<PAGE>
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-Q
---------------
(MARK ONE)
<TABLE>
<C> <S>
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
</TABLE>
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1999
OR
<TABLE>
<C> <S>
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
</TABLE>
FOR THE TRANSITION PERIOD FROM ______________ TO ______________
COMMISSION FILE NUMBER: 000-27265
------------------------
INTERNAP NETWORK SERVICES CORPORATION
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
WASHINGTON 91-1896926
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
</TABLE>
601 UNION STREET, SUITE 1000
SEATTLE, WASHINGTON 98101
(Address of principal executive offices)
(206) 441-8800
(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 / / No /X/
Indicate the number of shares outstanding of each of the registrant's
classes of common stock as of the latest practicable date: 65,792,882 shares of
common stock, no par value, outstanding as of November 1, 1999.
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<PAGE>
INTERNAP NETWORK SERVICES CORPORATION
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 1999
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
--------
<S> <C> <C> <C>
PART I CONDENSED FINANCIAL INFORMATION
Item 1. Condensed Financial Statements
Condensed Balance Sheets
September 30, 1999 and December 31, 1998.................. 3
Condensed Statements of Operations
Three and nine months ended September 30, 1999 and 1998... 4
Condensed Statements of Cash Flows
Nine months ended September 30, 1999 and 1998............. 5
Condensed Statement of Shareholders' Equity (Deficit)
Nine months ended September 30, 1999...................... 6
Notes to Condensed Financial Statements..................... 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 13
Item 3. Quantitative and Qualitative Disclosures About Market
Risk...................................................... 19
PART II. OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds................... 31
Item 4. Submissions of Matters to a Vote of Security Holders........ 31
Item 6. Exhibits and Reports on Form 8-K............................ 31
Signatures........................................................... 32
</TABLE>
2
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. CONDENSED FINANCIAL STATEMENTS
INTERNAP NETWORK SERVICES CORPORATION
CONDENSED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- ------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 827 $ 275
Accounts receivable, net of allowance of $135 and $65,
respectively............................................ 2,609 766
Stock subscription receivable............................. 176,700
Prepaid expenses.......................................... 250 280
--------- --------
Total current assets.................................... 180,386 1,321
Property and equipment, net............................... 19,784 5,828
Restricted cash........................................... 1,677
Patents and trademarks, net............................... 123 48
Deposits and other assets, net............................ 963 290
--------- --------
Total assets............................................ $ 202,933 $ 7,487
========= ========
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable.......................................... $ 5,674 $ 2,603
Accrued liabilities....................................... 1,278 713
Deferred revenues......................................... 9 284
Line of credit............................................ 1,525 650
Note payable, current portion............................. 482
Capital lease obligations, current portion................ 4,563 1,331
--------- --------
Total current liabilities............................... 13,531 5,581
Note payable, less current portion........................ 1,269
Capital lease obligations, less current portion........... 8,002 2,342
--------- --------
Total liabilities....................................... 22,802 7,923
--------- --------
Commitments and contingencies
Shareholders' equity (deficit):
Preferred stock, $0.001 par value, authorized 50,070
shares; 49,477 and 19,645 shares issued and outstanding,
respectively; aggregate liquidation preference of
$40,588 and $8,466, respectively........................ 50 20
Common stock, $0.001 par value, 300,000 shares authorized;
13,816 and 3,336 shares issued and outstanding,
respectively............................................ 14 3
Additional paid-in capital................................ 242,091 9,576
Deferred stock compensation............................... (20,505) (494)
Accumulated deficit....................................... (41,519) (9,541)
--------- --------
Total shareholders' equity (deficit).................... 180,131 (436)
--------- --------
Total liabilities and shareholders' equity (deficit).... $ 202,933 $ 7,487
========= ========
</TABLE>
The accompanying notes are an integral part of these condensed financial
statements
3
<PAGE>
INTERNAP NETWORK SERVICES CORPORATION
CONDENSED STATEMENTS OF OPERATIONS
(UNAUDITED, IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- --------------------
1999 1998 1999 1998
--------- -------- --------- --------
<S> <C> <C> <C> <C>
Revenues........................................... $ 3,613 $ 472 $ 7,022 $ 1,203
--------- -------- --------- --------
Costs and expenses:
Cost of network and customer support............. 8,428 797 16,335 1,791
Product development.............................. 1,053 187 2,448 505
Sales and marketing.............................. 4,691 715 10,560 1,067
General and administrative....................... 2,216 487 5,121 1,081
Amortization of deferred stock compensation...... 2,505 110 4,292 129
--------- -------- --------- --------
Total costs and expenses....................... 18,893 2,296 38,756 4,573
--------- -------- --------- --------
Loss from operations............................... (15,280) (1,824) (31,734) (3,370)
Other income (expense):
Interest income.................................. 93 38 543 159
Interest and financing expense................... (640) (27) (787) (63)
--------- -------- --------- --------
Net loss....................................... $ (15,827) $ (1,813) $ (31,978) $ (3,274)
========= ======== ========= ========
Basic and diluted net loss per share............... $ (3.84) $ (0.54) $ (8.77) $ (0.98)
========= ======== ========= ========
Weighted average shares used in computing basic and
diluted net loss per share....................... 4,123 3,337 3,646 3,336
========= ======== ========= ========
Pro forma basic and diluted net loss per
share(A)......................................... $ (0.30) $ (0.64)
========= =========
Weighted average shares used in computing pro forma
basic and diluted net loss per share............. 53,595 49,953
========= =========
</TABLE>
- ------------------------
(A) Assumes shares of the Company's convertible preferred stock outstanding
prior to the initial public offering have been converted into common stock
as of the date of issuance.
The accompanying notes are an integral part of these condensed financial
statements
4
<PAGE>
INTERNAP NETWORK SERVICES CORPORATION
CONDENSED STATEMENTS OF CASH FLOWS
(UNAUDITED, IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
--------------------
1999 1998
--------- --------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss.................................................. $ (31,978) $ (3,274)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization........................... 2,854 457
Non-cash interest and financing expense................. 549 4
Provision for doubtful accounts......................... 88 123
Amortization of deferred stock compensation............. 4,292 129
Changes in operating assets and liabilities:
Accounts receivable..................................... (1,931) (208)
Prepaid expenses and other assets....................... (705) (217)
Accounts payable........................................ 3,014 (189)
Deferred revenues....................................... (275) (72)
Accrued liabilities..................................... 565 206
--------- --------
Net cash used in operating activities................. (23,527) (3,041)
--------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment....................... (7,030) (679)
Purchase of short-term investments........................ (9,995)
Redemption of short-term investments...................... 9,995
Payments for patents and trademarks....................... (86)
--------- --------
Net cash used in investing activities................. (7,116) (679)
--------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from shareholder loan............................ 1,100
Repayment of shareholder loan............................. (1,100)
Proceeds from notes payable............................... 1,766
Principal payments on notes payable....................... (15) (34)
Net increase in line of credit............................ 875 250
Payments on capital lease obligations..................... (1,642) (303)
Proceeds from equipment leaseback financing............... 428
Restricted cash related to obtaining lease line........... (1,677)
Proceeds from exercise of warrants to purchase preferred
stock................................................... 121
Proceeds from exercise of stock options................... 71
Proceeds from sales of equity............................. 32,000 1,378
Cost of proceeds from sales of equity..................... (732)
--------- --------
Net cash provided by financing activities............. 31,195 1,291
--------- --------
Net increase (decrease) in cash and cash equivalents...... 552 (2,429)
Cash and cash equivalents at beginning of period.......... 275 4,770
--------- --------
Cash and cash equivalents at end of period................ $ 827 $ 2,341
========= ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest, net of amounts capitalized........ $ 238 $ 58
========= ========
Purchase of property and equipment financed with capital
leases.................................................. $ 10,105 $ 1,425
