 million was primarily due to decreased compensation, advertising costs and facilities costs, representing $0.4 million, $0.2 million and $0.5 million respectively, offset by increases in administrative expense and outside professional expense representing $0.3 million. Sales and marketing expenses are expected to remain consistent with those of the current quarter for the foreseeable future.

General and Administrative. General and administrative costs decreased 20% from $5.0 million for the three months ended June 30, 2002 to $4.1 million for the three months ended June 30, 2003. This decrease of $0.9 million was primarily due to decreased compensation, and tax costs, representing $0.8 million and $0.1 million, respectively. General and administrative costs are expected to remain consistent with those of the current quarter.

Depreciation and amortization. Depreciation and amortization decreased 28% from $13.5 million for the three months ended June 30, 2002 to $9.8 million for the three months ended June 30, 2003. This $3.7 million decrease was primarily due to assets becoming fully depreciated during the period ended June 30, 2003.

Amortization of Intangible Assets. Amortization of intangible assets decreased 11% from $1.6 million for the three months ended June 30, 2002 to $1.4 million for the three months ended June 30, 2003.

Other Income (Expense). Other income (expense), net expense, increased from other expense of $0.8 million for the three months ended June 30, 2002 to $1.1 million of other expense for the three months ended June 30, 2003. Other expense, net increased due to a reduction of investment and dividend income from money market funds.

Six months Ended June 30, 2003 and 2002

Net Loss. Net loss for the six months ended June 30, 2003 was $22.4 million, or a net loss of $0.14 per share, as compared to a net loss of $43.1 million, or a net loss of $0.28 per share, for the same period during the preceding year. The $20.7 million decrease in net loss was primarily due to decrease in operating expenses and revenue increase of $18.8 million and $2.8 million, respectively, offset by an $0.8 million increase in other expense. Direct cost of network, customer support, general and administrative expense, and depreciation and amortization expense were attributed to the decrease in net loss for the six months ended June 30, 2003 of $9.4 million, $2.9 million, $3.0 million, and $5.9 million respectively.

Revenues. Revenues increased 4% from $65.6 million for the six months ended June 30, 2002 to $68.4 million for the six months ended June 30, 2003. The increase of $2.8 million was attributable to increased sales at our existing service points resulting in a customer base of 1,487 at June 30, 2003 up from a customer base of 1,134 at June 30, 2002 and sales of complimentary services such as content distribution.

Direct cost of network. Direct cost of network decreased 20% from $46.7 million for the six months ended June 30, 2002 to $37.3 million for the six months ended June 30, 2003. This decrease of $9.4 million was primarily due to decreased costs related to Internet backbone and local exchange providers at each service point.

Customer support.Customer support expenses decreased 38% from $7.5 million for the six months ended June 30, 2002 to $4.6 million for the six months ended June 30, 2003. This decrease of $2.9 million was primarily due to decreased compensation and facility costs that decreased $2.3 million and $0.6 million, respectively.

Product Development. Product development costs decreased 14% from $3.9 million for the six months ended June 30, 2002 to $3.4 million for the six months ended June 30, 2003. This decrease of $0.5 million was due primarily to decreased compensation and facility costs, representing $0.1 million and $0.4 million, respectively.

Sales and Marketing. Sales and marketing costs decreased 14% from $11.9 million for the six months ended June 30, 2002 to $10.2 million for the six months ended June 30, 2003. This decrease of $1.7 million was primarily due to decreases in compensation costs and facility costs, representing $1.4 million and $0.4 million, respectively, which were offset by increases in marketing and advertising, administrative expenses and taxes representing $0.1 million increases for each of these three expense items.

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General and Administrative. General and administrative costs decreased 26% from $11.5 million for the six months ended June 30, 2002 to $8.5 million for the six months ended June 30, 2003. This decrease of $3.0 million was primarily due to decreased compensation, consulting and professional services costs, and insurance expense representing $2.4 million, $1.0 million and $0.5 million of the decrease, respectively. These decreases were offset by increases in office expense of $0.4 million, recruiting expense of $0.3 million, and facility cost of $0.2 million.

Depreciation and amortization. Depreciation and amortization decreased 22% from $26.3 million for the six months ended June 30, 2002 to $20.4 million for the six months ended June 30, 2003. This $5.9 million decrease was primarily due to assets becoming fully depreciated during the six months ended June 30, 2003.

Amortization of Intangible Assets.Amortization of intangible assets decreased 3% from $3.0 million for the six months ended June 30, 2002 to $2.9 million for the six months ended June 30, 2003.

Restructuring Costs.Restructuring costs were reversed for $5.0 million for the six months ended June 30, 2002 compared to expense of $1.0 million for the six months ended June 30, 2003. This increase of $6.0 million is primarily due to the adjustment made to the restructuring liability estimate in the six months ended June 30, 2002. Restructuring costs of $1.0 million incurred for the six months ended June 30, 2003, included retention bonuses for terminated employees due to the headquarter office move from Seattle to Atlanta and moving expenses paid for relocating employees.

Other Expense. Other expense increased from $1.4 million for the six months ended June 30, 2002 to $2.2 million of other expense for the six months ended June 30, 2003.

LIQUIDITY AND CAPITAL RESOURCES

Cash Flow for the Six months ended June 30, 2003 and 2002

Cash Flows From Operating Activities. Net cash used in operating activities was $7.1 million for the six months ended June 30, 2003 and was primarily due to the loss from continuing operations of $3.1 million of net income after adjusting it for non-cash items of $25.5 million and changes in working capital of $10.2 million.

Net cash used in operating activities was $26.2 million for the six months ended June 30, 2002 and was primarily due to the loss from continuing operations (adjusted for non-cash items) of $15.3 million and changes in working capital of $10.9 million.

Cash Flows From Investing Activities.Net cash used in investing activities was $2.0 million for the six months ended June 30, 2003 and was primarily from purchases of property and equipment. The purchases of property and equipment primarily represent equipment to be used within our network infrastructure for consolidation of services points.

Net cash provided by investing activities was $10.8 million for the six months ended June 30, 2002 and was primarily from proceeds of $18.7 million received from the maturity of investments, offset by $7.5 million in purchases of property and equipment and $1.3 million invested in our Japan joint venture Internap Japan. The purchases of property and equipment primarily represent payments made in conjunction with an amendment to our master lease agreement, capitalized labor for the development of internal use software and equipment to be used within our network infrastructure.

Cash Flows From Financing Activities. Since our inception, we have financed our operations primarily through the issuance of our equity securities, capital leases and bank loans. As of June 30, 2003, we have raised an aggregate of approximately $499.6 million, net of offering expenses, through the sale of our securities.

