<PAGE>
Filed Pursuant to Rule 424(b)(4)
Registration Statement No. 333-95503
PROSPECTUS
7,500,000 SHARES
[LOGO]
COMMON STOCK
-----------------
INTERNAP NETWORK SERVICES CORPORATION IS OFFERING 3,000,000 SHARES AND THE
SELLING SHAREHOLDERS ARE OFFERING 4,500,000 SHARES.
-------------------
INTERNAP NETWORK SERVICES CORPORATION'S COMMON STOCK IS LISTED ON THE NASDAQ
NATIONAL MARKET UNDER THE SYMBOL "INAP." ON APRIL 6, 2000, THE REPORTED LAST
SALE PRICE OF THE COMMON STOCK ON THE NASDAQ NATIONAL MARKET WAS $44.63 PER
SHARE.
-------------------
INVESTING IN THE COMMON STOCK INVOLVES RISKS. SEE "RISK FACTORS" BEGINNING ON
PAGE 6.
-----------------
PRICE $43 1/2 A SHARE
-------------------
<TABLE>
<CAPTION>
UNDERWRITING PROCEEDS TO
PRICE TO DISCOUNTS AND PROCEEDS TO SELLING
PUBLIC COMMISSIONS INTERNAP SHAREHOLDERS
------------------- ------------------- ------------------- -------------------
<S> <C> <C> <C> <C>
PER SHARE............... $43.50 $2.066 $41.434 $41.434
TOTAL................... $326,250,000 $15,495,000 $124,302,000 $186,453,000
</TABLE>
INTERNAP NETWORK SERVICES CORPORATION AND THE SELLING SHAREHOLDERS HAVE GRANTED
THE UNDERWRITERS THE RIGHT TO PURCHASE UP TO AN ADDITIONAL 1,125,000 SHARES OF
COMMON STOCK TO COVER OVER-ALLOTMENTS.
THE SECURITIES AND EXCHANGE COMMISSION AND STATE SECURITIES REGULATORS HAVE NOT
APPROVED OR DISAPPROVED THESE SECURITIES, OR DETERMINED IF THIS PROSPECTUS IS
TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
MORGAN STANLEY & CO. INCORPORATED EXPECTS TO DELIVER THE SHARES TO PURCHASERS ON
APRIL 12, 2000.
-------------------
MORGAN STANLEY DEAN WITTER
CREDIT SUISSE FIRST BOSTON
DONALDSON, LUFKIN & JENRETTE
CHASE H&Q
SALOMON SMITH BARNEY
APRIL 6, 2000
<PAGE>
TABLE OF CONTENTS
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PAGE
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<S> <C>
Prospectus Summary.................... 3
Risk Factors.......................... 6
Special Note Regarding Forward-Looking
Statements.......................... 17
Use of Proceeds....................... 18
Dividend Policy....................... 18
Price Range of Common Stock........... 18
Capitalization........................ 19
Dilution.............................. 20
Selected Financial Data............... 21
Management's Discussion and Analysis
of Financial Condition and Results
of Operations....................... 22
</TABLE>
<TABLE>
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PAGE
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Business.............................. 30
Management............................ 42
Certain Transactions.................. 53
Principal and Selling Shareholders.... 56
Description of Capital Stock.......... 60
Shares Eligible for Future Sale....... 63
Underwriters.......................... 65
Legal Matters......................... 67
Experts............................... 67
Where You Can Find More Information... 67
Index to Financial Statements......... F-1
</TABLE>
We are a Washington corporation. Our principal executive offices are located
at 601 Union Street, Suite 1000, Seattle, Washington 98101, and our telephone
number is (206) 441-8800. We maintain a worldwide web site at WWW.INTERNAP.COM.
The reference to our worldwide web address does not constitute incorporation by
reference of the information contained at this site.
You should rely only on the information contained in this prospectus. We
have not authorized anyone to provide you with information different from that
contained in this prospectus. We are offering to sell, and seeking offers to
buy, shares of our common stock only in jurisdictions where offers and sales are
permitted. The information contained in this prospectus is accurate only as of
the date of this prospectus, regardless of the time of delivery of this
prospectus or any sale of our common stock.
Except as otherwise indicated, all information in this prospectus relating
to the number of shares of our common stock, options and warrants is based upon
information as of February 29, 2000 and gives effect to 100% share dividend paid
on January 7, 2000 to shareholders of record on December 27, 1999. Except as
otherwise indicated, the information in this prospectus assumes that the
underwriters' over-allotment option is not exercised.
InterNAP-Registered Trademark- and P-NAP-Registered Trademark- are
registered trademarks of InterNAP. All other brand names or trademarks appearing
in this prospectus are the property of their respective holders.
<PAGE>
PROSPECTUS SUMMARY
YOU SHOULD READ THE FOLLOWING SUMMARY TOGETHER WITH THE MORE DETAILED
INFORMATION REGARDING OUR COMPANY AND THE COMMON STOCK BEING SOLD IN THIS
OFFERING, RISKS AFFECTING OUR COMPANY AND OUR FINANCIAL STATEMENTS AND THE NOTES
TO OUR FINANCIAL STATEMENTS APPEARING ELSEWHERE IN THIS PROSPECTUS.
INTERNAP NETWORK SERVICES CORPORATION
InterNAP is 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 Private-Network Access Points, or P-NAP facilities, which are our
patented network routing infrastructures coupled with our proprietary
ASsimilator routing technology, have their data optimally routed to and from
destinations on the Internet in a manner that minimizes data loss, resulting in
better performance. We offer our high performance Internet connectivity services
at dedicated line speeds of 1.5 Megabits per second, or Mbps, to 155 Mbps to
customers desiring higher transmission speeds, lower instances of data loss and
greater quality of service than they could receive from conventional Internet
connectivity providers. As of December 31, 1999, we provided consistent high
performance Internet connectivity services to 247 customers, including Akamai
Technologies, Amazon.com, Beyond.com, Bizrate.com, Datek Online, Fidelity
Investments, Go2Net, MindSpring, The Nasdaq Stock Market, Network Associates,
The Street.com, Travelocity, Warner Bros. Online, Waterhouse Securities and
WebTV.
THE OPPORTUNITY
The Internet is rapidly becoming a critically important medium for
communications and commerce. However, businesses are unable to benefit from the
full potential of the Internet due, in part, to slow and unreliable data
transfers. This results primarily from the way Internet backbone networks
exchange data, current routing technologies and the Internet's architecture,
which was not designed to support today's large volumes of traffic. To compound
this problem, Internet traffic is expected to grow rapidly. In addition,
widespread adoption of applications that rely on network quality require
consistent, high speed data transfer. We believe the future of Internet
connectivity services will be driven by providers that, through high performance
Internet routing services, enable businesses to successfully execute their
mission-critical Internet-based applications over the public network
infrastructures.
OUR SOLUTION
We provide high performance Internet connectivity services through the
deployment of P-NAP facilities. Our P-NAP facilities maintain high speed,
dedicated connections to major global Internet backbone networks, such as AT&T,
Cable & Wireless USA, Global Crossing, GTE Internetworking, ICG Communications,
Intermedia, PSINet, Qwest Communications International, Sprint, UUNET and Verio.
Our technology platform optimally routes our customers' data through these
multiple backbone networks, generally bypassing Internet traffic congestion and
reducing data loss that frequently occurs at Internet data exchange points known
as public network access points and private peering points. As of January 20,
2000, we operated 13 P-NAP facilities which are located in the Atlanta, Boston,
Chicago, Dallas, Denver, Los Angeles, Miami, New York, Philadelphia, San Jose,
Seattle and Washington, D.C. metropolitan areas. We expect to have a total of 24
P-NAP facilities operational by the end of 2000.
Our services provide the following key advantages:
- HIGH PERFORMANCE CONNECTIVITY. We route our customers' traffic over the
Internet in a way that we believe provides consistently greater speed and
superior end-to-end control, predictability and reliability, than services
offered by conventional Internet connectivity providers.
3
<PAGE>
- HIGHLY RELIABLE NETWORK ARCHITECTURE. P-NAP facilities are designed with a
highly redundant network infrastructure, such that any of the Internet
backbones connected to a P-NAP facility can be used to instantly reroute
customers' data in the event of a backbone provider network outage.
- SUPERIOR ROUTE OPTIMIZATION AND MANAGEMENT. Our proprietary routing
technology and network management system provide us with data to manage
and monitor network traffic and to offer economic settlements to backbone
providers for the transfer of our customers' data.
- SCALABILITY AND FLEXIBILITY. We manage each P-NAP facility independently
and make connection upgrades locally as required with each backbone
provider. This allows us to more readily scale our capacity as traffic
levels increase, without the need to make uniform upgrades throughout our
system of P-NAP facilities.
- SUPERIOR CUSTOMER SERVICE AND SUPPORT. Our customers receive the benefit
of our proprietary network monitoring and reporting tools and a single
point of contact with our highly skilled engineers for support inquiries,
network troubleshooting and diagnosis 24 hours a day, seven days a week.
OUR STRATEGY
Our objective is to be the leading provider of high performance Internet
connectivity services that enable businesses to run mission-critical
Internet-based applications over the public Internet and to establish and
maintain the standard of quality for Internet connectivity services. To achieve
this objective we intend to:
- Enhance our core technologies to continue to provide the highest
performance Internet connectivity services.
- Expand our suite of service offerings to drive additional demand for our
connectivity and satisfy our customers' needs.
- Continue to provide superior customer service and support.