========= ========
Purchase of property and equipment included in accounts
payable................................................. $ 1,153
=========
Subscription receivable on sale of equity................. $ 176,700
=========
Cost of proceeds included in accounts payable............. $ 442
=========
Value ascribed to warrants................................ $ 536 $ 54
========= ========
</TABLE>
The accompanying notes are an integral part of these condensed financial
statements
5
<PAGE>
INTERNAP NETWORK SERVICES CORPORATION
CONDENSED STATEMENT OF SHAREHOLDERS' EQUITY (DEFICIT)
NINE MONTHS ENDED SEPTEMBER 30, 1999
(UNAUDITED, IN THOUSANDS)
<TABLE>
<CAPTION>
PREFERRED STOCK COMMON STOCK
------------------- ------------------- DEFERRED
PAR PAR ADDITIONAL STOCK ACCUMULATED
SHARES VALUE SHARES VALUE PAID-IN CAPITAL COMPENSATION DEFICIT TOTAL
-------- -------- -------- -------- --------------- ------------ ----------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balances, December 31,
1998.................. 19,645 $ 20 3,336 $ 3 $ 9,576 $ (494) $ (9,541) $ (436)
Issuances of Series C
preferred stock, net
of issuance costs of
$90................... 29,630 30 31,880 31,910
Issuance of common
stock, net of
underwriter's
commissions of
$13,300............... 9,500 10 176,690 176,700
Costs of issuance of
common stock.......... (1,084) (1,084)
Exercise of warrants to
purchase Series B
preferred stock....... 202 120 120
Exercise of employee
stock options......... 980 1 70 71
Deferred compensation
related to grants of
stock options......... 24,303 (24,303)
Amortization of deferred
stock compensation.... 4,292 4,292
Value ascribed to
warrants issued in
connection with
standby credit
facility.............. 536 536
Net loss................ (31,978) (31,978)
------- ---- ------ ---- --------- --------- --------- ---------
Balances, September 30,
1999.................. 49,477 $ 50 13,816 $ 14 $ 242,091 $ (20,505) $ (41,519) $ 180,131
======= ==== ====== ==== ========= ========= ========= =========
</TABLE>
The accompanying notes are an integral part of these condensed financial
statements
6
<PAGE>
INTERNAP NETWORK SERVICES CORPORATION
NOTES TO CONDENSED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION:
The unaudited condensed financial statements have been prepared by InterNAP
Network Services Corporation (the "Company") pursuant to the rules and
regulations of the Securities and Exchange Commission and include the accounts
of the Company. Certain information and footnote disclosures, normally included
in financial statements prepared in accordance with generally accepted
accounting principles, have been condensed or omitted pursuant to such rules and
regulations. In the opinion of management, the unaudited condensed financial
statements reflect all adjustments, consisting only of normal recurring
adjustments, necessary for a fair presentation of the Company's financial
position at September 30, 1999, its operating results for the three months and
nine months ended September 30, 1999 and 1998 and cash flows for the nine months
ended September 30, 1999 and 1998. The condensed balance sheet at December 31,
1998 has been derived from audited financial statements as of that date. These
condensed financial statements and the related notes should be read in
conjunction with the Company's financial statements and notes thereto contained
in the Company's Registration Statement on Form S-1 (File No. 333-84035) filed
with the Securities and Exchange Commission.
The results of operations for the three months and nine months ended
September 30, 1999 are not necessarily indicative of the results that may be
expected for the future quarters or the year ending December 31, 1999.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
ESTIMATES AND ASSUMPTIONS
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities in the
financial statements and disclosure of contingent assets and liabilities at the
date of the financial statements. Examples of estimates subject to possible
revision based upon the outcome of future events include depreciation of
property and equipment, income tax liabilities, the valuation allowance against
the deferred tax assets and the allowance for doubtful accounts. Actual results
could differ from those estimates.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company's financial instruments include cash and cash equivalents,
short-term investments, accounts receivable, accounts payable, capital lease
obligations, and the line of credit. The carrying value of the Company's
short-term financial instruments approximate fair value due to their relatively
short maturities. The carrying value of the Company's long-term financial
instruments approximate fair value based upon interest rates currently available
to the Company for issuance of similar debt with similar terms and maturities.
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. The Company has excluded all convertible preferred stock,
warrants to purchase convertible preferred stock, 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 pro forma net loss per share, as presented in the
statements of operations, has been computed as described above and
7
<PAGE>
INTERNAP NETWORK SERVICES CORPORATION
NOTES TO CONDENSED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
also gives effect to the conversion of the convertible preferred stock (using
the if-converted method) from the original date of issuance. Basic and diluted
net loss per share for the three months and nine months ended September 30, 1999
and 1998, and the pro forma basic and diluted net loss per share for the three
months and nine months ended September 30, 1999, are calculated as follows (in
thousands, except per share amounts):
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------- --------------------
1999 1998 1999 1998
--------- --------- --------- --------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
Net loss.......................................... $ (15,827) $ (1,813) $ (31,978) $ (3,274)
========= ========= ========= ========
Basic and diluted:
Weighted-average shares used in computing basic
and diluted net loss per share................ 4,123 3,337 3,646 3,336
========= ========= ========= ========
Basic and diluted net loss per share.............. $ (3.84) $ (0.54) $ (8.77) $ (0.98)
========= ========= ========= ========
Pro forma:
Net loss........................................ $ (15,827) $ (31,978)
========= =========
Shares used above............................... 4,123 3,646
Pro forma adjustment to reflect weighted effect
of assumed conversion of convertible preferred
stock......................................... 49,472 46,307
--------- ---------
Weighted average shares used in computing pro
forma basic and diluted net loss per common
share......................................... 53,595 49,953
========= =========
Pro forma basic and diluted net loss per common
share......................................... $ (0.30) $ (0.64)
========= =========
Antidilutive securities not included in diluted
net loss per share calculation:
Convertible preferred stock..................... 49,477 19,529 49,477 19,529
Options to purchase common stock................ 7,600 1,916 7,600 1,916
Warrants to purchase Series B preferred stock... 693 902 693 902
Unvested shares of common stock subject to
repurchase.................................... 113 -- 113 --
--------- --------- --------- --------
57,883 22,347 57,883 22,347
========= ========= ========= ========
</TABLE>
8
<PAGE>
INTERNAP NETWORK SERVICES CORPORATION
NOTES TO CONDENSED FINANCIAL STATEMENTS (CONTINUED)
3. PROPERTY AND EQUIPMENT:
Property and equipment consists of the following (in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- ------------
(UNAUDITED)
<S> <C> <C>
Network equipment........................................... $ 2,843 $ 1,150
Network equipment under capital lease....................... 13,914 4,465
Furniture, equipment and software........................... 4,432 424
Furniture, equipment and software under capital lease....... 948 142
Leasehold improvements...................................... 1,514 688
-------- -------
23,651 6,869
Less: Accumulated depreciation and amortization ($2,845 and
$952 related to capital leases at September 30, 1999 and
December 31, 1998, respectively).......................... (3,867) (1,041)
-------- -------
Property and equipment, net................................. $ 19,784 $ 5,828
======== =======
</TABLE>
4. ACCRUED LIABILITIES:
Accrued liabilities consist of the following (in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- ------------
(UNAUDITED)
<S> <C> <C>
Compensation payable........................................ $ 872 $ 567
Taxes payable............................................... 36 95
Other....................................................... 370 51
------- -----
$ 1,278 $ 713
======= =====
</TABLE>
5. FINANCING ARRANGEMENTS:
In January 1999, the Company borrowed $1,100,000 from two existing
shareholders as a bridge loan until the completion of the Series C financing.
Interest on these notes was at prime plus 2% and these notes were repaid in
full, plus accrued interest, during February 1999.
During July 1999, the Company amended its existing line of credit and
established a new line of credit (the "New Line") with the same financial
institution. The New Line allows the Company to borrow up to $3,000,000, as
limited by certain borrowing base requirements which include maintaining certain
levels of monthly revenues and customer turnover ratios. The New Line requires
monthly payments of interest only at prime plus 1% (9.25% at September 30, 1999)
and matures on June 30, 2000. Events of default for the New Line include failure
to maintain certain financial covenants or a material adverse change in the
financial position of the Company. A material adverse change is defined as a
material impairment in the perfection or priority of the bank's collateral or a
material impairment of the prospect of repayment of the New Line. The Company
borrowed an additional $900,000 on the New Line during July 1999.