Net cash used in financing activities for the six month period ended June 30, 2003 was $5.8 million, and related primarily to the payments on notes payable, revolving credit facility and capital leases, totaling $6.5 million offset by proceeds from our line of credit of $0.4 million and employee stock purchases and exercise of options, totaling $0.3 million.

Net cash used in financing activities for the six months ended June 30, 2002 was $5.7 million, and related primarily to the payments on notes payable and capital leases, totaling $11.6 million offset by borrowings from our revolving credit facility of $5.0 million and employee stock purchase plan stock purchases and the exercise of options and warrants, totaling $0.9 million.

Liquidity

We have experienced significant net operating losses since inception. During the six months ended June 30, 2003, we incurred a net loss of $22.4 million and used $14.9 million of cash. As of June 30, 2003, we held $12.4 million in cash and marketable securities, of which $2.1 million was restricted cash.

Management expects net losses to continue for the foreseeable future. Over the past year, we have decreased the size of our workforce by 101 employees, a 23% reduction from the 433 full-time employees at June 30, 2002. Our plans indicate our existing cash and investments will be adequate to fund operations in 2003. Moreover, we anticipate reaching positive free cash flow by year-end 2003. Our cash requirements through the end of 2003 are primarily to fund operations, restructuring outlays, payments to service capital leases, payments on notes payable and capital expenses. However, our capital requirements depend on several factors, including the rate of market acceptance of our services, the

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ability to expand and retain our customer base, and other factors. If we fail to realize our planned revenues or costs, management believes it has the ability to curtail capital spending and reduce expenses to ensure cash and investments will be sufficient to meet our cash requirements in 2003. If, however, our cash requirements vary materially from those currently planned, if our cost reduction initiatives have unanticipated adverse effects on our business, or if we fail to generate sufficient cash flow from the sales of our services, we may require additional financing sooner than anticipated. We cannot assure you such financing will be available on acceptable terms, if at all.

With the slowdown in the macroeconomic environment in the U.S. economy, and with continuing declines and general uncertainty in the telecommunications market in particular, we have been focused on significantly reducing the cost structure of the business while maintaining a continued focus on growing revenue. During fiscal 2001, we announced two separate restructurings of our business. Under these restructuring programs, management made decisions to exit certain non-strategic real estate lease and license arrangements, consolidate and exit redundant network connections, and streamline the company’s operating cost structure. In total, restructuring costs of $71.6 million and a charge for asset impairment of $196.0 million have been recognized against earnings over the past nine quarters. We completed the majority of our restructuring activities related to the 2001 plan during 2002. We expect to complete the restructuring activities related to the 2002 plan during 2003, although certain remaining restructured real estate and network obligations represent long-term contractual obligations that extend through 2015.

Commitments and Other Obligations.We have commitments and other obligations that are contractual in nature and will represent a use of cash in the future unless there are modifications to the terms of those agreements. Network commitments primarily represent purchase commitments made to our largest bandwidth vendors and, to a lesser extent, contractual payments to license collocation space used for resale to customers. Our ability to improve cash used in operations in the future would be negatively impacted if we did not grow our business at a rate that would allow us to offset the service commitments with corresponding revenue growth.

Credit Facility. As of June 30, 2003, we used $9.2 million of the $15.0 million revolving credit facility. In March 2003, we entered into an amendment to our existing loan and security agreement. Pursuant to the loan amendment, the amount available under our credit facility was increased by an additional $5.0 million, to a total of $20.0 million, subject to certain conditions.

Preferred Stock. During the six months ended June 30, 2003, Series A convertible preferred stockholders converted 44,140 shares of convertible preferred stock at a recorded value of $1.2 million into 952,733 shares of common stock. As of June 30, 2003, the Company had 2,887,661 shares of Series A convertible preferred stock outstanding with a recorded value of $78.6 million.

Lease Facilities. Since our inception, we have financed the purchase of network routing equipment using capital leases. Our future capital lease payments totaled $23.5 million as of June 30, 2003. Of this total, $2.4 million is to be paid over the next 12 months. We have fully utilized available funds under our lease facilities.

In April 2003, we amended the terms of our master lease agreement with our primary supplier of networking equipment. Specifically, the lease amendment provides for adjustments to our required minimum quarterly revenue levels and minimum quarterly earnings before interest, taxes, depreciation and amortization (“EBITDA”) levels. Under the lease amendment we paid $2.2 million on April 15, 2003, which represented an advance payment of our lease payments due in March and April 2004.

RECENT ACCOUNTING PRONOUNCEMENTS

In January 2003, the FASB issued Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities,” which clarifies the application of Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” relating to consolidation of certain entities. First, FIN 46 will require identification of the Company’s participation in variable interests entities (“VIE”), which are defined as entities with a level of invested equity that is not sufficient to fund future activities to permit them to operate on a standalone basis, or whose equity holders lack certain characteristics of a controlling financial interest. Then, for entities identified as VIE, FIN 46 sets forth a model to evaluate potential consolidation based on an assessment of which party to the VIE, if any, bears a majority of the exposure to its expected losses, or stands to gain from a majority of its expected returns. FIN 46 also sets forth certain disclosures regarding interests in VIE that are deemed

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significant, even if consolidation is not required. The Company evaluated its investments and concluded that none qualify as a “variable interest” as defined in FIN 46.

In February 2003, the Emerging Issues Task Force (“EITF”) issued an abstract, Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables.” This Issue addresses certain aspects of the accounting by a vendor for arrangements under which it will perform multiple revenue-generating activities. Specifically, this Issue addresses how to determine whether an arrangement involving multiple deliverables contains more than one unit of accounting. The Company is currently assessing the impact of EITF No. 00-21 as it relates to revenue arrangements with multiple deliverables.

On May 15, 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity”. This statement establishes standards for classifying and measuring as liabilities certain financial instruments that embody obligations of the issuer and have characteristics of both liabilities and equity. This statement represents a significant change in practice in the accounting for a number of financial instruments, including mandatorily redeemable equity instruments and certain equity derivatives that frequently are used in connection with share repurchase programs. This statement is effective for all financial instruments created or modified after May 31, 2003, and to other instruments as of September 1, 2003. We have had no newly created or modified financial instruments since May 31, 2003. However, we currently have preferred stock on our balance sheet that is reported as a mandatorily redeemable financial instrument. The Company is currently assessing the impact of changes to rights of the preferred stock affected in July 2003 to evaluate whether these rights change the designation of the preferred stock from being a mandatorily redeemable financial instrument. This assessment will be made and be reported beginning with the Company’s reporting for the quarter ended September 30, 2003.