- Expand our geographic coverage in key markets.
- Continue to build our brand awareness.
- Continue to target strategic markets.
- Maintain backbone provider neutrality.
RECENT DEVELOPMENTS
EQUANT RELATIONSHIP. In December 1999, we entered into an agreement with
Equant to assist us in our international expansion. Equant will help support the
international deployment of our P-NAP facilities in exchange for the right to
provide our high performance connectivity services for customers connected to
its network.
PREFERRED CO-LOCATION PROGRAM. In January 2000, we entered into agreements
with leading co-location providers to offer our customers a high quality
co-location solution. Under this program we will provide our customers with the
ability to co-locate their equipment at various data centers throughout the
country while still maintaining access to our high performance connectivity
services.
AVENTAIL RELATIONSHIP. In February 2000, we invested $6.0 million in
Aventail Corporation. We also entered into a joint marketing agreement with
Aventail that grants us certain limited exclusive rights to sell Aventail's
managed extranet service and grants Aventail rights to sell our services.
4
<PAGE>
THE OFFERING
<TABLE>
<S> <C>
Common stock offered by:
InterNAP.................................... 3,000,000 shares
Selling shareholders........................ 4,500,000 shares
Total..................................... 7,500,000 shares
Common stock to be outstanding after the
offering...................................... 135,981,682 shares
Use of proceeds................................. For working capital and general corporate purposes.
See "Use of Proceeds."
Nasdaq National Market symbol................... INAP
</TABLE>
The foregoing information is based on the number of shares of common stock
outstanding as of February 29, 2000. This information does not include, as of
February 29, 1999:
- 16,160,981 shares subject to options with a weighted average exercise
price of $9.65 per share;
- 8,185,391 shares that could be issued under our stock plans; and
- 1,688,912 shares subject to outstanding warrants with a weighted average
exercise price of $5.79 per share.
SUMMARY FINANCIAL DATA
<TABLE>
<CAPTION>
PERIOD FROM
INCEPTION
(MAY 1, 1996)
TO YEAR ENDED DECEMBER 31,
DECEMBER 31, ------------------------------
1996 1997 1998 1999
-------------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues............................................. $ 44 $ 1,045 $ 1,957 $ 12,520
Total operating costs and expenses................... 961 2,455 8,907 64,751
Loss from operations................................. (917) (1,410) (6,950) (52,231)
Net loss............................................. (959) (1,609) (6,973) (49,917)
Basic and diluted net loss per share................. $(.14) $ (.24) $ (1.04) $ (1.31)
Pro forma basic and diluted net loss per share....... $ (.15) $ (.46)
Weighted average shares used in computing pro forma
basic and diluted net loss per share............... 45,466 108,391
</TABLE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1999
------------------------
ACTUAL AS ADJUSTED
---------- -----------
(IN THOUSANDS)
<S> <C> <C>
BALANCE SHEET DATA:
Cash, cash equivalents and short term investments........... $205,352 $328,894
Total assets................................................ 245,546 369,088
Notes payable and capital lease obligations, less current
portion................................................... 14,378 14,378
Total shareholders' equity.................................. 210,500 334,042
</TABLE>
The as adjusted column reflects our sale of 3,000,000 shares of common stock
at a public offering price of $43.50 per share and the application of the
estimated net proceeds of $123.5 million. We will not receive any of the
proceeds from the sale of shares by the selling shareholders.
5
<PAGE>
RISK FACTORS
YOU SHOULD CAREFULLY CONSIDER THE RISKS DESCRIBED BELOW BEFORE MAKING AN
INVESTMENT DECISION. THE RISKS AND UNCERTAINTIES DESCRIBED BELOW ARE NOT THE
ONLY ONES FACING US. ADDITIONAL RISKS AND UNCERTAINTIES NOT PRESENTLY KNOWN TO
US OR THAT WE CURRENTLY THINK ARE IMMATERIAL MAY ALSO IMPAIR OUR BUSINESS
OPERATIONS. IF ANY OF THE FOLLOWING RISKS ACTUALLY OCCUR, OUR BUSINESS,
FINANCIAL CONDITION OR RESULTS OF OPERATIONS COULD BE SERIOUSLY HARMED. IN SUCH
CASE, THE TRADING PRICE OF OUR COMMON STOCK COULD DECLINE, AND YOU MAY LOSE ALL
OR PART OF YOUR INVESTMENT.
RISKS RELATED TO OUR BUSINESS
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 net losses of $1.6 million, $7.0 million and
$49.9 million for the years ended December 31, 1997, 1998 and 1999,
respectively. As of December 31, 1999, our accumulated deficit was
$59.5 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 the next 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 December 31, 1999 have
varied between 13% and 74%, and total operating costs and expenses, as a
percentage of revenues, have fluctuated between 310% and 609%. 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.
6
<PAGE>
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 13 existing locations, we are planning to continue
to deploy P-NAP facilities across a wide range of geographic regions, including
foreign countries. 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 WILL INCUR ADDITIONAL EXPENSE ASSOCIATED WITH THE DEPLOYMENT OF NEW P-NAP
FACILITIES AND 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 quarter ended December 31, 1999, revenues from our five
largest customers represented approximately 25% 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. 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.
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.
7
<PAGE>
Currently, in each of our fully operational P-NAP facilities, we have
connections to some combination of the following 11 backbone providers: AT&T,
Cable & Wireless USA, Inc., Global Crossing Telecommunications, Inc., GTE
Internetworking, Inc., ICG Communications, Intermedia Communications Inc.,
PSINet, Inc., Qwest Communications International, Inc., Sprint Internet
Services, UUNET, a MCI WorldCom Company, and Verio, Inc. 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 AT&T, Cable & Wireless USA, Global Crossing,
GTE Internetworking, ICG Communications, Intermedia, PSINet, Qwest
Communications International, 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 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 5% 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
8
<PAGE>
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 13
P-NAP facilities which are located in the Atlanta, Boston, Chicago, Dallas,
Denver, Los Angeles, Miami, 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.
BECAUSE WE HAVE NO EXPERIENCE OPERATING INTERNATIONALLY, OUR INTERNATIONAL
EXPANSION MAY BE LIMITED
Although we currently operate in 12 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
- difficulties in locating, building and deploying P-NAP facilities and a
network operations center in foreign countries, including in the United
Kingdom and the Netherlands where we plan to deploy facilities in 2000,
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.
OUR BRAND IS RELATIVELY NEW, AND FAILURE TO DEVELOP BRAND RECOGNITION COULD
HURT OUR ABILITY TO COMPETE EFFECTIVELY
To successfully execute our strategy, we must strengthen our brand
awareness. If we do not build our brand awareness, our ability to realize our
strategic and financial objectives could be hurt. Many of our competitors have
well-established brands associated with the provision of Internet connectivity
services. To date, our market presence has been limited principally to the
Atlanta, Boston, Chicago, Dallas, Denver, Los Angeles, Miami, 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 marketing activities, including advertising, tradeshows, direct
response programs and new P-NAP facility launch events.
9
<PAGE>
WE ARE DEPENDENT UPON OUR KEY EMPLOYEES AND MAY BE UNABLE TO ATTRACT OR
RETAIN SUFFICIENT NUMBERS OF QUALIFIED PERSONNEL
Our future performance depends to a significant degree upon the continued
contributions of our executive management team and key technical personnel. The
loss of 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 operational P-NAP facility and nine employees compared to 12
operational P-NAP facilities and 299 full-time employees as of December 31,
1999. In addition, we had $44,000 in revenues for the period from May 1, 1996 to
December 31, 1996 compared to $12.5 million in revenues for the year ended
December 31, 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.
IF WE FAIL TO ADEQUATELY PROTECT OUR INTELLECTUAL PROPERTY, WE MAY LOSE
RIGHTS TO SOME OF OUR MOST VALUABLE ASSETS
We rely on a combination of patent, copyright, trademark, trade secret and
other intellectual property law, nondisclosure agreements and other protective
measures to protect our proprietary technology. InterNAP and P-NAP are
trademarks of InterNAP which are registered in the United States. The United
States Patent and Trademark Office, or USPTO, issued a patent in September 1999
relating to an initial patent application we filed on September 3, 1997. The
patent is enforceable for a duration of 20 years from the date of filing, or
until September 3, 2017. We cannot assure you that this patent or any future
issued patent will provide significant proprietary protection or commercial
advantage to us or that the USPTO will allow any additional or future claims. We
have a second application pending and may file additional applications in the
future. Additional claims that were included by amendment in our initial
application have now been included in our second patent application. Our patent
and patent applications relate to our P-NAP facility technology. In addition, we
have filed a corresponding international patent application under the Patent
Cooperation Treaty.
It is possible that any patents that have been or may be issued to us could
still be successfully challenged by third parties, which could result in our
loss of the right to prevent others from exploiting the inventions claimed in
those patents. Further, current and future competitors may independently develop
similar technologies, duplicate our services and products or design around any
patents that may be issued
10
<PAGE>
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.
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.
11
<PAGE>
WE MAY REQUIRE ADDITIONAL CAPITAL IN THE FUTURE AND MAY NOT BE ABLE TO
SECURE ADEQUATE FUNDS ON TERMS 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 12 months, we expect to meet our cash requirements with existing cash, cash
equivalents and short-term investments, the net proceeds from this 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.