9
<PAGE>
INTERNAP NETWORK SERVICES CORPORATION
NOTES TO CONDENSED FINANCIAL STATEMENTS (CONTINUED)
5. FINANCING ARRANGEMENTS: (CONTINUED)
During August 1999, the Company entered into an equipment financing
arrangement with a finance company which allows for borrowings of up to
$5,000,000 for the purchase of property and equipment. The equipment financing
arrangement includes sublimits of $3,500,000 for equipment costs and $1,500,000
for the acquisition of software and other P-NAP and facility costs. Loans under
the $3,500,000 sublimit require monthly principal and interest payments over a
term of 48 months. This facility bears interest at 7.47% plus an index rate
based on the yield of 4-year U.S. Treasury Notes (13.56% at September 30, 1999).
Loans under the $1,500,000 sublimit require monthly principal and interest
payments over a term of 36 months. This facility bears interest at 7.45% plus an
index rate based on the yield of 3-year U.S. Treasury Notes (13.38% at
September 30, 1999). Borrowings under each sublimit must be made prior to
May 1, 2000. During August and September 1999, the Company borrowed
approximately $1,765,000 pursuant to this arrangement. Amounts borrowed are
collateralized by the property and equipment purchased and require monthly
payments of principle and interest.
On September 23, 1999, the Company signed a standby loan facility agreement
with seven shareholders that matured upon closing of the Company's initial
public offering. This facility allowed the Company to draw up to $10,000,000
prior to the earlier of maturity or December 31, 1999 and would bear interest at
prime plus 2% with principal and interest due on the earlier of six months from
the first draw or maturity. The Company did not draw any amounts on the standby
credit facility prior to maturity. In connection with the standby credit
facility, the Company issued warrants to purchase 100,000 shares of common stock
with exercise prices of $20.00 per share. The estimated fair value ascribed to
the warrants was $536,000 based upon the Black-Scholes option pricing model, and
has been reflected as a financing expense for the three and nine months ended
September 30, 1999.
6. COMMITMENTS AND CONTINGENCIES:
During 1999, the Company entered into various operating lease agreements
which increased the total payments that will be paid on non-cancelable leases
over the next five years from approximately $4,095,000 as of December 31, 1998,
to approximately $16,000,000 as of September 30, 1999.
During September and October 1999, the Company entered into contracts with
backbone service providers to provide interconnection services. The contracts
provide for volume pricing based on minimum monthly payments aggregating
approximately $26,000,000 through 2002.
7. SHAREHOLDERS' EQUITY:
In February 1999, the Company sold 29,629,630 shares of Series C preferred
stock at a price of $1.08 per share, resulting in gross proceeds of
approximately $32,000,000, prior to deducting issuance costs.
During July 1999, the Board of Directors increased the number of authorized
shares of common stock to 300,000,000 shares.
On September 29, 1999, the Company sold 9,500,000 shares of its common stock
in an initial public offering at a price of $20.00 per share. As the actual
closing date of the offering was on October 4, 1999, the Company recorded a
stock subscription receivable of $176,700,000 at September 30, 1999, net of
underwriter's commissions of $13,300,000. On October 1, 1999, the underwriters
exercised their overallotment option, resulting in the sale of an additional
1,425,000 shares of common stock at $20.00 per share for total proceeds of
$26,505,000, net of underwriters'
10
<PAGE>
INTERNAP NETWORK SERVICES CORPORATION
NOTES TO CONDENSED FINANCIAL STATEMENTS (CONTINUED)
7. SHAREHOLDERS' EQUITY: (CONTINUED)
commissions of $1,995,000. Upon the closing of the Company's initial public
offering, the authorized shares of common stock were increased to 500,000,000
shares. Additionally, upon the closing of the Company's initial public offering,
all shares of preferred stock outstanding converted into 49,476,525 shares of
common stock and the authorized shares of preferred stock were decreased to
10,000,000 shares.
Concurrent with the closing of its initial public offering, the Company sold
1,075,269 shares of common stock to Inktomi Corporation for $18.60 per share,
resulting in proceeds of $19,000,000, net of a private placement fee of
$1,000,000. In conjunction with this investment, the Company issued a warrant to
purchase 537,634 shares of common stock at an exercise price of $27.90 per
share. The warrant has a two-year term and includes demand and piggyback
registration rights. The agreement also prohibits Inktomi from acquiring
additional shares of the Company's common stock for a period of two years. In
addition, the Company intends to complete a joint technical and marketing
agreement with Inktomi.
8. STOCK OPTION PLANS:
During June 1999, the Company's Board of Directors adopted the 1999 Equity
Incentive Plan (the "1999 Plan") which provides for the issuance of incentive
stock options ("ISOs") and nonqualified stock options to eligible individuals
responsible for the management, growth and financial success of the Company. As
of September 30, 1999, 6,500,000 shares of common stock have been reserved for
the 1999 Plan. The terms of the 1999 Plan are the same as the 1998 Stock
Option/Stock Issuance Plan (the "1998 Plan") with respect to ISO treatment and
vesting. During the nine months ended September 30, 1999, the Company granted an
additional 1,468,500 incentive stock options under the 1998 Plan and 3,577,500
incentive stock options under the 1999 Plan. During the nine months ended
September 30, 1999, the Company granted an aggregate of 4,928,039 stock options,
net of cancellations, with exercise prices below the deemed fair value of the
Company's common stock, recorded approximately $24,303,000 of deferred stock
compensation related to such options, and amortized approximately $4,292,000 to
expense. The weighted average exercise price per share of the options to
purchase common stock was $3.25, and the weighted average fair value per share
was $8.19 during 1999. As of September 30, 1999, 3,805,800 and 3,557,500 options
were outstanding under the 1998 Plan and 1999 Plan, respectively, net of
exercises and cancellations.
During July 1999, the Company adopted the 1999 Non-Employee Directors' Stock
Option Plan (the "Director Plan"). The Director Plan provides for the grant of
non-qualified stock options to non-employee directors. A total of 500,000 shares
of the Company's common stock have been reserved for issuance under the Director
Plan. Under the terms of the Director Plan, 240,000 fully vested options were
granted to existing directors on the effective date of the Company's initial
public offering with an exercise price of $20.00 per share. Subsequent to the
Company's initial public offering, initial grants, which are fully vested as of
the date of the grant, of 40,000 shares of the Company's common stock are to be
made under the Director Plan to all non-employee directors on the date such
person is first elected or appointed as a non-employee director. On the day
after each of the Company's annual shareholder meetings, starting with the
annual meeting in 2000, each non-employee director will automatically be granted
a fully vested and exercisable option for 10,000 shares, provided such person
has been a non-employee director of the Company for at least the prior six
months. The options are
11
<PAGE>
INTERNAP NETWORK SERVICES CORPORATION
NOTES TO CONDENSED FINANCIAL STATEMENTS (CONTINUED)
8. STOCK OPTION PLANS: (CONTINUED)
exercisable as long as the non-employee director continues to serve as a
director, employee or consultant of the Company or any of its affiliates.
During July 1999, the Company adopted the Employee Stock Purchase Plan (the
"ESPP"). The ESPP allows all full-time and certain part-time employees to
participate by purchasing the Company's common stock using a uniform percentage
of compensation at a discount allowed under guidelines issued by the Internal
Revenue Service. A total of 1,500,000 shares of the Company's common stock has
been reserved for issuance under the ESPP. Each year, the number of shares
reserved for issuance under the ESPP will automatically be increased by 2% of
the total number of shares of common stock then outstanding or, if less, by
1,500,000 shares.
12
<PAGE>
INTERNAP NETWORK SERVICES CORPORATION
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 the 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 Quarterly
Report, and in other documents we file with the Securities and Exchange
Commission.
OVERVIEW
We are a leading provider of fast, reliable and centrally managed Internet
connectivity services targeted at businesses seeking to maximize the performance
of mission-critical Internet-based applications. Customers connected to one of
our P-NAP facilities have their data optimally routed to and from destinations
on the Internet in a manner that minimizes the use of congested public network
access points and private peering points. This optimal routing of data traffic
over the multiplicity of networks that comprise the Internet enables higher
transmission speeds, lower instances of packet loss and greater quality of
service.