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RISK FACTORS

You should carefully consider the risks described below. These risks are not the only ones that we may face. Additional risks and uncertainties that we are unaware of, or that we currently deem immaterial, also may become important factors that affect us. If any of the following risks occurs, our business, financial condition or results of operations could be materially and adversely affected.

Risks Related to Our Business

We Have a History of Losses, Expect Future Losses and May Not Achieve or Sustain Profitability.

We have incurred net losses in each quarterly and annual period since we began operations in May 1996. We incurred a net loss of $10.0 million in the quarter ended June 30, 2003, and $185.5 million, $479.2 million and $72.3 million for the years ended December 31, 2000, 2001 and 2002, respectively. As of June 30, 2003, our accumulated deficit was $818.8 million. We may incur negative cash flows for the next several quarters and net losses for the foreseeable future.

Our Limited Operating History Makes It Difficult to Evaluate Our Prospects.

The revenue and income potential of our business and market is unproven, and our limited operating history makes it difficult to evaluate our prospects. We have only been in existence since 1996, and our services are only offered in limited regions. Investors should consider and evaluate our prospects in light of the risks and difficulties frequently encountered by relatively new companies, particularly companies in the rapidly evolving Internet infrastructure, connectivity and colocation markets.

Our Operating Results May Disappoint Analysts’ or Investors’ Expectations, Which Could Have a Negative Impact on Our Stock Price.

Our stock price could suffer in the future, as it has in the past, as a result of any failure to meet the expectations of public market analysts and investors about our results of operations from quarter to quarter. Any significant unanticipated shortfall of revenues or increase in expenses could negatively impact our expected results of operations should we be unable to make timely adjustments to compensate for them. Furthermore, a failure on our part to estimate accurately the timing or magnitude of particular anticipated revenues or expenses could also negatively impact our results of operations. Because our results of operations have fluctuated in the past and will continue to fluctuate in the future, investors should not rely on the results of any particular period as an indication of future performance in our business operations or stock price. For example, our quarterly revenue sequential growth rates for the quarters ended December 31, 2001 through June 30, 2003, have varied between (1.0%) and 7%, and total operating costs and expenses, as a percentage of revenues, have fluctuated between 133% and 193%. Fluctuations in our operating results depend on a number of factors. Some of these factors are industry and economic risks over which we have no control, including the introduction of new services by many of our competitors, fluctuations in demand and the length of sales cycle for our services, fluctuations in the market for qualified sales and other personnel, changes in the prices for Internet connectivity we pay backbone providers, our ability to obtain local loop connections to our service points at favorable prices, integration of people, operations, products and technologies of acquired businesses and general economic conditions. Other factors that may cause fluctuations in our operating results arise from strategic decisions we have made or may make with respect to the timing and magnitude of capital expenditures such as those associated with the deployment of additional service points and the terms of our Internet connectivity purchases. For example, our practice is to purchase Internet connectivity from backbone providers at new service points and license colocation space from providers before customers are secured. We also have agreed to purchase Internet connectivity from some providers without regard to the amount we resell to our customers.

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Pricing Pressure Could Decrease Our Revenue and Threaten the Viability of Our Business Model.

We face intense competition along several fronts (more fully described below), including price competition. Increased price competition and other related competitive pressures could erode revenues, and significant price deflation could threaten the viability of our business model. We currently charge, and expect to continue to charge, more for our Internet connectivity services than many of our competitors. By bundling their services and reducing the overall cost of their solutions, telecommunications companies that compete with us may be able to provide customers with reduced communications costs in connection with their Internet connectivity services or private network services, thereby significantly increasing the pressure on us to decrease our prices. Because we rely on Internet backbone providers in delivering our services and have agreed with some of these providers to purchase their services without regard to the amount we resell to our customers, we may not be able to offset the effects of competitive price reductions even with an increased number of customers, higher revenues per customer from enhanced services, cost reductions or otherwise. In addition, the Internet connectivity industry may encounter further consolidation in the future. Consolidation could result in increased pressure on us to decrease our prices. Furthermore, the prolonged downturn in the U.S. economy has prompted many companies who require Internet connectivity to reevaluate the cost of such services. We believe that a continuing and further prolonged economic downturn could result in existing and potential customers being unwilling to pay for premium Internet connectivity services, which would seriously harm our business and could make additional capital unavailable.

If We Are Unable to Continue to Receive Services from Our Backbone Providers, or Receive Their Services on a Cost-Effective Basis, We May Not Be Able to Provide Our Internet Connectivity Services on Favorable Terms.

In delivering our services, we rely on a number of Internet backbones, all of which are built and operated by others. In order to be able to provide high performance routing to our customers through our service points, we purchase connections from several Internet backbone providers. There can be no assurance that these Internet backbone providers will continue to provide service to us on a cost-effective basis or on otherwise favorable terms, if at all, or that these providers will provide us with additional capacity to adequately meet customer demand. Furthermore, it is very unlikely that we could replace our Internet backbone providers on comparable terms. Currently, in each of our domestic service points, we have connections to some combination of the following nine backbone providers: AT&T, Cable & Wireless USA, Genuity, Global Crossing Telecommunications, Qwest Communications International, Level 3 Communications, Sprint Internet Services, MCI Company (formally WorldCom) and Verio (an NTT Communications company). We may be unable to maintain relationships with, or obtain necessary additional capacity from, these backbone providers. We may be unable to establish and maintain relationships with other backbone providers that may emerge or that are significant in certain geographic areas, such as Asia and Europe, in which we locate our service points.

Competition from More Established Competitors Could Decrease Our Market Share.

The Internet connectivity services market is extremely competitive. We expect competition from existing competitors to intensify in the future, and we may not have the financial resources, technical expertise, sales and marketing abilities or support capabilities to compete successfully. Many of our existing competitors have greater market presence, engineering and marketing capabilities, and financial, technological and personnel resources than we do. As a result, our competitors may have several advantages over us as we seek to develop a greater market presence. Our competitors currently include backbone providers that provide connectivity services to us, regional Bell operating companies, which offer Internet access, and global, national and regional Internet service providers and other Internet infrastructure providers and manufacturers. In addition, Internet backbone providers may make technological advancements, such as improved router technology or the introduction of improved routing protocols, which could enhance the quality of their services. We also expect to encounter additional competition from international Internet service providers as well as international telecommunications companies in the countries where we provide services.

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Competition from New Competitors Could Decrease Our Market Share.