WE MAY FIND IT DIFFICULT TO INTEGRATE POTENTIAL FUTURE ACQUISITIONS, WHICH
COULD DISRUPT OUR BUSINESS, DILUTE SHAREHOLDER VALUE AND ADVERSELY AFFECT
OUR OPERATING RESULTS
We may acquire businesses and/or technology in the future, which would
complicate our management's tasks. We may need to integrate widely dispersed
operations that have different and unfamiliar corporate cultures. These
integration efforts may not succeed or may distract management's attention from
existing business operations. Our failure to successfully manage future
acquisitions could seriously harm our business. Also, our existing shareholders
would be diluted if we financed the acquisitions by issuing equity securities.
RISKS RELATED TO OUR INDUSTRY
BECAUSE THE DEMAND FOR OUR SERVICES DEPENDS ON CONTINUED GROWTH IN USE OF
THE INTERNET, A SLOWING OF THIS GROWTH COULD HARM THE DEVELOPMENT OF THE
DEMAND FOR OUR SERVICES
Critical issues concerning the commercial use of the Internet remain
unresolved and may hinder the growth of Internet use, especially in the business
market we target. Despite growing interest in the varied commercial uses of the
Internet, many businesses have been deterred from purchasing Internet
connectivity services for a number of reasons, including inconsistent or
unreliable quality of service, lack of availability of cost-effective,
high-speed options, a limited number of local access points for corporate users,
inability to integrate business applications on the Internet, the need to deal
with multiple and frequently incompatible vendors and a lack of tools to
simplify Internet access and use. Capacity constraints caused by growth in the
use of the Internet may, if left unresolved, impede further development of the
Internet to the extent that users experience delays, transmission errors and
other difficulties. Further, the adoption of the Internet for commerce and
communications, particularly by those individuals and enterprises that have
historically relied upon alternative means of commerce and communication,
generally requires an understanding and acceptance of a new way of conducting
business and exchanging information. In particular, enterprises that have
already invested substantial resources in other means of
12
<PAGE>
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.
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
13
<PAGE>
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.
CAPACITY CONSTRAINTS COULD CAUSE SERVICE INTERRUPTIONS AND HARM CUSTOMER
RELATIONS
Failure of the backbone providers and other Internet infrastructure
companies to continue to grow in an orderly manner could result in capacity
constraints leading to service interruptions to our customers. Although the
national telecommunications networks and Internet infrastructures have
historically developed in an orderly manner, there is no guarantee that this
orderly growth will continue as more services, users and equipment connect to
the networks. Failure by our telecommunications and Internet service providers
to provide us with the data communications capacity we require could cause
service interruptions.
OUR NETWORK AND SOFTWARE ARE VULNERABLE TO SECURITY BREACHES AND SIMILAR
THREATS WHICH COULD RESULT IN OUR LIABILITY FOR DAMAGES AND HARM OUR
REPUTATION
Despite the implementation of network security measures, the core of our
network infrastructure is vulnerable to computer viruses, break-ins, 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 determined.
The adoption of any future laws or regulations might decrease the growth of the
Internet, decrease demand for our services, impose taxes or other costly
technical requirements or otherwise increase the cost of doing business on the
Internet or in some other manner have a significantly harmful effect on us or
our customers. The government may also seek to regulate some segments of our
activities as it has with basic telecommunications services. Moreover, the
14
<PAGE>
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.
RISKS RELATED TO OUR OFFERING
OUR STOCK PRICE HAS BEEN AND MAY CONTINUE TO BE VOLATILE
The market price of our common stock has been highly volatile and has
fluctuated significantly in the past. We believe that it may continue to
fluctuate significantly in the future in response to the following factors, some
of which are beyond our control:
- Variations in quarterly operating results;
- Changes in financial estimates by securities analysts;
- Changes in market valuations of Internet and telecommunications related
companies;
- Announcements by us of significant new customers, acquisitions, strategic
partnerships, joint ventures or capital commitments;
- Delays in our P-NAP facility deployment schedule;
- Loss of a major client or failure to add new customers;
- Additions or departures of key personnel;
- Sales of equity securities in the future; and
- Fluctuations in stock market price and volume, which are particularly
common among highly volatile securities of Internet and telecommunications
related companies.
SIGNIFICANT SHAREHOLDERS AND CURRENT MANAGEMENT WILL BENEFICIALLY OWN
APPROXIMATELY 51.4% OF OUR COMMON STOCK AFTER THIS OFFERING, AND THEIR
BENEFICIAL OWNERSHIP MAY LIMIT YOUR ABILITY TO INFLUENCE THE OUTCOME OF
MATTERS REQUIRING SHAREHOLDER APPROVAL
Based on common stock beneficial ownership information available as of
February 29, 2000, adjusted to reflect this offering, Morgan Stanley Venture
Partners III, L.P. and certain affiliated funds, collectively, Morgan Stanley
Dean Witter Venture Partners, H&Q InterNAP Investors, L.P. and TI
Ventures L.P., collectively, H&Q/TI Investors, Oak Investment Partners VIII,
L.P. and Oak VIII Affiliates Fund L.P., collectively, Oak, Vulcan Ventures
Incorporated and Robert J. Lunday, Jr. could have been deemed to have
beneficially owned approximately 12.9%, 9.9%, 8.5%, 6.6% and 7.9%, respectively,
of our outstanding common stock. Morgan Stanley Dean Witter Venture Partners
have entered into a letter agreement with us that restricts their voting of
shares they hold in excess of 9.9% of our outstanding common stock. For
additional information regarding significant shareholders, see "Principal and
Selling Shareholders" and "Underwriters." In addition, our executive officers
and directors could have been deemed to have beneficially owned in the aggregate
approximately 44.9% of our outstanding common stock, including shares of our
common stock that could have been deemed to have been owned by some of our
officers and directors as a result of their relationships with these entities.
Accordingly, although there is no agreement to do so, Morgan Stanley Dean
Witter Venture Partners, H&Q/TI Investors, Oak, Vulcan Ventures Incorporated and
Robert J. Lunday, Jr., our executive officers, certain other officers and our
directors, if acting together, could exert considerable influence over any
shareholder vote, including any vote on the election or removal of directors and
any merger, consolidation or sale of all or substantially all of our assets.
Consequently, your ability to influence the outcome of matters requiring
shareholder approval may be limited. Each of Morgan Stanley Dean Witter Venture
15
<PAGE>
Partners, H&Q/TI Investors, Oak and Vulcan Ventures Incorporated has one
representative on our board of directors. In addition, Robert J. Lunday, Jr. is
one of our directors.
FUTURE SALES OF OUR COMMON STOCK BY OUR EXISTING SHAREHOLDERS COULD CAUSE
OUR STOCK PRICE TO FALL
If our shareholders sell substantial amounts of our common stock, including
shares issued upon the exercise of outstanding options and warrants, the market
price of our common stock may fall. Such sales might also make it more difficult
for us to sell equity or equity-related securities in the future at a time and
price that we deem appropriate. After completion of this offering, we will have
135,981,682 shares of common stock outstanding, assuming no exercise of
outstanding options or warrants after February 29, 2000. Our officers, directors
and selling shareholders have agreed not to sell or otherwise dispose of any of
their shares for a period of 90 days after the date of this prospectus. Morgan
Stanley & Co. Incorporated, however, may in its own discretion, at any time and
in most cases without notice, release all or any portion of the shares subject
to lock-up agreements. For further information regarding sales of stock
subsequent to this offering, see "Shares Eligible for Future Sale" and
"Underwriters."
OUR MANAGEMENT HAS BROAD DISCRETION IN THE APPLICATION OF PROCEEDS, WHICH
MAY INCREASE THE RISK THAT THE PROCEEDS WILL NOT BE APPLIED EFFECTIVELY
The net proceeds of this offering are not allocated for specific purposes.
Our management will have broad discretion in determining how to spend the
proceeds of this offering and may spend proceeds in a manner that our
shareholders may not deem desirable.
WE HAVE IMPLEMENTED ANTI-TAKEOVER PROVISIONS THAT MAY DISCOURAGE TAKE-OVER
ATTEMPTS AND DEPRESS THE MARKET PRICE OF OUR STOCK
Provisions of our amended and restated articles of incorporation and
by-laws, as well as provisions of Washington law, may make it more difficult for
a third party to acquire us, even if doing so would be beneficial to our
shareholders. See "Description of Capital Stock" for a discussion of such
anti-takeover provisions.
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<PAGE>
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This prospectus contains forward-looking statements, within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934, that are based on our current expectations about our
company and our industry. These statements relate to future events or our future
financial performance. In some cases, you can identify forward-looking
statements by terminology such as "may," "will," "should," "expect," "plan,"
"anticipate," "believe," "estimate," "predict," "potential" or "continue," the
negative of such terms or other comparable terminology. These statements are
only predictions. Actual events or results may differ materially. In evaluating
these statements, you should specifically consider various factors, including
the risks outlined under "Risk Factors." These factors may cause our actual
results to differ materially from any forward-looking statement.
Although we believe that the expectations reflected in the forward-looking
statements are reasonable, we cannot guarantee future results, levels of
activity, performance or achievements. Moreover, neither we nor any other person
assumes responsibility for the accuracy and completeness of the forward-looking
statements. We are under no duty to update any of the forward-looking statements
after the date of this prospectus to conform such statements to actual results
or to changes in our expectations.