After we decide to open a new P-NAP facility, we enter into a deployment
phase which typically lasts four to six months, during which time we execute the
required steps to make the P-NAP facility commercially ready for service. Among
other things, this usually entails obtaining co-location space to locate our
equipment, entering into agreements with backbone providers, obtaining local
loop connections from local telecommunications providers, building P-NAP
facilities and initiating pre-sales and marketing activities. Consequently, we
usually incur a significant amount of upfront costs related to making a P-NAP
facility commercially ready for service prior to generating revenues. Therefore,
our results of operations will be negatively affected during times of P-NAP
facility deployment. As of September 30, 1999, we had a total of nine P-NAP
facilities deployed in the Atlanta, Boston, Chicago, Los Angeles, New York,
Philadelphia, San Jose, Seattle and Washington, D.C. metropolitan areas, as
compared to two P-NAP facilities deployed as of September 30, 1998.
During the year ended December 31, 1998 and the nine months ended
September 30, 1999, 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 deemed fair value of our common stock on
the date such options were granted and the exercise price. Such amount is
included as a component of shareholders' equity and is being amortized over the
vesting period of the individual options, generally four years, using an
accelerated method as described in Financial Accounting Standards Board
Interpretation No. 28. We recorded amortization of deferred stock compensation
in the amount of $4.2 million for the nine months ended September 30, 1999. At
September 30, 1999, we had a total of $20.5 million remaining to be amortized
over the corresponding vesting periods of the stock options.
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INTERNAP NETWORK SERVICES CORPORATION
RESULTS OF OPERATIONS
The following table sets forth, as a percentage of total revenues, selected
statement of operations data for the periods indicated:
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- --------------------
1999 1998 1999 1998
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Revenues.................................................... 100% 100% 100% 100%
---- ---- ---- ----
Costs and expenses:
Cost of network and customer support...................... 233 169 233 149
Product development....................................... 29 40 35 42
Sales and marketing....................................... 130 151 150 89
General and administrative................................ 61 103 73 90
Amortization of deferred stock compensation............... 69 23 61 11
---- ---- ---- ----
Total costs and expenses................................ 522 486 552 381
---- ---- ---- ----
Loss from operations...................................... (422) (386) (452) (281)
Other income (expense):
Interest income........................................... 3 8 8 13
Interest and financing expense............................ (18) (5) (11) (5)
---- ---- ---- ----
Net loss.................................................. (437)% (383)% (455)% (273)%
==== ==== ==== ====
</TABLE>
NINE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998
REVENUES. Revenues increased 483% from $1.2 million for the nine-month
period ended September 30, 1998, to $7.0 million for the nine-month period ended
September 30, 1999. This increase of $5.8 million was primarily due to increased
Internet connectivity revenues. The increase in Internet connectivity revenues
was attributable to the increased sales at our existing P-NAP facilities and the
deployment of additional P-NAP facilities during 1999 and the second half of
1998.
COSTS OF NETWORK AND CUSTOMER SUPPORT. Costs of network and customer
support increased 806% from $1.8 million for the nine-month period ended
September 30, 1998 to $16.3 million for the nine-month period ended
September 30, 1999. This increase of $14.5 million was primarily due to
increased connectivity costs related to added connections to Internet backbone
providers at each P-NAP facility and to a lesser extent, additional compensation
costs, and depreciation expense related to the equipment at newly deployed P-NAP
facilities. Network and customer support costs as a percentage of total revenues
are generally greater than 100% for newly deployed P-NAP facilities because we
purchase Internet connectivity capacity from the backbone providers in advance
of securing new customers. We expect these costs to increase in absolute dollars
as we deploy additional P-NAP facilities.
PRODUCT DEVELOPMENT. Product development costs increased 376% from $505,000
for the nine-month period ended September 30, 1998, to $2.4 million for the
nine-month period ended September 30, 1999. This increase of $1.9 million was
primarily due to compensation costs and outside consulting fees. We expect
product development costs to increase in absolute dollars for the foreseeable
future.
SALES AND MARKETING. Sales and marketing costs increased 864% from
$1.1 million for the nine-month period ended September 30, 1998, to
$10.6 million for the nine-month period ended
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INTERNAP NETWORK SERVICES CORPORATION
September 30, 1999. This increase of $9.5 million was primarily due to
compensation costs and to a lesser extent, facility costs related to the
addition of sales offices. As part of our expanded sales and marketing
activities, we hired a vice president of sales and marketing during the second
quarter of 1998 and additional sales personnel during the second half of 1998
and the first nine months of 1999.
GENERAL AND ADMINISTRATIVE. General and administrative costs increased 364%
from $1.1 million for the nine-months ended September 30, 1998, to $5.1 million
for the nine-months ended September 30, 1999. This increase of $4.0 million was
primarily due to compensation costs, professional services costs and increased
depreciation and amortization costs due to the addition of corporate office
space during the third quarter of 1998 and third quarter of 1999. We expect
general and administrative costs to increase in absolute dollars as we deploy
additional P-NAP facilities.
OTHER INCOME (EXPENSE). Other income (expense) consists of interest income,
interest and financing expense and other non-operating expenses. Other income
(expense), net, decreased 351% from $96,000 of other income for the nine-month
period ended September 30, 1998 to $244,000 of other expense for the nine-month
period ended September 30, 1999. This decrease of $340,000 was primarily due to
interest income earned on the proceeds from the Series C preferred stock
financing, offset by increased interest expense on capital lease obligations and
a one-time charge to interest expense of $536,000 related to the warrants issued
in conjunction with our standby credit facility.
THREE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998
REVENUES. Revenues increased 663% from $472,000 for the three-month period
ended September 30, 1998 to $3.6 million for the three-month period ended
September 30, 1999. This increase of $3.1 million was primarily due to increased
Internet connectivity revenues. The increase in Internet connectivity revenues
was attributable to the increased sales at our existing P-NAP facilities and the
deployment of additional P-NAP facilities during 1999 and the second half of
1998.
COSTS OF NETWORK AND CUSTOMER SUPPORT. Costs of network and customer
support increased 954% from $797,000 for the three-month period ended
September 30, 1998 to $8.4 million for the three-month period ended
September 30, 1999. This increase of $7.6 million was primarily due to increased
connectivity costs related to added connections to Internet backbone providers
at each P-NAP facility and, to a lesser extent, depreciation expense related to
the equipment at newly deployed P-NAP facilities and additional compensation
costs. Network and customer support costs as a percentage of total revenues are
generally greater than 100% for newly deployed P-NAP facilities because we
purchase Internet connectivity capacity from the backbone providers in advance
of securing new customers. We expect these costs to increase in absolute dollars
as we deploy additional P-NAP facilities.
PRODUCT DEVELOPMENT. Product development costs increased 488% from $187,000
for the three-month period ended September 30, 1998, to $1.1 million for the
three-month period ended September 30, 1999. This increase of $913,000 was
primarily due to compensation costs and outside consulting fees. We expect
product development costs to increase in absolute dollars for the foreseeable
future.
SALES AND MARKETING. Sales and marketing costs increased 559% from $715,000
for the three-month period ended September 30, 1998 to $4.7 million for the
three-month period ended September 30, 1999. This increase of $4.0 million was
primarily due to compensation costs and, to a lesser extent, facility costs
related to the addition of sales offices. As part of our expanded sales and
marketing activities, we hired a vice president of sales and marketing during
the second quarter of 1998 and additional sales personnel during the second half
of 1998 and the first nine months of 1999.
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INTERNAP NETWORK SERVICES CORPORATION
GENERAL AND ADMINISTRATIVE. General and administrative costs increased 349%
from $487,000 for the three-months ended September 30, 1998, to $2.2 million for
the three-months ended September 30, 1999. This increase of $1.7 million was
primarily due to compensation costs, professional services costs, and increased
depreciation and amortization costs due to the addition of corporate office
space during the third quarter of 1998. We expect general and administrative
costs to increase in absolute dollars as we deploy additional P-NAP facilities.
OTHER INCOME (EXPENSE). Other income (expense) consists of interest income,
interest and financing expense and other non-operating expenses. Other income
(expense), net, decreased 5,073% from $11,000 of other income for the
three-month period ended September 30, 1998 to $547,000 of other expense for the
three-month period ended September 30, 1999. This decrease of $558,000 was
primarily due to interest income earned on the proceeds from the Series C
preferred stock financing, offset by increased interest expense on capital lease
obligations and a one-time charge to interest expense of $536,000 related to the
warrants issued in conjunction with our standby credit facility.