We expect new competitors will continue to enter our market. These new competitors could include computer hardware, software, media and other technology and telecommunications companies. A number of telecommunications companies and online service providers have been offering or expanding their network services. Further, the ability of some of these potential competitors to bundle other services and products with their network services could place us at a competitive disadvantage. Various companies are also exploring the possibility of providing, or are currently providing, high-speed, intelligent data services that use connections to more than one backbone or use alternative delivery methods including the cable television infrastructure, direct broadcast satellites, wireless cable and wireless local loop.

Some of Our Customers Are Emerging Internet-Based Businesses That May Not Pay Us for Our Services on a Timely Basis and May Not Succeed Over the Long Term.

A portion of our revenue is derived from customers that are emerging Internet-based businesses. The unproven business models of some of these customers and an uncertain economic climate make their continued financial viability uncertain. Some of these customers have encountered financial difficulties and, as a result, have delayed or defaulted on their payments to us. In the future others may also do so. If these payment difficulties become substantial, then our business and financial results could be seriously harmed.

We May Require Additional Cash in the Future and May Not Be Able to Secure Adequate Funds on a Timely Basis or on Terms Acceptable to Us.

We expect to meet our cash requirements in 2003 with existing cash, cash equivalents, short-term investments, cash flows from sales of our services and credit facilities. If, however, our cash requirements vary materially from those currently planned, or if we fail to generate sufficient cash flow from the sales of our services, management believes it has the ability to curtail capital spending and reduce expenses to ensure our cash and investments will be sufficient to meet our cash requirements in 2003. We may, however, require additional financing sooner than anticipated. In that event, we might not be able to obtain equity or debt financing on acceptable terms, if at all. Also, future borrowing instruments, such as credit facilities and lease agreements, will likely contain covenants restricting our ability to incur further indebtedness and will likely require us to pledge assets as security for any such borrowings.

Given our recent efforts to reduce our capital and operating expenditures, we may not be able to expand our business in the future. Any such expansion would require significant capital and we may be unable to obtain additional financing on satisfactory terms, if at all.

A Failure in Our Network Operations Centers, Service Points or Computer Systems Would Cause a Significant Disruption in Our Internet Connectivity Services.

Although we have taken precautions against systems failure, interruptions could result from natural or human caused disasters, power loss, telecommunications failure and similar events. Our business depends on the efficient and uninterrupted operation of our network operations centers, our service points and our computer and communications hardware systems and infrastructure. If we experience a problem at our network operations center, we may be unable to provide Internet connectivity services to our customers, provide customer service and support or monitor our network infrastructure or service points, any of which would seriously harm our business.

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MANAGEMENT’S DISCUSSION AND ANALYSIS, continued

Because We Have Limited Experience Operating Internationally, Our International Operations May Not Be Successful.

Although we currently have service points in London, England and a joint venture with NTT-ME Corporation operating a service point in Tokyo, Japan, we have limited experience operating internationally. We may not be able to adapt our services to international markets or market and sell these services to customers abroad. In addition to general risks associated with international business operations, we face the following specific risks in our international business operations:

• Difficulties in establishing and maintaining relationships with foreign customers as well as foreign backbone providers and local vendors, including colocation and local loop providers;

• Difficulties in locating, building and deploying network operations centers and service points in foreign countries, and managing service points and network operations centers across disparate geographic areas; and

• Exposure to fluctuations in foreign currency exchange rates.

We may be unsuccessful in our efforts to address the risks associated with our international operations, and our international sales growth may therefore be limited.

We Would Incur Additional Expense Associated with the Deployment of Any New Service Points and May Be Unable to Effectively Integrate New Service Points into Our Existing Network, Which Could Disrupt Our Service.

New service points, if any, would result in substantial new operating expenses, including expenses associated with hiring, training, retaining and managing new employees, provisioning capacity from backbone providers, purchasing new equipment, implementing new systems, leasing additional real estate and incurring additional depreciation expense. In addition, if we do not institute adequate financial and managerial controls, reporting systems, and procedures with which to operate multiple service points in geographically dispersed locations, our financial performance could be significantly harmed. Furthermore, in any effort to deploy new service points, we would face various risks associated with significant construction projects, including identifying and locating service point sites, construction delays, cost estimation errors or overruns, delays in connecting with local exchanges, equipment and material delays or shortages, the inability to obtain necessary permits on a timely basis, if at all, and other factors, many of which are beyond our control and all of which could delay the deployment of a new service point.

Our Brand Is Relatively New, and Failure to Develop Brand Recognition Could Hurt Our Ability to Compete Effectively.

To successfully execute our strategy, we must strengthen our brand awareness. If we do not build our brand awareness, our ability to realize our strategic and financial objectives could be hurt. Many of our competitors have well-established brands associated with the provision of Internet connectivity services. To date, we have attracted our existing customers primarily through a relatively small sales force, word of mouth and a limited, print-focused advertising campaign. In order to build our brand awareness, we must continue to provide high quality services.

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MANAGEMENT’S DISCUSSION AND ANALYSIS, continued

We Are Dependent Upon Our Key Employees and May Be Unable to Attract or Retain Sufficient Numbers of Qualified Personnel.

Our future performance depends to a significant degree upon the continued contributions of our executive management team and key technical personnel. The loss of members of our executive management team or key technical employees could significantly harm us. Any of our officers or employees can terminate his or her relationship with us at any time. To the extent we are able to expand our operations and deploy additional service points, we may need to increase our workforce. Accordingly, our future success depends on our ability to attract, hire, train and retain highly skilled management, technical, sales, marketing and customer support personnel. Competition for qualified employees is intense and our financial resources are limited. Consequently, we may not be successful in attracting, hiring, training and retaining the people we need, which would seriously impede our ability to implement our business strategy.

If We Are Not Able to Support Our Growth Effectively, Our Expansion Plans May Be Constrained or May Fail.

Our inability to manage growth effectively would seriously harm our plans to expand our Internet connectivity services into new markets. Since the introduction of our Internet connectivity services, we have experienced a period of rapid growth and expansion, which has placed, and continues to place, a significant strain on all of our resources. For example, as of December 31, 1996, we had one operational service point and nine employees compared to 30 operational service points and 332 full-time employees as of June 30, 2003. In addition, we had $69.6 million in revenues for the year ended December 31, 2000, compared to $132.5 million in revenues for the year ended December 31, 2002. Furthermore, we currently offer our services in Europe and Japan, through our joint venture, Internap Japan. We also resell certain products and services of Akamai Technologies, Inc., and others. We expect our recent growth will continue to strain our management, operational and financial resources. For example, we may not be able to install adequate financial control systems in an efficient and timely manner, and our current or planned information systems, procedures and controls may be inadequate to support our future operations. The difficulties associated with installing and implementing new systems, procedures and controls may place a significant burden on our management and our internal resources.