17
<PAGE>
USE OF PROCEEDS
Our net proceeds from the sale of the 3,000,000 shares of common stock we
are offering will be approximately $123.5 million at a public offering price of
$43.50 per share after deducting underwriting discounts and commissions and
estimated offering expenses of $760,000 payable by us. If the underwriters'
over-allotment option is exercised in full, we estimate that such net proceeds
to us will be approximately $142.2 million. We will not receive any of the
proceeds from the sale of shares of common stock by the selling shareholders or
from the underwriters' exercise of the over-allotment option to purchase
additional shares from the selling shareholders.
We expect to use our net proceeds for capital expenditures associated with
the expansion of our network, working capital, and for general corporate
purposes. The amounts we actually expend for this expansion and other purposes
may vary significantly and will depend on a number of factors, including the
amount of our future revenues and other factors described under "Risk Factors."
Accordingly, our management will retain broad discretion in the allocation of
the net proceeds of this offering. A portion of the net proceeds may also be
used to acquire or invest in complementary businesses, technologies, product
lines or products. We have no current plans, agreements or commitments with
respect to any acquisitions, and we are not currently engaged in any
negotiations with respect to any such transaction. Pending these uses, the net
proceeds of this offering will be invested in short term, interest-bearing,
investment grade securities.
DIVIDEND POLICY
We have never declared nor paid any cash dividends on our capital stock. We
currently intend to retain any future earnings to finance the growth and
development of our business and therefore do not anticipate paying any cash
dividends in the foreseeable future. In addition, our loan and security
agreement with a commercial bank prohibits the payment of dividends.
PRICE RANGE OF COMMON STOCK
Our common stock is traded on the Nasdaq National Market under the symbol
INAP. Public trading of the common stock commenced on September 29, 1999. Prior
to that time, there was no public market for our common stock. The table below
sets forth the high and low sale price for our common stock for the periods
indicated as adjusted for our 100% share dividend paid on January 7, 2000 to
shareholders of record on December 27, 1999:
<TABLE>
<CAPTION>
HIGH LOW
-------- --------
<S> <C> <C>
YEAR ENDED DECEMBER 31, 1999:
Fourth Quarter (from September 29, 1999)................ $ 92.97 $10.00
YEAR ENDED DECEMBER 31, 2000:
First Quarter (through April 6, 2000)................... $111.00 $32.00
</TABLE>
The last reported sale price of our common stock on the Nasdaq National
Market on April 6, 2000 was $44.63 per share.
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<PAGE>
CAPITALIZATION
The following table sets forth our capitalization as of December 31, 1999 on
an actual basis and on an as adjusted basis to give effect to our sale of
3,000,000 shares of our common stock offered in this offering at a public
offering price of $43.50 per share and the application of the estimated net
proceeds of $123.5 million.
This information should be read in conjunction with our audited financial
statements included elsewhere in this prospectus.
<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1999
------------------------
ACTUAL AS ADJUSTED
---------- -----------
(IN THOUSANDS, EXCEPT
SHARE DATA)
<S> <C> <C>
Notes payable and capital lease obligations, less current
portion................................................... $ 14,378 $ 14,378
-------- --------
Shareholders' equity:
Convertible preferred stock: 10,000,000 shares authorized,
no shares issued and outstanding, actual and as
adjusted................................................ -- --
Common stock: $.001 par value per share, 500,000,000
shares authorized, 132,089,172 issued and outstanding,
actual; 135,089,172 shares issued and outstanding, as
adjusted................................................ 132 135
Additional paid-in capital................................ 287,054 410,593
Deferred stock compensation............................... (17,228) (17,228)
Accumulated deficit....................................... (59,458) (59,458)
-------- --------
Total shareholders' equity.............................. 210,500 334,042
-------- --------
Total capitalization.................................. $224,878 $348,420
======== ========
</TABLE>
This capitalization table excludes the following shares as of December 31, 1999:
- 15,480,942 shares subject to options with a weighted average exercise
price of $4.10 per share;
- 9,524,058 shares that could be issued under our stock plans; and
- 1,923,814 shares issuable upon exercise of outstanding warrants at a
weighted average exercise price of $5.12 per share. See "Description of
Capital Stock" and "Management - Incentive Stock Plans."
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<PAGE>
DILUTION
Our net tangible book value as of December 31, 1999 was approximately $210.3
million, or approximately $1.59 per share of common stock. Net tangible book
value per share represents the amount of our total tangible assets less total
liabilities, divided by 132,089,172 shares of common stock outstanding as of
December 31, 1999. After giving effect to the receipt of the net proceeds from
our sale of 3,000,000 shares of common stock at a public offering price of
$43.50 per share, our net tangible book value as of December 31, 1999 would have
been approximately $333.9 million, or $2.47 per share. This represents an
immediate increase in net tangible book value of $.88 per share to existing
shareholders and an immediate dilution of $41.03 per share to new investors. The
following table illustrates this per share dilution:
<TABLE>
<S> <C> <C>
Public offering price per share............................. $43.50
Net tangible book value per share as of December 31,
1999.................................................... $1.59
Increase in net tangible book value per share attributable
to new investors........................................ .88
-----
Net tangible book value per share after this offering....... 2.47
-------
Dilution per share to new investors......................... $41.03
=======
</TABLE>
The foregoing discussion and tables assume no exercise of any stock options
or warrants outstanding after December 31, 1999. As of December 31, 1999, there
were options outstanding to purchase a total of 15,480,942 shares with a
weighted average exercise price of $4.10 per share and warrants outstanding to
purchase a total of 1,923,814 shares with a weighted average exercise price of
$5.12 per share. To the extent that any of these options or warrants are
exercised, there will be further dilution to new investors.
20
<PAGE>
SELECTED FINANCIAL DATA
The following selected financial data are qualified by reference to, and
should be read in conjunction with, our financial statements and the notes
thereto and "Management's Discussion and Analysis of Financial Condition and
Results of Operations" appearing elsewhere in this prospectus. The statement of
operations data presented below for the years ended December 31, 1997, 1998 and
1999, and the selected balance sheet data at December 31, 1998 and 1999 are
derived from our financial statements that have been audited by
PricewaterhouseCoopers LLP, independent accountants, included elsewhere in this
prospectus. The statement of operations data presented below for the period from
inception (May 1, 1996) to December 31, 1996, and the selected balance sheet
data at December 31, 1996 and 1997 are derived from our financial statements
that have also been audited by PricewaterhouseCoopers LLP and that are not
included in this prospectus.
<TABLE>
<CAPTION>
PERIOD FROM INCEPTION
(MAY 1, 1996) YEAR ENDED DECEMBER 31,
TO DECEMBER 31, ------------------------------
1996 1997 1998 1999
--------------------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues.................................................... $ 44 $ 1,045 $ 1,957 $ 12,520
------ ------- ------- --------
Costs and expenses:
Cost of network and customer support...................... 321 1,092 3,216 27,412
Product development....................................... 184 389 754 3,919
Sales and marketing....................................... 78 261 2,822 17,523
General and administrative................................ 378 713 1,910 8,328
Amortization of deferred stock compensation............... -- -- 205 7,569
------ ------- ------- --------
Total operating costs and expenses.................... 961 2,455 8,907 64,751
------ ------- ------- --------
Loss from operations........................................ (917) (1,410) (6,950) (52,231)
Other income (expense):
Interest income........................................... 6 36 169 3,388
Interest and financing expense............................ (48) (235) (90) (1,074)
Loss on disposal of assets................................ -- -- (102) --
------ ------- ------- --------
Net loss.................................................... $ (959) $(1,609) $(6,973) $(49,917)
====== ======= ======= ========
Basic and diluted net loss per share (1).................... $ (.14) $ (.24) $ (1.04) $ (1.31)
====== ======= ======= ========
Weighted average shares used to compute basic and diluted
net loss per share (1).................................... 6,666 6,666 6,673 37,994
====== ======= ======= ========
Pro forma basic and diluted net loss per share (2).......... $ (.15) $ (.46)
======= ========
Weighted average shares used in computing pro forma basic
and diluted net loss per share (2)........................ 45,466 108,391
======= ========
</TABLE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
-----------------------------------------
1996 1997 1998 1999
-------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash, cash equivalents and short-term investments........... $ 145 $4,770 $ 275 $205,352
Total assets................................................ 1,099 5,987 7,487 245,546
Notes payable and capital lease obligations, less current
portion................................................... 421 240 2,342 14,378
Total shareholders' equity (deficit)........................ 43 4,829 (436) 210,500
</TABLE>
- ------------------------------
(1) See note 1 of notes to financial statements for a description of the
computation of basic and diluted net loss per share and the number of shares
used to compute basic and diluted net loss per share.
(2) Pro forma per share calculations reflect the conversion of preferred stock
into shares of common stock that occurred upon the closing of the Company's
initial public offering as if the conversion occurred as of the date of
original issuance of the preferred stock.
21
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
YOU SHOULD READ THE FOLLOWING DISCUSSION AND ANALYSIS TOGETHER WITH OUR
FINANCIAL STATEMENTS, INCLUDING THE NOTES, APPEARING ELSEWHERE IN THIS
PROSPECTUS. SOME INFORMATION CONTAINED IN THE DISCUSSION AND ANALYSIS SET FORTH
BELOW AND ELSEWHERE IN THIS PROSPECTUS, INCLUDING INFORMATION WITH RESPECT TO
OUR PLANS AND STRATEGY FOR OUR BUSINESS AND RELATED FINANCING, INCLUDES
FORWARD-LOOKING STATEMENTS THAT INVOLVE RISK AND UNCERTAINTIES. SEE "RISK
FACTORS" FOR A DISCUSSION OF IMPORTANT FACTORS THAT COULD CAUSE ACTUAL RESULTS
TO DIFFER MATERIALLY FROM THE RESULTS DESCRIBED IN OR IMPLIED BY THE
FORWARD-LOOKING STATEMENTS CONTAINED IN THIS PROSPECTUS.