LIQUIDITY AND CAPITAL RESOURCES
Since our inception through September 1999, we financed our operations
primarily through the issuance of our equity securities, capital leases and bank
loans. We raised an aggregate of $40.7 million, net of offering expenses,
through the sale of our equity securities prior to our initial public offering.
In September 1999, we sold 9,500,000 shares of our common stock at an
initial public offering price of $20.00 per share and, at September 30, 1999,
recorded a stock subscription receivable of $176.7 million, net of underwriters'
commissions and discounts of $13.3 million. During October 1999, in connection
with our initial public offering, the underwriters exercised their overallotment
option, resulting in the sale of an additional 1,425,000 shares of our common
stock at $20.00 per share for total proceeds of $26.5 million, net of
underwriters' commissions and discounts of $2.0 million. Upon the closing of our
initial public offering, all shares of outstanding preferred stock converted
into 49,476,525 shares of common stock.
Concurrent with the closing of our initial public offering on October 4,
1999, we sold 1,075,269 shares of common stock to Inktomi Corporation for $18.60
per share, resulting in proceeds of $19.0 million net of a private placement fee
of $1.0 million. In conjunction with this investment, we issued a warrant to
purchase 537,634 shares of our common stock at an exercise price of $27.90 per
share. The warrant has a two-year term and includes demand and piggyback
registration rights. The agreement also prohibits Inktomi from acquiring
additional shares of our common stock for a period of two years. In addition, we
intend to complete a joint technical and marketing agreement with Inktomi.
At September 30, 1999, we had cash and cash equivalents of $827,000. We have
a revolving line of credit with Silicon Valley Bank under which we are allowed
to borrow up to $3.0 million, as limited by certain borrowing base requirements
which include maintaining certain levels of monthly revenues and customer
turnover ratios. The line of credit requires monthly payments of interest only
at prime plus 1%, 9.25% as of September 30, 1999, and matures on September 30,
2000. At September 30, 1999, we had drawn $1.5 million on the line of credit.
On August 23, 1999, we entered into an equipment financing arrangement with
Finova Capital Corporation allowing us to borrow up to $5.0 million for the
purchase of property and equipment. The equipment financing arrangement includes
sublimits of $3.5 million for equipment costs and $1.5 million for the
acquisition of software and other P-NAP and facility costs. Loans under the
$3.5 million sublimit require monthly principal and interest payments over a
term of 48 months. This facility bears interest at 7.47% plus an index rate
based on the yield of 4-year U.S. Treasury Notes, 13.56% at September 30, 1999.
Loans under the $1.5 million sublimit require monthly principal and interest
payments over a term of 36 months. This facility bears interest at 7.45% plus an
index rate
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INTERNAP NETWORK SERVICES CORPORATION
based on the yield of 3-year U.S. Treasury Notes, 13.38% at September 30, 1999.
Borrowings under each sublimit must be made prior to May 1, 2000. During
August 1999, we borrowed approximately $1.8 million pursuant to this
arrangement.
On September 23, 1999, we signed a standby loan facility agreement with
seven shareholders, which matured upon the closing of our initial public
offering. This facility allowed us to draw up to $10,000,000, prior to the
earlier of maturity or December 31, 1999, and would bear interest at prime plus
2% with principal and interest due on the earlier of six months from the first
draw or maturity. We did not draw any amounts on the standby credit facility
prior to maturity. In connection with the standby credit facility, we issued
warrants to purchase 100,000 shares of common stock with exercise prices of
$20.00 per share. The estimated fair value ascribed to the warrants was $536,000
based upon the Black-Scholes option pricing model and we recorded this amount as
a financing expense for the three and nine months ended September 30, 1999.
Net cash used in operations was $23.5 million for the nine months ended
September 30, 1999. Net cash used in operations was $3.0 million for the nine
months ended September 30, 1998. Net cash used in operations for the nine months
ended September 30, 1999 was primarily due to funding our operating losses and
increases in accounts receivable and prepaid expenses, partially offset by
non-cash charges and an increase in accounts payable.
Net cash used in investing activities was $7.1 million for the nine months
ended September 30, 1999 and $679,000 for the nine months ended September 30,
1998. Net cash used in investing activities in each period reflects increased
purchases of property and equipment not financed by capital leases. Purchases of
property and equipment related to P-NAP facility deployments were primarily
financed by capital leases (these purchases and the related financings are
excluded from the net cash used in investing and financing activities in the
statement of cash flows because they are classified as non-cash transactions),
and totaled $17.1 million ($10.1 million financed by capital leases) for the
nine months ended September 30, 1999 and $2.1 million ($1.4 million financed by
capital leases) for the nine months ended September 30, 1998. Additionally, for
the nine month period ended September 30, 1999, $10.0 million was used to
purchase short-term investments which were redeemed in the same period.
Net cash provided from financing activities was $31.2 million for the nine
months ended September 30, 1999, and $1.3 million for the nine months ended
September 30, 1998. Net cash from financing activities primarily reflects
proceeds from the private sales of our equity securities offset by the costs of
those proceeds. Additionally, for the nine months ended September 30, 1999, we
recorded a non-cash subscription receivable of $176.7 million related to our
initial public offering.
We expect to spend significant additional capital to recruit and train our
customer installation team and the sales force and to build out the sales
facilities related to newly deployed P-NAP facilities. In addition to P-NAP
facility deployment, product development and the development of our internal
systems and software will continue to require significant capital expenditures
in the foreseeable future, as will the expansion of our marketing efforts. We
expect to continue to expend significant amounts of capital on property and
equipment related to the expansion of facility infrastructure, computer
equipment and for research and development laboratory and test equipment to
support on-going research and development operations.
We believe that the net proceeds from our initial public offering and the
net proceeds from our private placement to Inktomi, together with our cash and
cash equivalents, and funds available under the revolving and capital lease
lines will be sufficient to satisfy our cash requirements for the next
12 months. Depending on our rate of growth and cash requirements, we may require
additional equity or debt financing to meet future working capital needs, which
may have a dilutive effect on our then current shareholders. We cannot assure
you that such additional financing will be available or, if available, that such
financing can be obtained on satisfactory terms. Our management intends to
invest
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INTERNAP NETWORK SERVICES CORPORATION
cash in excess of current operating requirements in short-term,
interest-bearing, investment-grade securities.
IMPACT OF YEAR 2000
OVERVIEW. For many large, older companies that rely on mainframe-based
computing technology, solving Year 2000 problems is an enormous, complex task,
requiring significant resources and expense. InterNAP, however, was founded in
late 1996, and although seasoned in terms of the history of the Internet, its
technology is relatively recent in the context of the legacy systems which are
at risk from year 2000 problems.
Many of InterNAP's internal systems, including its billing system, Network
Management System ("NMS") and Trouble Ticketing System ("TTS"), were developed
internally, and were designed at inception to anticipate the date change.
Accordingly, although InterNAP's conformity strategy involves assessing and
testing internal systems, its primary focus centers on ascertaining and/or
testing third party equipment, systems, and infrastructure for compliance and
interoperability concerns.
At the time InterNAP designed and deployed its unique network
infrastructure, most selected hardware and software vendors were already aware
of year 2000 issues and were designing their products with year 2000 issues in
mind. Through careful vendor and product selection, InterNAP has attempted to
limit its exposure to possible year 2000 problems. Nevertheless, InterNAP has
very little, if any, control over the readiness of certain third parties upon
whom it depends and will not in any event be responsible for the failures,
noncompliance, lack of contingency plans, statements, claims, representations or
warranties of any such third parties, which may include but are not limited to
telecommunication access companies, equipment and software vendors or various
infrastructure providers.
GENERAL ASSESSMENT. InterNAP recognizes the potential for the year 2000
problem to affect network infrastructure, computers, software and other
equipment that we use, operate or maintain. As a result, we have formalized our
year 2000 compliance plan, to be implemented by a team of employees, led by our
internal information technology staff, which is responsible for monitoring the
assessment and remediation status of our year 2000 projects. Pursuant to our
year 2000 compliance plan, the project team has compiled a listing of all
mission-critical items, both internally developed and externally purchased,
which might be impacted by the year 2000 problem. We are nearing completion of
obtaining verification or validation from any independent third parties deemed
mission-critical to our processes to assess and correct, if necessary, our year
2000 problems associated with these third parties
ASSESSMENT OF INFORMATION TECHNOLOGY SYSTEMS. Beginning in 1998, we began
assessing the ability of the software, information systems and technologies we
developed ourselves or purchased from third parties to operate properly in the
year 2000. We believe that these software, information systems and technologies
are year 2000 compliant. We have completed a testing plan and verified
compliance of or replaced required components identified through our testing
process. In addition, we verified compliance of or replaced required components
identified by third party suppliers. Furthermore, as we design, develop or
purchase new components, we subject them to testing for year 2000 compliance and
the ability to distinguish between various date formats.