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MANAGEMENT’S DISCUSSION AND ANALYSIS, continued

If We Fail to Adequately Protect Our Intellectual Property, We May Lose Rights to Some of Our Most Valuable Assets.

We rely on a combination of patent, copyright, trademark, trade secret and other intellectual property law, nondisclosure agreements and other protective measures to protect our proprietary technology. Internap and P-NAP are trademarks of Internap that are registered in the United States. In addition, we have threepatents that have been issued by the United States Patent and Trademark Office, or USPTO. The dates of issuance for these patents range from September 1999 through December 1999, and each of these patents is enforceable for a period of 20 years after the date of its filing. We cannot assure you that these patents or any future issued patents will provide significant proprietary protection or commercial advantage to us or that the USPTO will allow any additional or future claims. We have nine additional applications pending, two of which are continuation in patent filings. We may file additional applications in the future. Our patents and patent applications relate to our service point technologies and other technical aspects of our services. In addition, we have filed corresponding international patent applications under the Patent Cooperation Treaty. It is possible that any patents that have been or may be issued to us could still be successfully challenged by third parties, which could result in our loss of the right to prevent others from exploiting the inventions claimed in those patents. Further, current and future competitors may independently develop similar technologies, duplicate our services and products or design around any patents that may be issued to us. In addition, effective patent protection may not be available in every country in which we intend to do business. In addition to patent protection, we believe the protection of our copyrightable materials, trademarks and trade secrets is important to our future success. We rely on a combination of laws, such as copyright, trademark and trade secret laws and contractual restrictions, such as confidentiality agreements and licenses, to establish and protect our proprietary rights. In particular, we generally enter into confidentiality agreements with our employees and nondisclosure agreements with our customers and corporations with whom we have strategic relationships. In addition, we generally register our important trademarks with the USPTO to preserve their value and establish proof of our ownership and use of these trademarks. Any trademarks that may be issued to us may not provide significant proprietary protection or commercial advantage to us. Despite any precautions that we have taken, intellectual property laws and contractual restrictions may not be sufficient to prevent misappropriation of our technology or deter others from developing similar technology.

We May Face Litigation and Liability Due to Claims of Infringement of Third Party Intellectual Property Rights.

The telecommunications industry is characterized by the existence of a large number of patents and frequent litigation based on allegations of patent infringement. From time to time, third parties may assert patent, copyright, trademark, trade secret and other intellectual property rights to technologies that are important to our business. Any claims that our services infringe or may infringe proprietary rights of third parties, with or without merit, could be time-consuming, result in costly litigation, divert the efforts of our technical and management personnel or require us to enter into royalty or licensing agreements, any of which could significantly harm our operating results. In addition, in our customer agreements, we agree to indemnify our customers for any expenses or liabilities resulting from claimed infringement of patents, trademarks or copyrights of third parties. If a claim against us was to be successful, and we were not able to obtain a license to the relevant or a substitute technology on acceptable terms or redesign our products to avoid infringement, our ability to compete successfully in our competitive market would be impaired.

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INTERNAP NETWORK SERVICES CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS, continued

Because We Depend on Third Party Suppliers for Key Components of Our Network Infrastructure, Failures of These Suppliers to Deliver Their Components as Agreed Could Hinder Our Ability to Provide Our Services on a Competitive and Timely Basis.

Any failure to obtain required products or services from third party suppliers on a timely basis and at an acceptable cost would affect our ability to provide our Internet connectivity services on a competitive and timely basis. We are dependent on other companies to supply various key components of our infrastructure, including the local loops between our service points and our Internet backbone providers and between our service points and our customers’ networks. In addition, the routers and switches used in our network infrastructure are currently supplied by a limited number of vendors. Additional sources of these services and products may not be available in the future on satisfactory terms, if at all. We purchase these services and products pursuant to purchase orders placed from time to time. Furthermore, we do not carry significant inventories of the products we purchase, and we have no guaranteed supply arrangements with our vendors. We have in the past experienced delays in installation of services and receiving shipments of equipment purchased. To date, these delays have neither been material nor have they adversely affected us, but these delays could affect our ability to deploy service points in the future on a timely basis. If our limited source of suppliers fails to provide products or services that comply with evolving Internet and telecommunications standards or that interoperate with other products or services we use in our network infrastructure, we may be unable to meet our customer service commitments.

We Have Acquired and May Acquire Other Businesses, and these Acquisitions Involve Numerous Risks.

During 2000, we acquired CO Space and VPNX, respectively, in purchase transactions. On June 16, 2003, we announced that advanced discussions were underway to acquire netVmg, a privately held route optimization company. We may engage in additional acquisitions in the future in order to, among other things, enhance our existing services and enlarge our customer base. Acquisitions involve a number of risks that could potentially, but not exclusively, include the following:

• Difficulties in integrating the operations, personnel, technologies, products and services of the acquired companies in a timely and efficient manner;

• Diversion of management’s attention from normal daily operations;

• Insufficient revenues to offset significant unforeseen costs and increased expenses associated with the acquisitions;

• Difficulties in completing projects associated with in-process research and development being conducted by the acquired businesses;

• Risks associated with our entrance into markets in which we have little or no prior experience and where competitors have a stronger market presence;

• Deferral of purchasing decisions by current and potential customers as they evaluate the likelihood of success of the acquisitions;

• Difficulties in pursuing relationships with potential strategic partners who may view the combined company as a more direct competitor than our predecessor entities taken independently;

• Issuance by us of equity securities that would dilute ownership of existing stockholders;

• Incurrence of significant debt, contingent liabilities and amortization expenses; and

• Loss of key employees of the acquired companies.

Acquiring high technology businesses as a means of achieving growth is inherently risky. To meet these risks, we must maintain our ability to manage effectively any growth that results from using these means. Failure to effectively

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MANAGEMENT’S DISCUSSION AND ANALYSIS, continued

manage our growth through mergers and acquisitions could harm our business and operating results and could result in impairment of related long-term assets.

A Significant Number of Our Service Points are Located in Facilities of Third Parties, and We May Experience Significant Disruptions in Our Ability to Service Our Customers.

A significant number of our service points are located in facilities of third parties. In many of those arrangements, we do not have property rights similar to those customarily possessed by a lessee or sublessee, but instead have lesser rights of occupancy. In certain situations, the financial condition of those parties providing occupancy to us could have an adverse impact on the continued occupancy arrangement or the level of service delivered to us under such arrangement.

For Certain of Our Service Points, We May Be Obligated to Purchase Local Access or Other Services on Unfavorable Terms.