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 data 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 December 31, 1999, we had a total of 12 P-NAP facilities deployed in
the Atlanta, Boston, Chicago, Dallas, Los Angeles, Miami, New York,
Philadelphia, San Jose, Seattle and Washington D.C. metropolitan areas, and
expect to have a total of 24 P-NAP facilities operational by the end of 2000.
Our customers are primarily businesses that desire high performance Internet
connectivity services in order to run mission-critical Internet-based
applications. Due to our high quality of service we generally price our services
at a premium to providers of conventional Internet connectivity services. We
expect to remain a premium provider of high quality Internet connectivity
services and anticipate continuing our pricing policy in the future. We believe
customers will continue to demand the highest quality of service as their
Internet connectivity needs grow and become even more complex and, as such, will
continue to pay a premium for high quality of service.
Our revenues are generated primarily from the sale of Internet connectivity
services and, to a lesser extent, other ancillary services primarily provided
from our Seattle data center, such as co-location, web hosting and server
management services and installation services at fixed rate or usage based
pricing to our customers that desire a DS-3 or faster connection. We offer T-1
connections only at a fixed rate. We recognize our revenues when we have
provided the related services.
Network and customer support costs are primarily comprised of the costs for
connecting to and accessing Internet backbone providers, as well as the costs
related to deploying, operating, installing and maintaining P-NAP facilities and
our network operations center. To the extent a P-NAP facility is located a
distance from the respective Internet backbone providers, we may incur
additional local loop charges on a recurring basis. Additionally, rental fees
and depreciation costs related to our P-NAP facilities are included in cost of
network and customer support.
22
<PAGE>
Product development costs consist principally of compensation and other
personnel costs, consultant fees and prototype costs related to the design,
development and testing of our proprietary technology, enhancement of our
network management software and development of our internal systems. Our product
development costs are generally expensed as incurred.
Sales and marketing costs consist of compensation, commissions and other
costs for personnel engaged in marketing, sales and field service support
functions, as well as advertising, tradeshows, direct response programs, new
P-NAP facility launch events, management of our web site and other promotional
costs.
General and administrative costs consist primarily of compensation and other
expenses for executive, finance, human resources and administrative personnel,
professional fees and other general corporate costs.
During the years ended December 31, 1998 and December 31, 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 reduction 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 $205,000
for the year ended December 31, 1998 and $7.6 million for the year ended
December 31, 1999. At December 31, 1999, we had a total of $17.2 million
remaining to be amortized over the corresponding vesting periods of the stock
options.
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. We have incurred net losses in each quarterly and annual period
since our inception, and as of December 31, 1999, our accumulated deficit was
$59.5 million.
QUARTERLY RESULTS OF OPERATIONS
The following tables set forth our statement of operations data for the
eight quarters ended December 31, 1999, as well as the percentage of total
revenues represented by each item. This information has been derived from our
unaudited financial statements. In the opinion of our management, the unaudited
financial statements have been prepared on the same basis as the audited
financial statements appearing elsewhere in this prospectus and include all
adjustments, consisting only of normal recurring adjustments that we consider
necessary for a fair presentation of such information. The quarterly data should
be read in conjunction with our audited financial statements and the notes
thereto appearing elsewhere in this prospectus. The results of operations for
any one quarter are not necessarily indicative of the results of operations for
any future period.
23
<PAGE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED
---------------------------------------------------------------------------------------
MAR. 31, JUN. 30, SEPT. 30, DEC. 31, MAR. 31, JUN. 30, SEPT. 30, DEC. 31,
1998 1998 1998 1998 1999 1999 1999 1999
-------- -------- --------- -------- -------- -------- --------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues................................ $ 314 $ 417 $ 472 $ 754 $ 1,244 $ 2,166 $ 3,613 $ 5,497
----- ------ ------- ------- ------- -------- -------- --------
Costs and expenses:
Costs of network and customer
support............................. 440 554 797 1,425 2,346 5,560 8,428 11,078
Product development................... 160 158 187 249 565 830 1,053 1,471
Sales and marketing................... 128 224 715 1,755 2,236 3,633 4,691 6,963
General and administrative............ 235 359 487 829 1,172 1,733 2,216 3,207
Amortization of deferred stock
compensation........................ 10 9 110 76 349 1,438 2,505 3,277
----- ------ ------- ------- ------- -------- -------- --------
Total operating costs and and
expenses........................ 973 1,304 2,296 4,334 6,668 13,194 18,893 25,996
----- ------ ------- ------- ------- -------- -------- --------
Loss from operations.................... (659) (887) (1,824) (3,580) (5,424) (11,028) (15,280) (20,499)
Other income (expenses):
Interest income....................... 65 56 38 10 206 244 93 2,845
Interest and financing expense........ (12) (24) (27) (27) (57) (90) (640) (287)
Loss on disposal of assets............ -- -- -- (102) -- -- -- --
----- ------ ------- ------- ------- -------- -------- --------
Net loss................................ $(606) $ (855) $(1,813) $(3,699) $(5,275) $(10,874) $(15,827) $(17,941)
===== ====== ======= ======= ======= ======== ======== ========
Basic and diluted net loss per share.... $(.09) $ (.13) $ (.27) $ (.55) $ (.79) $ (1.59) $ (1.92) $ (.14)
===== ====== ======= ======= ======= ======== ======== ========
Weighted average shares used in
computing basic and diluted net loss
per share............................. 6,671 6,673 6,673 6,673 6,674 6,839 8,246 129,314
===== ====== ======= ======= ======= ======== ======== ========
AS A PERCENTAGE OF REVENUES:
Revenues................................ 100% 100% 100% 100% 100% 100% 100% 100%
----- ------ ------- ------- ------- -------- -------- --------
Costs and expenses:
Costs of network and customer
support............................. 140 133 170 189 189 257 233 202
Product development................... 51 38 40 33 45 38 29 27
Sales and marketing................... 41 54 151 233 180 168 130 127
General and administrative............ 75 86 103 110 94 80 61 58
Amortization of deferred stock
compensation........................ 3 2 23 10 28 66 69 60
----- ------ ------- ------- ------- -------- -------- --------
Total operating costs and
expenses........................ 310 313 487 575 536 609 522 474
----- ------ ------- ------- ------- -------- -------- --------
Loss from operations.................... (210) (213) (387) (475) (436) (509) (422) (374)
Other income (expenses):
Interest income....................... 21 14 8 1 17 11 3 52
Interest and financing expenses....... (4) (6) (5) (4) (5) (4) (18) (5)
Loss on disposal of assets............ -- -- -- (13) -- -- -- --
----- ------ ------- ------- ------- -------- -------- --------
Net loss................................ (193)% (205)% (384)% (491)% (424)% (502)% (437)% (327)%
===== ====== ======= ======= ======= ======== ======== ========
</TABLE>
Our quarterly operating results have fluctuated significantly. We expect
that future operating results will be subject to similar fluctuations for a
variety of factors, which are difficult or impossible to predict. See "Risk
Factors - Negative Movements in Our Quarterly Operating Results May Disappoint
Analysts' Expectations, Which Could Have a Negative Impact on Our Stock Price."
24
<PAGE>
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>
YEAR ENDED
DECEMBER 31,
----------------------------------
1997 1998 1999
-------- -------- --------
<S> <C> <C> <C>
Revenues.................................................... 100% 100% 100%
---- ---- ----
Costs and expenses:
Cost of network and customer support...................... 105 164 219
Product development....................................... 37 39 31
Sales and marketing....................................... 25 144 140
General and administrative................................ 68 98 67
Amortization of deferred stock compensation............... -- 10 60
---- ---- ----
Total operating costs and expenses...................... 235 455 517
---- ---- ----
Loss from operations........................................ (135) (355) (417)
Other income (expense):
Interest income........................................... 3 9 27
Interest and financing expense............................ (22) (5) (9)
Loss on disposal of assets................................ -- (5) --
---- ---- ----
Net loss.................................................... (154)% (356)% (399)%
==== ==== ====
</TABLE>
YEARS ENDED DECEMBER 31, 1998 AND 1999
REVENUES. Revenues increased 525% from $2.0 million for the year ended
December 31, 1998, to $12.5 million for the year ended December 31, 1999. This
increase of $10.5 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 opening of nine
additional P-NAP facilities during 1999, resulting in a total of 12 operational
P-NAP facilities at December 31, 1999, as compared to three P-NAP facilities at
December 31, 1998.
COSTS OF NETWORK AND CUSTOMER SUPPORT. Costs of network and customer
support increased 756% from $3.2 million for the year ended December 31, 1998,
to $27.4 million for the year ended December 31, 1999. This increase of
$24.2 million was primarily due to increased connectivity costs related to added
connections to Internet backbone providers at each P-NAP facility, comprising
48% of the increase, and to a lesser extent, additional compensation costs,
related to the addition of 69 personnel, comprising 14% of the increase, and
depreciation expense related to the equipment at newly deployed P-NAP
facilities, comprising 13% of the increase. 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 411% from $754,000
for the year ended December 31, 1998, to $3.9 million for the year ended
December 31, 1999. This increase of $3.1 million was primarily due to
compensation costs related to the addition of 53 personnel, comprising 52% of
the increase, and outside consulting fees, comprising 25% of the increase. We
expect product development costs to increase in absolute dollars for the
foreseeable future.