SYSTEMS OTHER THAN INFORMATION TECHNOLOGY SYSTEMS. In addition to computers
and related systems, the operation of office and facilities equipment, such as
fax machines, telephone switches, security systems and other common devices may
be affected by the year 2000 problem. We have contacted the third parties that
we have identified as suppliers of mission-critical components and have replaced
those items that were identified as non-year 2000 compliant by the supplier.
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INTERNAP NETWORK SERVICES CORPORATION
SUPPLIERS. As part of our year 2000 plan, we are in the final phases of
confirming year 2000 readiness with our third-party suppliers. However, we have
limited or no control over the actions of these third-party suppliers. Thus,
while we expect that we will be able to resolve any significant year 2000
problems with these third parties, there can be no assurance that these
suppliers will resolve any or all year 2000 problems before the occurrence of a
material disruption to the operation of our business. Any failure of these third
parties to timely resolve year 2000 problems with their systems could have a
material adverse effect on our business, financial condition and results of
operations.
MOST LIKELY CONSEQUENCES OF YEAR 2000 PROBLEMS. We expect to identify and
resolve the year 2000 problems that could significantly harm our business
operations. However, we believe that it is not possible to determine with
complete certainty that all year 2000 problems affecting us have been identified
or corrected. We believe that the most reasonably likely worst-case year 2000
scenarios would relate to problems with the systems of third parties rather than
our internal systems or our P-NAP facilities. These scenarios include possible
infrastructure collapse, the failure of electricity supply and water and sewer
service, financial, transportation and telecommunications disruptions, product
shortages and the unavailability of other services. Any one of these scenarios
could have a major and material effect on our ability to deliver services to our
customers or on our customers' ability to pay for our services.
CONTINGENCY PLANS. We have developed our contingency plans to be
implemented if our efforts to identify and correct year 2000 problems affecting
our internal systems are not effective. Depending on the systems affected, these
plans could include:
- accelerated replacement of affected equipment or software;
- short to medium-term use of backup equipment and software or other
redundant systems;
- increased work hours for our personnel or the hiring of additional
information technology staff; and
- the use of contract personnel to correct, on an accelerated basis, any
year 2000 problems that arise or to provide interim alternate solutions
for information system deficiencies.
We have also developed our contingency plans to be implemented if the
components, systems and services we have purchased or purchase from third-party
suppliers experience year 2000 problems. However, we have limited or no control
over the actions of these third parties, and there can be no assurance that
these suppliers will resolve any or all year 2000 problems.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risk for the impact of interest rate changes and
changes in the market value of our investments. Substantially all of our cash
equivalents, short-term investments and capital lease obligations are at fixed
interest rates, and therefore the fair value of these instruments is affected by
changes in market interest rates. However, as of September 30, 1999, all of our
cash equivalents mature within three months. As of September 30, 1999, we
believe the reported amounts of cash equivalents and capital lease obligations
to be reasonable approximations of their fair values.
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INTERNAP NETWORK SERVICES CORPORATION
RISK FACTORS
WE HAVE A HISTORY OF LOSSES, EXPECT FUTURE LOSSES AND MAY NOT ACHIEVE OR SUSTAIN
ANNUAL PROFITABILITY
We have incurred net losses in each quarterly and annual period since we
began operations. We incurred a net loss of $1.6 million for the year ended
December 31, 1997 and a net loss of $7.0 million for the year ended
December 31, 1998. Our net loss for the three months and the nine months ended
September 30, 1999 was $15.8 million and $32.0 million, respectively. As of
September 30, 1999, our accumulated deficit was $41.5 million. As a result of
our expansion plans, we expect to incur net losses and negative cash flows from
operations on a quarterly and annual basis for at least 24 months, and we may
never become profitable.
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. You 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 and
connectivity markets.
NEGATIVE MOVEMENTS IN OUR QUARTERLY OPERATING RESULTS MAY DISAPPOINT ANALYSTS'
EXPECTATIONS, WHICH COULD HAVE A NEGATIVE IMPACT ON OUR STOCK PRICE
Should our results of operations from quarter to quarter fail to meet the
expectations of public market analysts and investors, our stock price could
suffer. Any significant unanticipated shortfall of revenues or increase in
expenses could negatively impact our expected quarterly 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 quarterly results of operations.
Because our quarterly results of operations have fluctuated in the past and
will continue to fluctuate in the future, you should not rely on the results of
any past quarter or quarters as an indication of future performance in our
business operations or stock price. For example, increases in our quarterly
revenues for the quarters ended March 31, 1998 through September 30, 1999 have
varied between 13% and 74%, and total operating costs and expenses have
fluctuated between 34% and 98%. Fluctuations in our quarterly operating results
depend on a number of factors. Some of these factors are industry risks over
which we have no control including the introduction of new services by our
competitors, fluctuations in the demand and 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 and our ability
to obtain local loop connections to our P-NAP facilities at favorable prices.
Other factors that may cause fluctuations in our quarterly operating results
arise from strategic decisions we have made or will make with respect to the
timing and magnitude of capital expenditures such as those associated with the
deployment of additional P-NAP facilities and the terms of our Internet
connectivity purchases. For example, our practice is to purchase Internet
connectivity from backbone providers at new P-NAP facilities 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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INTERNAP NETWORK SERVICES CORPORATION
IF WE ARE UNABLE TO MANAGE COMPLICATIONS THAT ARISE DURING DEPLOYMENT OF NEW
P-NAP FACILITIES, WE MAY NOT SUCCEED IN OUR EXPANSION PLANS
Any delay in the opening of new P-NAP facilities would significantly harm
our plans to expand our business. In our effort to deploy new P-NAP facilities,
we face various risks associated with significant construction projects,
including identifying and locating P-NAP facility 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 P-NAP
facility. The deployment of new P-NAP facilities, each of which takes
approximately four to six months to complete, is a key element of our business
strategy. In addition to our nine existing locations, we are planning to
continue to deploy P-NAP facilities across a wide range of geographic regions.
Although we do market research in a geographic area before deploying a P-NAP
facility, we do not enter into service contracts with customers prior to
building a new P-NAP facility.
WE MAY BE UNABLE TO EFFECTIVELY INTEGRATE NEW P-NAP FACILITIES INTO OUR EXISTING
NETWORK, WHICH COULD DISRUPT OUR SERVICE
New P-NAP facilities, if completed, will 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 facilities in geographically dispersed
locations, our operations will be significantly harmed.
BECAUSE OUR REVENUES DEPEND HEAVILY ON A FEW SIGNIFICANT CUSTOMERS, A LOSS OF
MORE THAN ONE OF THESE SIGNIFICANT CUSTOMERS COULD REDUCE OUR REVENUES
We currently derive a substantial portion of our total revenues from a
limited number of customers, and the revenues from these customers may not
continue. For the year ended December 31, 1998, revenues from Go2Net represented
13.6% of our total revenues. For the year ended December 31, 1997, revenues from
Starcom Service Corporation represented 20.8% of our total revenues and Go2Net
represented 18.1% of our total revenues. Typically, the agreements with our
customers are based on our standard terms and conditions of service and
generally have terms ranging from one year to three years. Revenues from these
customers or from other customers that have accounted for a significant portion
of our revenues in past periods, individually or as a group, may not continue.
If such revenues do continue, they may not reach or exceed historical levels in
any future period. For example, in 1998 Starcom defaulted on its payments to us,
subsequently filed for bankruptcy and is no longer a customer of ours. In
addition, we may not succeed in diversifying our customer base in future
periods. Accordingly, we may continue to derive a significant portion of our
revenues from a relatively small number of customers. Further, we have had
limited experience with the renewal of contracts by customers whose initial
service contract terms have been completed and these customers may not renew
their contracts with us.