In certain of our service point occupancy arrangements, the facility we have occupied is not carrier neutral, and the occupancy provider may have the contractual right, or an effective right given available alternatives, to provide local access or other services to us in providing service to our customers. Consequently, we may not be able to purchase local access or such services in such situations on market terms or on other favorable non-price terms and conditions.

Risks Related to Our Industry

Because the Demand for Our Services Depends on Continued Growth in Use of the Internet, a Slowing of this Growth Could Harm the Development of the Demand for Our Services.

Critical issues concerning the commercial use of the Internet remain unresolved and may hinder the growth of Internet use, especially in the business market we target. Despite growing interest in the varied commercial uses of the Internet, many businesses have been deterred from purchasing Internet connectivity services for a number of reasons, including inconsistent or unreliable quality of service, lack of availability of cost-effective, high-speed options, a limited number of local access points for corporate users, inability to integrate business applications on the Internet, the need to deal with multiple and frequently incompatible vendors and a lack of tools to simplify Internet access and use. Capacity constraints caused by growth in the use of the Internet may, if left unresolved, impede further development of the Internet to the extent that users experience delays, transmission errors and other difficulties. Further, the adoption of the Internet for commerce and communications, particularly by those individuals and enterprises that have historically relied upon alternative means of commerce and communication, generally requires an understanding and acceptance of a new way of conducting business and exchanging information. In particular, enterprises that have already invested substantial resources in other means of conducting commerce and exchanging information may be particularly reluctant or slow to adopt a new strategy that may make their existing personnel and infrastructure obsolete. Additionally, even individuals and enterprises that have invested significant resources in the use of the Internet may, for cost reduction purposes during difficult economic times, decrease future investment in the use of the Internet. The failure of the market for business related Internet solutions to further develop could cause our revenues to grow more slowly than anticipated and reduce the demand for our services.

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MANAGEMENT’S DISCUSSION AND ANALYSIS, continued

Because the Internet Connectivity Market Is New and Its Viability Is Uncertain, There Is a Risk Our Services May Not Be Accepted.

We face the risk that the market for high performance Internet connectivity services might fail to develop, or develop more slowly than expected, or that our services may not achieve widespread market acceptance. This market for high performance Internet connectivity services has only recently begun to develop, is evolving rapidly and likely will be characterized by an increasing number of new entrants. There is significant uncertainty as to whether this market ultimately will prove to be viable or, if it becomes viable, that it will grow. Furthermore, we may be unable to market and sell our services successfully and cost-effectively to a sufficiently large number of customers. We typically charge more for our services than do our competitors, which may affect market acceptance of our services or adversely impact the rate of market acceptance. We believe the danger of nonacceptance is particularly acute during economic slowdowns and when there is significant pricing pressure across the Internet connectivity industry. Finally, if the Internet becomes subject to a form of central management, or if the Internet backbone providers establish an economic settlement arrangement regarding the exchange of traffic between backbones, the problems of congestion, latency and data loss addressed by our Internet connectivity services could be largely resolved, and our core business rendered obsolete.

If We Are Unable to Respond Effectively and on a Timely Basis to Rapid Technological Change, We May Lose or Fail to Establish a Competitive Advantage in Our Market.

The Internet connectivity industry is characterized by rapidly changing technology, industry standards, customer needs and intense market competition, as well as by frequent new product and service introductions. We may be unable to successfully use or develop new technologies, adapt our network infrastructure to changing customer requirements and industry standards, introduce new services, such as virtual private networking and video conferencing, or enhance our existing services on a timely basis. Furthermore, new technologies or enhancements we use or develop may not gain market acceptance or may develop slower than anticipated. Our pursuit of necessary technological advances may require substantial time and expense, and we may be unable to successfully adapt our network and services to alternate access devices and technologies. If our services do not continue to be compatible and interoperable with products and architectures offered by other industry members, our ability to compete could be impaired. Our ability to compete successfully is dependent, in part, upon the continued compatibility and interoperability of our services with products and architectures offered by various other industry participants. Although we intend to support emerging standards in the market for Internet connectivity, there can be no assurance that we will be able to conform to new standards in a timely fashion, if at all, or maintain a competitive position in the market.

New Technologies Could Displace Our Services or Render Them Obsolete.

New technologies and industry standards have the potential to replace or provide lower cost alternatives to our services. The adoption of such new technologies or industry standards could render our existing services obsolete and unmarketable. For example, our services rely on the continued widespread commercial use of the set of protocols, services and applications for linking computers known as Transmission Control Protocol/Internetwork Protocol, or TCP/IP. Alternative sets of protocols, services and applications for linking computers could emerge and become widely adopted. A resulting reduction in the use of TCP/IP could render our services obsolete and unmarketable. Our failure to anticipate the prevailing standard or the failure of a common standard to emerge could hurt our business. Further, we anticipate the introduction of other new technologies, such as telephone and facsimile capabilities, private networks, multimedia document distribution and transmission of audio and video feeds, requiring broadband access to the Internet, but there can be no assurance that such technologies will create opportunities for us or that the cost of implementing such technologies will provide a positive economic return.

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Service Interruptions Caused by System Failures Could Harm Customer Relations, Expose Us to Liability and Increase Our Capital Costs.

Interruptions in service to our customers could harm our customer relations, expose us to potential lawsuits and require us to spend more money adding redundant facilities. Our operations depend upon our ability to protect our customers’ data and equipment, our equipment and our network infrastructure, including our connections to our backbone providers, against damage from human error or attack or “acts of God.” Even if we take precautions, the occurrence of a natural disaster, attack or other unanticipated problem could result in interruptions in the services we provide to our customers.

Capacity Constraints Could Cause Service Interruptions and Harm Customer Relations.

Failure of the backbone providers and other Internet infrastructure companies to continue to grow in an orderly manner could result in capacity constraints leading to service interruptions to our customers. Although the national telecommunications networks and Internet infrastructures have historically developed in an orderly manner, there is no guarantee that this orderly growth will continue as more services, users and equipment connect to the networks. Failure by our telecommunications and Internet service providers to provide us with the data communications capacity we require could cause service interruptions.

Our Network and Software Are Vulnerable to Security Breaches and Similar Threats Which Could Result in Our Liability for Damages and Harm Our Reputation.