SALES AND MARKETING. Sales and marketing costs increased 525% from
$2.8 million for the year ended December 31, 1998, to $17.5 million for the year
ended December 31, 1999. This increase of $14.7 million
25
<PAGE>
was primarily due to compensation costs related to the addition of 71 personnel,
comprising 66% of the increase, marketing and advertising costs, comprising 11%
of the increase, and to a lesser extent, facility costs related to the addition
of sales offices.
GENERAL AND ADMINISTRATIVE. General and administrative costs increased 337%
from $1.9 million for the year ended December 31, 1998, to $8.3 million for the
year ended December 31, 1999. This increase of $6.4 million was primarily due to
compensation costs related to the addition of 44 personnel, comprising 46% of
the increase, increased depreciation and amortization costs due to the addition
of corporate office space during the third quarter of 1999, comprising 9% of the
increase, and professional services costs, comprising 12% of the increase. 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,
net, increased from an expense of $23,000 for the year ended December 31, 1998,
to other income, net of $2.3 million for the year ended December 31, 1999. This
increase was primarily due to interest income earned on the proceeds from our
private equity financings and initial public offering.
YEARS ENDED DECEMBER 31, 1997 AND 1998
REVENUES. Revenues increased 100% from $1.0 million in 1997 to
$2.0 million in 1998. This increase was primarily due to increased Internet
connectivity revenues, comprising 76% of the increase, other ancillary service
revenues, comprising 12% of the increase, and to a lesser extent, customer
installation fees, comprising 12% of the increase. The increase in Internet
connectivity revenues was attributable to the deployment of two additional P-NAP
facilities resulting in a total of three operational P-NAP facilities at
December 31, 1998.
COSTS OF NETWORK AND CUSTOMER SUPPORT. Costs of network and customer
support increased 191% from $1.1 million in 1997 to $3.2 million in 1998. This
increase was primarily due to increased connectivity costs related to added
connections to Internet backbone providers at each P-NAP facility, comprising
40% of the increase, and depreciation expense related to the equipment at newly
deployed P-NAP facilities, comprising 17% of the increase. In addition, the
increase in costs of network and customer support from 1997 to 1998 also
included compensation costs, comprising 22% of the increase, related to six
additional personnel at our network operations center, seven additional
personnel in our customer installation department and seven additional personnel
in our P-NAP facility deployment department.
PRODUCT DEVELOPMENT. Product development costs increased 94% from $389,000
in 1997 to $754,000 in 1998. This increase was primarily due to increased
compensation costs, comprising 67% of the increase, and increased travel costs
related to developing systems at new P-NAP facilities, comprising 20% of the
increase. The increased compensation costs were related to the addition of
product development personnel during 1998.
SALES AND MARKETING. Sales and marketing costs increased 973% from $261,000
in 1997 to $2.8 million in 1998. The increase was primarily due to increased
compensation costs, comprising 74% of the increase, and increased travel and
entertainment costs, comprising 10% of the increase. The increased compensation
costs were related to the addition of 40 personnel during 1998.
GENERAL AND ADMINISTRATIVE. General and administrative costs increased 166%
from $713,000 in 1997 to $1.9 million in 1998. The increase was primarily due to
compensation costs, comprising 11% of the increase, depreciation and
amortization comprising 6% of the increase, facility costs, comprising 38% of
the increase, outside consulting fees, comprising 13% of the increase, travel
costs related to the deployment of new P-NAP facilities, comprising 13% of the
increase, and bad debt expense in 1998 and the
26
<PAGE>
subsequent bankruptcy of a significant customer, comprising 9% of the increase.
The increased compensation costs were related to the addition of 13 personnel
during the second half of 1998.
OTHER INCOME (EXPENSE). Other expense, net, decreased from $199,000 in 1997
to $23,000 in 1998. Other expense, net, decreased by $176,000, or 88%, in 1998
primarily due to increased interest income earned on the proceeds from our
private equity financings, offset by a loss on disposal of assets of $102,000.
PROVISION FOR INCOME TAXES
We incurred operating losses from inception through December 31, 1999, and
therefore have not recorded a provision for income taxes. We have recorded a
valuation allowance for the full amount of our net deferred tax assets, as the
future realization of the tax benefit is not currently likely.
As of December 31, 1999, we had net operating loss carry-forwards of
$50.3 million. These loss carry-forwards are available to reduce future taxable
income and expire at various dates through 2019. Under the provisions of the
Internal Revenue Code, certain substantial changes in our ownership may limit
the amount of net operating loss carry-forwards that could be utilized annually
in the future to offset taxable income.
LIQUIDITY AND CAPITAL RESOURCES
Since our inception, we have financed our operations primarily through the
issuance of our equity securities, capital leases and bank loans. We have raised
an aggregate of approximately $261.6 million, net of offering expenses, through
the sale of our equity securities. In January 2000, a 100% stock dividend was
paid on our common stock and, accordingly, all related disclosures have been
revised to reflect the stock dividend for all periods presented.
In October 1999, we sold 19,000,000 shares of our common stock at an initial
public offering price of $10.00 per share resulting in net proceeds of
$176.7 million. During October 1999, in connection with our initial public
offering, the underwriters exercised their overallotment option, resulting in
the sale of an additional 2,850,000 shares of our common stock at $10.00 per
share for additional net proceeds of $26.5 million. Upon the closing of our
initial public offering, all shares of outstanding preferred stock converted
into 98,953,050 shares of common stock.
Concurrent with the closing of our initial public offering on October 4,
1999, we sold 2,150,537 shares of common stock to Inktomi Corporation for $9.30
per share, resulting in proceeds of $19.0 million. In conjunction with this
investment, we issued a warrant to Inktomi to purchase 1,075,268 shares of our
common stock at an exercise price of $13.95 per share. The warrant has a
two-year term and includes demand and piggyback registration rights. On
November 24, 1999, Inktomi exercised 50% of these warrants through a cashless
exercise, resulting in the issuance of 397,250 shares of our common stock to
Inktomi. 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 December 31, 1999, we had cash, cash equivalents and investments of
$210.4 million. 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%, or 9.5%, as of December 31, 1999,
and matures on June 30, 2000. As of December 31, 1999, we had outstanding
borrowings of $1.5 million on the line of credit.
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 million, prior to the
earlier of maturity or December 31, 1999, but we did not draw any amounts on
this facility
27
<PAGE>
prior to maturity. In connection with this facility, we issued warrants to
purchase 200,000 shares of common stock with exercise prices of $10.00 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 year ended December 31, 1999.
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 facility 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 7.5% plus an index rate based
on the yield of 4-year U.S. Treasury Notes. This rate was 13.7% at December 31,
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 7.9%
plus an index rate based on the yield of three-year U.S. Treasury Notes. This
rate was 14.0% at December 31, 1999. Borrowings under each sublimit must be
drawn prior to May 1, 2000. As of December 31, 1999, we had outstanding
borrowings of approximately $3.9 million pursuant to this arrangement.
On November 19, 1999, we amended an existing equipment lease credit facility
with a vendor to increase our available credit by $17.5 million to
$35.5 million. As of December 31, 1999, we had approximately $18.4 million
available under this credit facility.
Net cash used in operations was $1.1 million, $5.3 million and
$33.8 million in the years ended December 31, 1997, 1998 and 1999, respectively.
Net cash used in operations for the year ended December 31, 1999 was primarily
due to net operating losses, increases in accounts receivable and prepaid
expenses, partially offset by non-cash charges and an increase in accounts
payable. Net cash used in operations for the year ended December 31, 1998 was
primarily due to net operating losses and increases in accounts receivable and
prepaid expenses, partially offset by non-cash charges and increases in accounts
payable and accrued liabilities. Net cash used in operations for the year ended
December 31, 1997 was primarily due to net operating losses and increases in
accounts receivable, partially offset by non-cash charges.
Net cash used in investing activities was $141,000, $855,000 and
$68.0 million in the years ended December 31, 1997, 1998 and 1999, respectively.
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 was primarily
financed by capital leases (such purchases are excluded from the net cash used
in investing activities in the statement of cash flows), and totaled $260,000,
$3.6 million and $15.9 million for the years ended December 31, 1997, 1998 and
1999, respectively. Additionally, for the year ended December 31, 1999,
$65.2 million was used to purchase investments offset by proceeds of
$10 million from the disposition of certain investments.
Net cash provided from financing activities was $5.9 million, $1.7 million
and $256.7 million for the years ended December 31, 1997, 1998 and 1999,
respectively. Net cash from financing activities primarily reflects proceeds
from the public and private sales of our equity securities.
On February 22, 2000, pursuant to an investment agreement, we purchased
588,236 shares of Aventail Corporation Series D preferred stock at $10.20 per
share for a total cash investment of $6,000,007. The Series D preferred stock is
convertible to common stock at a ratio of one share of preferred stock to one
share of common stock, subject to adjustment for certain equity transactions.
Additionally, we entered into a joint marketing agreement with Aventail which,
among other things, granted us certain limited exclusive rights to sell
Aventail's managed extranet service and granted Aventail certain rights to sell
our services. In return, we committed to either sell Aventail services or pay
Aventail, or a combination of both, which would result in Aventail's recognition
of $3,000,000 of revenue over a two-year period.