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INTERNAP NETWORK SERVICES CORPORATION
IF WE ARE UNABLE TO CONTINUE TO RECEIVE COST-EFFECTIVE SERVICE FROM OUR BACKBONE
PROVIDERS, WE MAY NOT BE ABLE TO PROVIDE OUR INTERNET CONNECTIVITY SERVICES ON
PROFITABLE TERMS AND THESE BACKBONE PROVIDERS MAY NOT CONTINUE TO PROVIDE
SERVICE TO US
In delivering our services, we rely on Internet backbones which are built
and operated by others. In order to be able to provide optimal routing to our
customers through our P-NAP facilities, we must purchase connections from
several Internet backbone providers. We cannot assure you that these Internet
backbone providers will continue to provide service to us on a cost-effective
basis, 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 fully operational P-NAP facilities, we have
connections to at least six of the following 10 backbone providers: Apex Global
Information Systems (AGIS), AT&T, Cable & Wireless USA, Inc., GTE
Internetworking, Inc., ICG Communications, Intermedia Communications Inc.,
PSINet, Inc., Sprint Internet Services, UUNET, an MCI WorldCom company, and
Verio, Inc. In addition, we do not begin to operate a P-NAP facility until it is
connected to at least two of the following four backbone providers: UUNET,
Sprint, Cable & Wireless USA and GTE Internetworking. We may be unable to
maintain relationships with, or obtain necessary additional capacity from, these
backbone providers. Furthermore, we may be unable to establish and maintain
relationships with other backbone providers that may emerge or that are
significant in geographic areas in which we locate our P-NAP facilities.
COMPETITION FROM MORE ESTABLISHED COMPETITORS WHO HAVE GREATER REVENUES COULD
DECREASE OUR MARKET SHARE
The Internet connectivity services market is extremely competitive, and
there are few substantial barriers to entry. 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 in our market. 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 us
connectivity services, including AGIS, AT&T, Cable & Wireless USA, GTE
Internetworking, ICG Communications, Intermedia, PSINet, Sprint, UUNET and
Verio, regional Bell operating companies which offer Internet access, and
global, national and regional Internet service providers.
In addition, if we are successful in implementing our international
expansion, we expect to encounter additional competition from international
Internet service providers as well as international telecommunications
companies.
COMPETITION FROM NEW COMPETITORS COULD DECREASE OUR MARKET SHARE
We also believe that new competitors will enter our market. Such new
competitors could include computer hardware, software, media and other
technology and telecommunications companies. A number of telecommunications
companies and online service providers have announced plans to offer or expand,
their network services. For example, GTE Internetworking, PSINet and Verio have
expanded their Internet access products and services through acquisition.
Further, the ability of some of
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INTERNAP NETWORK SERVICES CORPORATION
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 data services using alternative delivery methods including the cable
television infrastructure, direct broadcast satellites, wireless cable and
wireless local loop. In addition, Internet backbone providers may make
technological developments, such as improved router technology, that will
enhance the quality of their services.
PRICING PRESSURE COULD DECREASE OUR MARKET SHARE
Increased price competition or other competitive pressures could erode our
market share. We currently charge, and expect to continue to charge, more for
our Internet connectivity services than our competitors. For example, our
current standard pricing is approximately 4% more than UUNET's current standard
pricing and approximately 18% more than Sprint's current standard pricing. 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. We may not be able to
offset the effects of any such price reductions even with an increase in the
number of our customers, higher revenues from enhanced services, cost reductions
or otherwise. In addition, we believe that the Internet connectivity industry is
likely to encounter consolidation in the future. Consolidation could result in
increased pressure on us to decrease our prices.
A FAILURE IN OUR NETWORK OPERATIONS CENTER, P-NAP FACILITIES OR COMPUTER SYSTEMS
WOULD CAUSE A SIGNIFICANT DISRUPTION IN THE PROVISION OF OUR INTERNET
CONNECTIVITY SERVICES
Although we have taken precautions against systems failure, interruptions
could result from natural disasters as well as power loss, telecommunications
failure and similar events. Our business depends on the efficient and
uninterrupted operation of our network operations center, our P-NAP facilities
and our computer and communications hardware systems and infrastructure. We
currently have one network operations center located in Seattle, and we have
nine P-NAP facilities which are located in the Atlanta, Boston, Chicago, Los
Angeles, New York, Philadelphia, San Jose, Seattle and Washington, D.C.
metropolitan areas. 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 and
P-NAP facilities, any of which would seriously harm our business.
OUR BRAND IS NOT WELL-KNOWN, 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, our market presence has been limited principally to the
Atlanta, Boston, Chicago, Los Angeles, New York, Philadelphia, San Jose, Seattle
and Washington D.C. metropolitan areas. To date, we have attracted our existing
customers primarily through a relatively small sales force and word of mouth. In
order to build our brand awareness, we intend to significantly increase our
marketing efforts, which may not be successful, and we must continue to provide
high quality services. As part of our brand building efforts, we expect to
increase our marketing budget substantially as well as our
23
<PAGE>
INTERNAP NETWORK SERVICES CORPORATION
marketing activities, including advertising, tradeshows, direct response
programs and new P-NAP facility launch events. We may not succeed as planned.
BECAUSE ANY OF OUR KEY EMPLOYEES COULD TERMINATE HIS OR HER EMPLOYMENT AT WILL,
WE MAY BE UNABLE TO 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 any member of our executive management team or a key technical employee,
such as our Chief Executive Officer, Anthony Naughtin, our Chief Technology
Officer, Christopher Wheeler, or our Chief Financial Officer, Paul McBride,
could significantly harm us. Any of our officers or employees can terminate his
or her relationship with us at any time. To the extent that we are able to
expand our operations and deploy additional P-NAP facilities, our workforce will
be required to grow. Accordingly, our future success depends on our ability to
attract, hire, train and retain a substantial number of highly skilled
management, technical, sales, marketing and customer support personnel.
Competition for qualified employees is intense. 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 RAPID GROWTH EFFECTIVELY, OUR EXPANSION PLANS
MAY BE FRUSTRATED 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 revenue generating P-NAP facility and nine employees compared to nine
revenue generating P-NAP facilities and 294 full-time employees as of
September 30, 1999. In addition, we had $44,000 in revenues for the period from
May 1, 1996 to December 31, 1996 compared to $7.0 million in revenues for the
nine months ended September 30, 1999. We expect our growth to 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. Our plans to
rapidly deploy additional P-NAP facilities could place a significant strain on
our management's time and resources.
BECAUSE WE HAVE NO EXPERIENCE OPERATING INTERNATIONALLY, OUR INTERNATIONAL
EXPANSION MAY BE LIMITED.
Although we currently operate in nine domestic metropolitan markets, a key
component of our strategy is to expand into international markets. We have no
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 expansion,
we face the following specific risks in our international business expansion
plans:
-- difficulties in establishing and maintaining relationships with foreign
backbone providers and local vendors, including co-location and local
loop providers; and
24
<PAGE>
INTERNAP NETWORK SERVICES CORPORATION
-- difficulties in locating, building and deploying P-NAP facilities in
foreign countries and managing P-NAP facilities and network operations
centers across disparate geographic areas.
We may be unsuccessful in our efforts to address the risks associated with
our currently proposed international operations and our international sales
growth may therefore be limited.