Despite the implementation of network security measures, the core of our network infrastructure is vulnerable to computer viruses, break-ins, attacks and similar disruptive problems. This could result in our liability for damages, and our reputation could suffer, thereby deterring potential customers from working with us. Security problems or other attacks caused by third parties could lead to interruptions and delays or to the cessation of service to our customers. Furthermore, inappropriate use of the network by third parties could also jeopardize the security of confidential information stored in our computer systems and in those of our customers. Although we intend to continue to implement industry-standard security measures, in the past third parties have occasionally circumvented some of these industry-standard measures, although not in our system. Therefore, there can be no assurance that the measures we implement will not be circumvented. The costs and resources required to eliminate computer viruses and alleviate other security problems may result in interruptions, delays or cessation of service to our customers, which could hurt our business.

Should the Government Modify or Increase Regulation of the Internet, the Provision of Our Services Could Become More Costly.

There is currently only a small body of laws and regulations directly applicable to access to or commerce on the Internet. However, due to the increasing popularity and use of the Internet, international, federal, state and local governments may adopt laws and regulations that affect the Internet. The nature of any new laws and regulations and the manner in which existing and new laws and regulations may be interpreted and enforced cannot be fully determined. The adoption of any future laws or regulations might decrease the growth of the Internet, decrease demand for our services, impose taxes or other costly technical requirements or otherwise increase the cost of doing business on the Internet or in some other manner have a significantly harmful effect on us or our customers. The government may also seek to regulate some segments of our activities as it has with basic telecommunications services. Moreover, the applicability to the Internet of existing laws governing intellectual property ownership and infringement, copyright, trademark, trade secret, obscenity, libel, employment, personal privacy and other issues is uncertain and developing. We cannot predict the impact, if any, that future regulation or regulatory changes may have on our business.

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MANAGEMENT’S DISCUSSION AND ANALYSIS, continued

Risks Related to Our Capital Stock

The Series A Preferred Stock and Warrants Issued in 2001 Have Dilutive Impacts That Could Dilute the Voting Power of our Common Shareholders and Depress the Market Price of Our Common Stock.

Our Series A preferred stock and warrants originally issued in 2001 have substantially increased the number of shares of common stock that may be issued in the future. If all Series A preferred stock was converted and all warrants were exercised, our outstanding shares of common stock would increase from approximately 162 million shares to approximately 242 million shares, or an increase of approximately 49%, as of June 30, 2003. The issuance of our common stock upon the conversion of Series A preferred stock or the exercise of warrants could have a depressive effect on the market price of the common stock by increasing the number of shares of common stock outstanding on an absolute basis or as a result of the timing of additional shares of common stock becoming available on the market.

The Holders of Our Series A Preferred Stock, as a Group, Have the Ability to Control a Significant Portion of Our Common Stock.

The holders of our Series A preferred stock, as a group, control a significant portion of our outstanding capital stock and, as such, have significant voting power with respect to our shares. In light of certain holders’ combined ownership of a substantial amount of outstanding shares of our common stock (see “Security Ownership of Certain Beneficial Owners and Management” below), those holders may be able to influence the outcome of matters brought before the shareholders, including a vote for the election of directors, changes to our certificate of incorporation and bylaws and other matters requiring shareholder approval.

The Holders of Our Series A Preferred Stock Have Payment Rights That are Senior to Holders of Our Common Stock in Certain Events.

In the event of a liquidation, dissolution or winding up of the Company, holders of our Series A preferred stock would have claims against our assets that are senior to any claims of the holders of our common stock. In that event, the holders of the Series A preferred stock would be entitled to be paid out of the proceeds received from the sale of such assets before any payments would be made to the holders of our common stock. More specifically, the holders of our Series A preferred stock would be entitled to receive an amount equal to the original price of the Series A preferred stock plus any declared and unpaid dividends thereon. That amount is currently equal to $32.00 per share of preferred or $92,405,161 in the aggregate for all shares of Series A preferred stock outstanding as of June 30, 2003. After receiving that preferential distribution, holders of our Series A preferred stock would then be entitled to participate ratably with the holders of our common stock in any receipt until the holders of our Series A preferred stock shall have received three times the original issue price.

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The Holders of Our Series A Preferred Stock Have Substantial Approval Rights Over Any Transaction Pursuant to Which the Company Would Undergo a Change in Control, Even if the Terms of That Transaction Included a Substantial Premium to the Then-current Market Price of Our Common Stock or Included Other Terms Deemed by Our Management or Board of Directors to be in the Best Interests of the Holders of Our Common Stock.

In the event of a “deemed liquidation” (defined in our certificate of incorporation as including a transaction involving a change in control of the Company), the holders of our Series A preferred stock would be entitled to be paid out of the consideration received in that transaction certain substantial preferential distributions before any distributions would be made to the holders of our common stock. More specifically, the holders of our Series A preferred stock would be entitled to receive an amount equal to the original price of the Series A preferred stock plus any declared and unpaid dividends thereon. That amount is currently equal to $32.00 per share of preferred or $92,405,161 in the aggregate for all shares of Series A preferred stock outstanding as of June 30, 2003. After receiving that preferential distribution, holders of our Series A preferred stock would then be entitled to participate ratably with the holders of our common stock in any receipt of remaining consideration received in that transaction until the holders of our Series A preferred stock shall have received three times the original issue price. As a result, as long as a significant number of shares of our Series A preferred stock remain outstanding, it is highly unlikely that a transaction contemplating a change of control of the Company would be received by the Company from a third party, or if received could be approved and recommended by our management or board of directors consistent with the relevant fiduciary duties of those persons in considering that approval or recommendation.

The Terms of Our Series A Preferred Stock Contain a Number of Restrictive Covenants in Favor of the Holders of That Stock That Could Impair or Impede Our Ability to Carry Out Our Business Plan or Take Other Actions, Including Those Otherwise Deemed to be in the Best Interests of the Holders of Our Common Stock.

The terms of our Series A preferred stock contain covenants that restrict the Company’s operations in a number of significant respects. Without the approval of holders of at least 50% of the outstanding shares of such stock, the Company may not, among other things: increase or decrease its authorized number shares of capital stock; authorize, issue or sell securities that rank equal with or senior to our Series A preferred stock as to redemption, voting rights, liquidation preferences or dividends; issue debt in excess of $5 million; or increase the number of shares available under our stock compensation plans. The terms of our Series A preferred stock also contain an anti-dilution provision that would, if we issue shares of common stock or are deemed to issue those shares in certain circumstances or at prices below the conversion price of the Series A preferred stock (currently $1.48 per share of common stock), cause us to issue substantial numbers of shares of common stock to our holders of Series A preferred stock, resulting in potentially substantial dilution in the economic and voting power of the holders of our common stock. There is no assurance that the Company could obtain the approval of the requisite percentage of holders of Series A preferred stock to the waiver or amendment of one or more of the foregoing restrictive covenants on a timely basis, if at all.