28
<PAGE>
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, although to a lesser extent, 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 this offering together with our cash
and cash equivalents, investments and funds available under our 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 cash in excess of current operating requirements in
short-term, interest-bearing, investment-grade securities.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Substantially all of our cash equivalents, 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
December 31, 1999, all of our cash equivalents mature within three months and
all of our short-term investments mature within one year. As of December 31,
1999, we believe the reported amounts of cash equivalents, investments and
capital lease obligations to be reasonable approximations of their fair values.
As a result, we believe that the market risk arising from our holdings of
financial instruments is minimal.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, or SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities," which establishes accounting and
reporting standards for derivative instruments and hedging activities. SFAS
No. 133, which will be effective for us for the fiscal years and quarters
beginning after June 15, 2000, requires that an entity recognize all derivatives
as either assets or liabilities in the statement of financial position and
measure those instruments at fair value. We are assessing the requirements of
SFAS No. 133 and the effects, if any, on our financial position, results of
operations and cash flows.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition," which provides
guidance on the recognition, presentation and disclosure of revenue in financial
statements filed with the Securities and Exchange Commission. SAB 101 outlines
the basic criteria that must be met to recognize revenue and provides guidance
for disclosures related to revenue recognition policies. We believe that the
impact of SAB 101 would have no material effect on our financial position or
results of operations.
29
<PAGE>
BUSINESS
OVERVIEW
InterNAP is 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 Private-Network Access Points, or 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 data loss and greater quality of service than services offered by
conventional Internet connectivity providers. As of December 31, 1999, we
provided consistent high performance Internet connectivity services to
approximately 247 customers, including Akamai Technologies, Amazon.com,
Beyond.com, Bizrate.com, Datek Online, Fidelity Investments, Go2Net, MindSpring,
The Nasdaq Stock Market, Network Associates, The Street.com, Travelocity, Warner
Bros. Online, Waterhouse Securities, and WebTV.
We offer our high performance Internet connectivity services at dedicated
line speeds of 1.5 Megabits per second, or Mbps, to 155 Mbps to customers
desiring a superior level of Internet performance. We provide our high
performance connectivity services through the deployment of P-NAP facilities,
which are highly redundant network infrastructure facilities coupled with our
patented routing technology. P-NAP facilities maintain high speed, dedicated
connections to major global Internet networks, commonly referred to as
backbones, such as AT&T, Cable & Wireless USA, Global Crossing, GTE, ICG
Communications, Intermedia, PSINet, Qwest Communications International, Sprint,
UUNET and Verio. As of January 20, 2000, we operated 13 P-NAP facilities which
are located in the Atlanta, Boston, Chicago, Dallas, Denver, Los Angeles, Miami,
New York, Philadelphia, San Jose, Seattle and Washington, D.C. metropolitan
areas, and expect to have 24 P-NAP facilities operational by the end of 2000.
We believe that our P-NAP facilities provide a superior quality of service
over the public Internet enabling our customers to realize the full potential of
their existing Internet-based applications, such as e-commerce and on-line
trading. In addition, we believe our P-NAP facilities will enable our customers
to take advantage of new services, such as using the Internet to make telephone
calls or send facsimiles, create private networks, distribute multimedia
documents and send and receive audio and video feeds.
INDUSTRY BACKGROUND
THE GROWING IMPORTANCE OF THE INTERNET FOR MISSION-CRITICAL INTERNET-BASED
APPLICATIONS
The Internet has emerged as a global medium for communications and commerce.
The growth in data that is transmitted over the Internet, or data traffic, is
driven by a number of factors, including the rapidly increasing number of
network-enabled and Internet-based applications, the growing number of personal
computers linked to the Internet, improvements in network-enabled devices,
servers and routers and the increasing availability of broadband connections. As
an illustration of this growth, Pioneer Consulting, LLC estimates that Internet
bandwidth demand in North America will grow from 300 Gigabits per second in 1999
to 4,500 Gigabits per second in 2004, representing a 72% compound annual growth
rate.
Once primarily used for e-mail and retrieving information, the Internet is
now being used as a communications platform for an increasing number of
mission-critical Internet-based applications, such as those relating to
electronic commerce, private networks, telephone and facsimile capabilities,
supply chain management, customer service and project coordination. To improve
the effectiveness of their mission-critical Internet-based applications,
businesses are requiring increasing levels of network performance, including
speed, reliability and manageability, across the Internet.
The loss of data as it is transmitted over the Internet and inefficiencies
in transferring data across the Internet are fundamental causes of
unsatisfactory performance of Internet-based applications. Many of
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these problems are caused by the architectural shortcomings of the Internet that
have led to the largely unorchestrated transfer of data traffic from one
commercially run network to another. The recent increases in network capacity
and improvements in the performance of network devices fail to address many of
the problems associated with exchanging data between the multiple networks,
which comprise the Internet. Further, the popularity of the Internet has
resulted in an ever-increasing number of users transmitting rapidly increasing
volumes of data across the Internet, thereby compounding the problem.
THE EMERGENCE OF MULTIPLE INTERNET BACKBONES
The Internet originated as a restricted network designed to provide
efficient and reliable long distance data communications among the disparate
computer systems used by government funded researchers and organizations. As
businesses began to use the Internet for functions critical to their core
strategies, telecommunications companies established additional networks, or
backbones, to supplement the original public infrastructure and satisfy this
increasing demand. In this way, the original public Internet infrastructure has
grown into a "network of networks" run by numerous commercial telecommunications
companies, each of which manages its own backbone. Currently, the Internet is a
global collection of hundreds of interconnected computer networks. Of these
networks, approximately a dozen commercial backbones contain the substantial
majority of the global addressable routes on the Internet. These backbones were
developed at great expense but are nonetheless constrained by the fundamental
limitations of the Internet's architecture. They must connect to one another, or
peer, to permit their customers to communicate with each other. Consequently,
many backbone providers have agreed to exchange large volumes of data traffic
through a limited number of public network access points.
Five major public network access points are in use today, including the
Metropolitan Area Exchange East, or MAE East, near Washington, D.C. and MAE West
in San Jose. The public network access points are not centrally managed and no
single entity has the economic incentive or ability to facilitate problem
resolution, to optimize peering within the public network access points or to
bring about centralized routing administration. As a consequence of the lack of
coordination among backbones at these public peering points and in order to
avoid the increasing congestion and resulting data loss at the public network
access points, a number of the backbone providers have established private
interfaces connecting pairs of backbones for the exchange of traffic. Although
private peering arrangements are helpful for exchanging traffic, they do not
overcome the structural and economic shortcomings of the Internet.
THE PROBLEM OF INEFFICIENT ROUTING OF DATA TRAFFIC ON THE INTERNET
Data loss is a fundamental cause of the slowness and unreliability that are
characteristic of the Internet today. Data loss occurs when the devices handling
data lose track of packets before they can be transferred, or routed, to their
destination. When this occurs, the computer that originally sent a lost packet
will resend it until it receives confirmation of receipt by the destination
device, thus compounding the congestion. Data loss most frequently occurs at
Internet exchange points, such as public network access points and private
peering points. We believe that packet loss at the public network access points
can exceed 20% during peak hours. This can have a dramatic impact on the
effective speed at which data is transmitted over the Internet. For example,
according to an industry source, downloading a file from a web site under
conditions with 1% data loss can take up to twice as long as doing so when there
is no data loss.
Due to the Internet's lack of central management, there is no organized
mechanism to route traffic to avoid congestion at the public network access
points and private peering points. The individual backbone providers only
control the routing of data within their backbones, and their routing practices
tend to compound the inefficiency of the Internet. When a backbone provider
receives a packet that is not destined for one of its own customers, it must
route it to another backbone provider to complete the delivery of the packet on
the Internet.
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Since the use of a public network access point or a private peering point
typically involves no economic settlement, a backbone provider will often route
the data to the nearest point of traffic exchange, in an effort to get the
packet off its network and onto a competitor's backbone as quickly as possible.
In this manner, the backbone provider reduces capacity and management burdens on
its transport network. Consequently, in order to complete a communication, data
ordinarily passes through multiple networks and peering points without regard to
congestion or other factors that inhibit performance. Further, once data leaves
a backbone destined for another network, the backbone provider has no way of
controlling the quality of the end-to-end connection. As a result, it is
virtually impossible for a single backbone provider to offer a high quality of
service across disparate networks. For customers of conventional Internet
connectivity providers, this results in lost data, slower and more erratic
transmission speeds, and an overall lower quality of service. Equally important,
these customers have no control over these arrangements and have no single point
of contact that they can hold accountable for any decrease in service levels,
such as poor data transmission performance. An example of routing over the
Internet is depicted in the figure below.
CONVENTIONAL ROUTING OVER THE INTERNET TODAY
[Graphic depicting an example of routing over the Internet]
The Inefficiencies of the Internet Today:
A. Backbone A passes off the ISP Customer request for data at the nearest public
or private with Backbone B, regardless of congestion or performance problems
occurring at the exchange. Free private peering provides no economic settlement
between 2 networks, thereby resulting in "best effort" delivery with no
guarantees or accountability for poor performance or lost data. B. Using an
asymmetric return route, Backbone B passes off the ISP Customer request at a
public peering exchange forcing the data to transit across yet another
potentially congested network infrastructure.