IF WE FAIL TO ADEQUATELY PROTECT OUR INTELLECTUAL PROPERTY, WE MAY LOSE RIGHTS
TO SOME OF OUR MOST VALUABLE ASSETS
We believe that patents and other intellectual property rights are important
to our business and our future success. We file patent applications to protect
our technology, inventions and improvements to inventions that we consider
important to our business. The United States Patent and Trademark Office, USPTO,
has recently notified us that it has allowed the claims in our initial patent
application. Additional claims that were included by amendment in that
application are still pending. We cannot assure you that the USPTO will allow
any additional claims under our patent application, or, if allowed, that any
patent issued will provide significant proprietary protection or commercial
advantage to us. 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 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 were 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
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 P-NAP facilities and our
Internet backbone providers and between our P-NAP facilities and our customers'
networks. In addition, the routers and switches used in our network
infrastructure are currently supplied by a limited number of vendors, including
Cisco Systems, Inc. Additional sources of these products may not be available in
the future on satisfactory terms, if at all. We purchase these products pursuant
to purchase orders placed from time to time. We do not carry significant
inventories of these products, and we have no guaranteed supply arrangements
with our vendors. We have in the past experienced delays in receiving shipments
of equipment purchased. To date, these delays have neither been material nor
have adversely affected us, but these delays could affect our ability to deploy
P-NAP facilities in the future on a timely basis. If Cisco Systems does not
provide us with its routers, or if our limited source suppliers fail 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 MAY REQUIRE ADDITIONAL CAPITAL IN THE FUTURE AND MAY NOT BE ABLE TO SECURE
ADEQUATE FUNDS ON TERMS AND CONDITIONS ACCEPTABLE TO US
The expansion and development of our business will require significant
capital, which we may be unable to obtain, to fund our capital expenditures and
operations, including working capital needs. Our principal capital expenditures
and lease payments include the purchase, lease and installation of network
equipment such as routers, telecommunications equipment and other computer
equipment. The timing and amount of our future capital requirements may vary
significantly depending on numerous factors, including regulatory,
technological, competitive and other developments in our industry. During the
next twelve months, we expect to meet our cash requirements with existing cash,
cash equivalents and short-term investments, the net proceeds from our initial
public offering and cash flow from sales of our services. However, our capital
requirements depend on several factors, including the rate of market acceptance
of our services, the ability to expand our customer base, the rate of deployment
of additional P-NAP facilities and other factors. If our capital 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 or we may have to delay or abandon some or all
of our development and expansion plans or otherwise forego market opportunities.
We may not be able to obtain future equity or debt financing on favorable
terms, if at all. In addition, our credit agreement contains covenants
restricting our ability to incur further indebtedness. Future borrowing
instruments such as credit facilities and lease agreements are likely to contain
similar or more restrictive covenants and will likely require us to pledge
assets as security for borrowings thereunder. Our inability to obtain additional
capital on satisfactory terms may delay or prevent the expansion of our
business.
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<PAGE>
INTERNAP NETWORK SERVICES CORPORATION
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. 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.
BECAUSE THE INTERNET CONNECTIVITY MARKET IS NEW AND ITS VIABILITY IS UNCERTAIN,
THERE IS A RISK THAT 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 has only
recently begun to develop, is evolving rapidly and likely will be characterized
by an increasing number of 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. 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 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 or enhance
our existing services on a timely basis. Furthermore, new technologies or
enhancements that we use or develop may not gain market acceptance. 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.
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<PAGE>
INTERNAP NETWORK SERVICES CORPORATION
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, we cannot assure you 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 we cannot assure you that
such technologies will create opportunities for us.
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 "acts of God." Even if we take precautions, the occurrence of a natural
disaster or other unanticipated problem could result in interruptions in the
services we provide to our customers.
Although we have built redundancy into our network and hosting facilities,
we do not have a formal disaster recovery plan and our network is currently
subject to various single points of failure. For example, a problem with one or
more of our backbone providers could cause an interruption in the services we
provide to some of our customers.
CAPACITY CONSTRAINTS COULD HARM CUSTOMER RELATIONS AND EXPOSE US TO LIABILITY
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.
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INTERNAP NETWORK SERVICES CORPORATION
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, network
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 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 some of these industry-standard measures have occasionally
been circumvented by third parties, although not in our system. Therefore, we
cannot assure you 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 ITS 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 which 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 foreseen.
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.
INTERNET RELATED STOCK PRICES ARE ESPECIALLY VOLATILE, AND THIS VOLATILITY MAY
DEPRESS OUR STOCK PRICE
The stock market and specifically the stock prices of Internet related
companies have been very volatile. This volatility is often not related to the
operating performance of the companies. This broad market volatility and
industry volatility may reduce the price of our common stock, without regard to
our operating performance. Due to this volatility, the market price of our
common stock could significantly decrease.
YEAR 2000 PROBLEMS MAY DISRUPT OUR BUSINESS
Many computers, software and other equipment include computer code in which
calendar year data is abbreviated to only two digits. As a result of this design
decision, some of these systems could fail to operate or fail to produce correct
results if "00" is interpreted to mean 1900, rather than 2000.
29
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INTERNAP NETWORK SERVICES CORPORATION
These problems are widely expected to increase in frequency and severity as the
year 2000 approaches and are commonly referred to as the "Year 2000 problem."
The Year 2000 problem could result in system failures or miscalculations
causing disruptions of operations, including among other things, a temporary
inability to process transactions, send invoices or engage in similar normal
business activities. The Year 2000 problem may affect the network
infrastructure, computers, software and other equipment that we use, operate or
maintain for our operations. We believe that we have identified most of the
major computers, software applications and related equipment used in connection
with our internal operations that will need to be evaluated to determine if they
must be modified, upgraded or replaced to minimize the possibility of a material
disruption to our business. We cannot assure you that our computers and systems
are Year 2000 compliant. In addition, many of our customers' and suppliers'
Internet operations may be affected by complications related to the Year 2000
problem. The failure of our customers or suppliers to ensure that their systems
are Year 2000 compliant could have a significantly harmful effect on our
customers and suppliers, resulting in decreased Internet usage or the delay or
inability to obtain necessary data communication or telecommunication capacity,
which in turn could have a significantly harmful effect on our business,
financial condition and results of operations.
30
<PAGE>
PART II. OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
Our Registration Statement on Form S-1 (Registration No. 333-84035) under
the Securities Act of 1933, as amended, for our initial public offering became
effective on September 29, 1999. In the offering, we sold an aggregate of
10,925,000 shares of our common stock for an initial price of $20.00 per share,
including 1,425,000 shares pursuant to the exercise of the underwriters'
over-allotment option. The net proceeds from the offering were approximately
$202 million. We expect to use approximately $40 million of our net proceeds for
capital expenditures associated with expansion of our network. We intend to use
the remaining net proceeds for general corporate purposes.
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
By written consent dated as of July 27, 1999, the Company's shareholders
approved a proposal to amend the Articles of Incorporation to authorize
300,000,000 shares of common stock.
By written consent dated as of August 23, 1999, the Company's shareholders
approved the following proposals:
- A proposal to approve the Company's Amended and Restated Articles of
Incorporation to authorize 500,000,000 shares of common stock and
10,000,000 shares of preferred stock at the closing of the initial public
offering;
- A proposal to approve the Company's Amended and Restated Bylaws at the
closing of the initial public offering;
- A proposal to approve the adoption of the 1999 Equity Incentive Plan, the
1999 Non-Employee Directors' Stock Option Plan and the 1999 Employee Stock
Purchase Plan; and
- A proposal to approve the form of Indemnity Agreement for use as an
agreement between the Company and each of its executive officers and
directors.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
27.1 Financial Data Schedule (filed only with the electronic submission
of Form 10-Q in accordance with the Edgar requirements).
(b) Reports on Form 8-K:
No reports on Form 8-K were filed by the Company during the period ended
September 30, 1999.
31
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, the Registrant has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized on this 12th day of November,
1999.
<TABLE>
<S> <C> <C>
INTERNAP NETWORK SERVICES CORPORATION
(Registrant)
By: /s/ PAUL E. MCBRIDE
-----------------------------------------
Paul E. McBride
VICE PRESIDENT AND CHIEF FINANCIAL OFFICER
(PRINCIPAL FINANCIAL AND ACCOUNTING
OFFICER)
</TABLE>
32
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
INDEX TITLE
- --------------------- -----
<C> <S>
27.1 Financial Data Schedule.
</TABLE>
33
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 827
<SECURITIES> 0
<RECEIVABLES> 2,744
<ALLOWANCES> 135
<INVENTORY> 0
<CURRENT-ASSETS> 180,386
<PP&E> 23,651
<DEPRECIATION> 3,867
<TOTAL-ASSETS> 202,933
<CURRENT-LIABILITIES> 13,531
<BONDS> 14,316
0
50
<COMMON> 14
<OTHER-SE> 180,067
<TOTAL-LIABILITY-AND-EQUITY> 202,933
<SALES> 0
<TOTAL-REVENUES> 7,022
<CGS> 0
<TOTAL-COSTS> 38,756
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 88
<INTEREST-EXPENSE> 244
<INCOME-PRETAX> (31,978)
<INCOME-TAX> 0
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (31,978)
<EPS-BASIC> (8.77)
<EPS-DILUTED> (8.77)
</TABLE>