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We maintain cash and short-term deposits at our financial institutions that have daily liquidity. Due to the short-term nature of our deposits, they are recorded on the balance sheet at fair value. We also have a $1.2 million equity investment in Aventail, an early stage, privately held company. This strategic investment is inherently risky, in part because the market for the products or services being offered or developed by Aventail has not been proven and may never materialize. Because of risk associated with this investment, we could lose our entire initial investment in Aventail. Furthermore we have invested $4.1 million in a Japan based joint venture with NTT-ME Corporation, Internap Japan. This investment is accounted for using the equity-method and to date we have recognized $3.0 million in equity-method losses, representing our proportionate share of the aggregate joint venture losses. Furthermore, the joint venture investment is subject to foreign currency exchange rate risk. In addition, the market for services being offered by Internap Japan has not been proven and may never materialize.

As of June 30, 2003, our cash equivalents mature within three months and our short-term investments generally mature in less than one year. Therefore, as of June 30, 2003, we believe the reported amounts of cash and cash equivalents and investments to be reasonable approximations of fair value and the market risk arising from our holdings to be minimal.

As of June 30, 2003, our notes payable, revolving credit facility and capital lease obligations are recorded at the face amount of the obligation, which approximates the fair value and the market risk. None of the obligations have been hedged through the use of derivative instruments as of June 30, 2003.

Substantially all of our revenues are currently in United States dollars and from customers primarily in the United States. Therefore, we do not believe we currently have any significant direct foreign currency exchange rate risk.

ITEM 4. CONTROLS AND PROCEDURES

(a) Evaluation of disclosure controls and procedures. Our chief executive officer and chief financial officer, after evaluating the effectiveness of our “disclosure controls and procedures” (as defined in the Securities Exchange Act of 1934 Rules 13a-14(c) and 15d-14(c)) as of the end of the period covered by this quarterly report, have concluded that our disclosure controls and procedures were effective in timely alerting them to material information relating to us which were required to be included in our periodic SEC filings.

(b) Changes in internal controls. There were no changes in our internal controls over financial reporting that occurred during our most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

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PART II. OTHER INFORMATION

ITEM1. LEGAL PROCEEDINGS

None

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

None

ITEM3. DEFAULTS UPON SENIOR SECURITIES

None

ITEM4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

On June 17, 2003, we held our 2003 Annual Meeting of Stockholders at which stockholders approved the re-election of Gregory A. Peters and Robert D. Shurtleff, Jr. to serve as Class I directors until the 2006 Annual Meeting of Stockholders and also ratified the appoint of PricewaterhouseCoopers LLP as our independent accountants for the 2003 fiscal year. With respect to the election of directors, there were 167,935,093 votes cast, with 165,042,871 votes in favor and 2,892,222 votes withheld with respect to Mr. Peters and 166,349,320 votes in favor and 1,585,773 votes withheld with respect to Mr. Shurtleff. With respect to the ratification of accountants, 164,215,330 votes were in favor of ratification, 3,370,872 votes were against and 348,869 were abstentions. The 2003 Annual Meeting of Stockholders was adjourned to July 11, 2003 with respect to the remaining nine proposals constituting the remaining business of the meeting. On July 11, 2003, the 2003 Annual Meeting of Stockholders was resumed and stockholders approved nine proposals constituting the business of the meeting. With respect to the proposal to amend our certificate of incorporation and bylaws to permit the holders of Series A preferred stock to take action by written consent in lieu of a meeting, there were 141,407,189 shares votes cast in favor, 6,717,300 against and 564,509 abstaining. With respect to the proposal to amend the company’s certificate of incorporation to limit the liquidation rights of the holders of our Series A preferred stock upon certain events that have not been approved by our Board of Directors, there were 137,876,161 votes cast in favor, 3,516,930 against and 7,295,908 abstaining. With respect to the proposal to amend the company’s certificate of incorporation to increase the authorized size of our Board of Directors to nine members, there were 174,512,218 votes cast in favor, 11,461,020 against and 7,823,861 abstaining. With respect to the proposal to ratify our 2002 Stock Compensation Plan, increase by 22,000,000 shares the number of shares available for issuance thereunder and to amend the definition of “change in control” in that Plan, there were 112,803,363 votes in favor, 25,787,274 against and 10,098,362 abstaining. With respect to the proposal to increase by 3,000,000 shares the number of shares available for issuance under our 1999 Non-Employee Directors’ Stock Option Plan, there were 115,887,947 votes in favor, 20,280,927 against and 12,520,103 abstaining. With respect to the proposal to ratify the 1999 Equity Incentive Plan and amend the definition of “change of control” in that Plan, there were 128,275,025 votes in favor, 14,527,275 against and 25,195,853 abstaining. With respect to the proposal to ratify our Amended and Restated 1999 Stock Incentive Plan and amend the definition of “change of control” in that Plan, there were 129,514,973 votes in favor, 13,365,860 against and 25,117,319 abstaining. With respect to the proposal to ratify our Amended and Restated 1998 Stock Option/Stock Issuance Plan and amend the definition of “change of control” in that Plan, there were 128,067,088 votes in favor, 14,091,834 against and 25,839,230 abstaining. With respect to the proposal to ratify our 2000 Non-Officer Equity Incentive Plan and amend the definition of “change in control” in that Plan, there were 129,335,978 votes in favor, 13,537,119 against and 25,125,056 abstaining. The foregoing matters are more fully described in our definitive proxy statement dated April 28, 2003, available at the SEC’s website at www.sec.gov.

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ITEM5. OTHER INFORMATION

None

ITEM6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits:

Exhibit Number	Description
3.1	Certificate of Incorporation of the Registrant (incorporated herein by reference to Exhibit 3.1 to the Company’s Amended Quarterly Report on Form 10Q/A for the quarter ended September 30, 2002, filed January 9, 2003
3.2	Amendment to Certificate of Incorporation filed July 11, 2003
10.2	Amendment to Loan Documents between the Registrant and Silicon Valley Bank, dated March 25, 2003 (incorporated by reference herein to Exhibit 10.32 to the Company’s Form 10-K for the fiscal year ended December 31, 2002, filed April 15, 2003
31	Rule 13a – 14 (a) / 15d – 14 (a) Certifications
32	Section 1350 Certifications

(b) Reports on Form 8-K

None

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SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

INTERNAPNETWORKSERVICESCORPORATION                                 (Registrant)
By:	/S/ ROBERT R. JENKS
	Robert R. Jenks VicePresidentandChiefFinancialOfficer (PrincipalFinancialandAccountingOfficer)
Date:	August 14, 2003

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