The Internet is rapidly becoming a critically important medium for
communications and commerce. However, businesses are unable to benefit from the
full potential of the Internet primarily because peering and routing practices,
current routing technologies, and the Internet's architecture were not designed
to support today's large and rapidly growing volume of traffic. We believe the
emergence of technologies and applications that rely on network quality and
require consistent and high speed data transfer, such as voice and fax over
Internet Protocol, virtual private network services, multimedia document
distribution and audio and video streaming, will be hindered by the performance
problems of the Internet. We also believe the future of Internet connectivity
services will be driven by providers that, through high performance Internet
routing services, provide consistent high quality of service and enable
businesses to successfully execute their mission-critical Internet-based
applications over the public network infrastructures.
THE INTERNAP SOLUTION
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.
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Utilizing our proprietary network architecture and advanced routing
technologies, we route our customers' data in an optimal manner over the
Internet. As of January 20, 2000, we had 13 P-NAP facilities in operation across
the United States. Our P-NAP facility network model is depicted below:
THE INTERNAP SOLUTION
[Graphic depicting P-NAP facility routing method]
The InterNAP Solution:
A. The P-NAP facility intelligently routes data transmissions between the ISP
customer and the P-NAP facility customer Web Site, bypassing congested and
unreliable public NAPs and private peering relationships.
B. The P-NAP facility intelligently routes data transmissions between the Web
Site and the P-NAP ISP Customer, bypassing congested and unreliable public and
private peering relationships.
C. For ISPs and Web Sites that are customers of the same P-NAP facility, data
transmissions occur within the local P-NAP facility infrastructure, bypassing
the Internet entirely.
By connecting to one of our P-NAP facilities, mission-critical inbound and
outbound data transmissions travel an optimal route to and from destinations on
the Internet. This optimal routing of data traffic over the Internet enables
higher transmission speeds, lower instances of data loss and greater quality of
service. Our high performance Internet connectivity services provide the
following key advantages:
HIGH PERFORMANCE CONNECTIVITY. We route our customers' traffic over the
Internet in a way that we believe provides consistently greater speed and
superior end-to-end control, predictability and reliability, than services
offered by conventional Internet connectivity providers. Our P-NAP facilities
have high- speed, direct connections to major global Internet backbones. Our
proprietary technology may be used to route data directly to the Internet
backbone on which a given destination resides, thereby giving our customers
direct access to the destination network for a large majority of global Internet
addresses. This network architecture combined with our proprietary routing
technology generally bypasses congested public network access points and private
peering points, reduces data loss and improves reliability and performance for
our customers to any of our multiple backbone connections. In addition,
customers directly connected to the same P-NAP facility get one-hop access when
communicating with each other, completely avoiding the public Internet.
We use multiple connections to major backbones to create our own virtual
backbone, instead of owning or operating an expensive long-haul backbone
infrastructure. As a result, we can offer customers improved service levels by
optimally routing traffic between any two P-NAP facilities using our virtual
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backbone. Consequently, any customer connected to any P-NAP facility will
experience optimal public backbone network performance in communicating with any
other customer connected to any other P-NAP facility. A model of InterNAP's
virtual backbone created between any two P-NAP facilities is depicted below:
THE INTERNAP VIRTUAL BACKBONE
[Graphic depicting the InterNAP virtual backbone]
HIGHLY RELIABLE NETWORK ARCHITECTURE. P-NAP facilities are designed with a
highly redundant network infrastructure, including multiple local loop
connections from multiple carriers. This design minimizes interruptions of
network operations. If a backbone network connected to a P-NAP facility should
fail, we can instantly reroute data using any of the remaining networks
connected to the P-NAP facility. As a result, our customers experience more
reliable services and are less likely to need and pay for redundant Internet
backbone connections.
SUPERIOR ROUTE OPTIMIZATION AND MANAGEMENT. Our proprietary routing
technology and network management system provide us with data that enables us to
manage network traffic and to offer economic settlements to backbone providers
for the transfer of our customers' data packets. As a result, we are able to
obtain full sets of global Internet Protocol routes from each backbone provider
connected to a P-NAP facility, and choose from among these routes the most
optimal route for our customers' traffic. We are therefore able to hold all of
our backbone providers accountable for performance within their respective
networks. In addition, because we manage all backbone connections into and out
of each P-NAP facility, we are able to centrally forecast and plan for upgrades.
We believe this consistently provides our customers with better service and
minimizes congestion and data packet loss for all of the backbones to which our
P-NAP facilities are connected.
SCALABILITY AND FLEXIBILITY. Our Internet connectivity services are
designed to be scalable and flexible. Since P-NAP facilities are localized
infrastructures, not long haul backbones, we can manage capacity
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issues and traffic flows for each backbone provider at each P-NAP facility
separately. Unlike a backbone provider, we do not need to make uniform capacity
upgrades across an entire network as traffic levels increase. Furthermore, an
upgrade to one backbone provider does not require similar upgrades to all
backbones connected to a P-NAP facility or upgrades throughout our system of
P-NAP facilities. This allows us to more readily scale our capacity as traffic
levels increase.
SUPERIOR CUSTOMER SERVICE AND SUPPORT. Our network operations center is
staffed 24 hours a day, seven days a week, by skilled engineers. Equipped with
sophisticated traffic management reporting and diagnostic tools, they provide
our customers with a single point of contact for support inquiries, network
troubleshooting and diagnosis. The network operations center constantly monitors
the operation of all our P-NAP facilities, as well as the backbones connected to
them, and provides our customers and backbone providers with real-time
notification and management of events that might affect service, such as network
congestion, equipment failures and network or power outages. Given the overall
complexity of our technology and our highly skilled engineers, we believe that
our customer support services create a significant barrier to entry for
competitors. In addition, since we are a paying customer of each backbone
provider connected to a P-NAP facility, we believe we can get better response
times, service level agreements and trouble ticket resolution than Internet
service providers that rely on free public peering arrangements.
STRATEGY
Our objective is to be the leading provider of high performance Internet
connectivity services that enable businesses to run mission-critical
Internet-based applications and to establish and maintain the standard of
quality for Internet connectivity services. We are committed to attracting,
hiring and retaining exceptional employees at all levels of our organization in
order to realize these objectives. Key components of our strategy include:
ENHANCE OUR CORE TECHNOLOGIES TO CONTINUE TO PROVIDE THE HIGHEST PERFORMANCE
INTERNET CONNECTIVITY SERVICES. We plan to continue developing our P-NAP
facilities, as well as our network operations center, to enhance the level of
service we provide to our customers. Our P-NAP facilities and network operations
center have been designed to allow expansion of the features and functionalities
of our services and have the scalability required to meet the growing needs of
customers. We believe that enhancements to our proprietary technologies are
integral to our ability to continue to penetrate new markets and to provide new
value-added services to existing customers. For example, we intend to use the
intelligent routing capabilities of our P-NAP facilities to enable our customers
to take advantage of new services such as telephone and facsimile capabilities,
private networks, multimedia document distribution and audio and video feeds.
EXPAND SERVICE OFFERING. We intend to expand our suite of service offerings
to drive additional demand for our connectivity and satisfy our customers needs.
We will continue to evaluate additional service offerings, which we may offer or
partner with providers of such service offerings, in order to drive additional
connectivity sales. Such services may include but are not limited to
co-location, advanced encryption services, data recovery services, content
replication, IP clearinghouse and settlement, and audio and video streaming
services. In January 2000, we entered into agreements with leading co-location
providers to offer our customers a high quality co-location solution. Under this
program we will provide our customers with the ability to co-locate their
equipment at various data centers throughout the country while still maintaining
access to our high performance connectivity services.
CONTINUE TO PROVIDE SUPERIOR CUSTOMER SERVICE AND SUPPORT. We intend to
continue providing our customers with superior customer service and support
24 hours a day, seven days a week. We believe that we can continue to improve
our competitive position by supporting our service with our highly-skilled
engineers, sophisticated traffic management reporting and diagnostic tools, and
network operations center. To reduce the risk of service interruptions, we plan
to build a second network operations center that will
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also monitor all of our P-NAP facilities. We also use our status as a paying
customer of the major backbone providers to obtain a higher level of service,
which we pass on to our customers.
EXPAND OUR GEOGRAPHIC COVERAGE IN KEY MARKETS. We currently offer our
services through our P-NAP facilities in 12 key metropolitan areas across the
United States and intend to continue to aggressively deploy additional P-NAP
facilities in key markets across the United States and internationally. As part
of our deployment plan, we expect to have a total of 24 P-NAP facilities in the
United States and abroad by the end of 2000. In December 1999, we entered into
an agreement with Equant to assist us in our international expansion. Equant
will help support the international deployment of our P-NAP facilities in
exchange for the right to provide our high performance connectivity services to
customers connected to its network.
CONTINUE TO BUILD OUR BRAND AWARENESS. We intend to aggressively build our
customer base by increasing awareness of the InterNAP brand. We believe that
associating our brand with a high quality of service is key to the expansion of
our customer base. As we grow in size, we intend to invest in building brand
awareness through a marketing plan that includes P-NAP facility launch events,
trade shows, speaking events and media appearances, news announcements,
advertisements and customer testimonials.
CONTINUE TO TARGET STRATEGIC MARKETS. We intend to expand our sales and
marketing activities by continuing to focus on five strategic market segments,
including high technology, e-commerce and retail, communication providers,
financial services, and entertainment and publishing. The businesses in these
market segments are characterized by early adoption of Internet services and a
need for fast, reliable and manageable Internet connectivity services. By
focusing on specific strategic markets we expect to be able to leverage our
industry knowledge and highly experienced sales force to extend our market
reach. We also intend to expand our indirect sales channels by partnering with
leading resellers with strong backgrounds and market presence in these markets.
MAINTAIN BACKBONE PROVIDER NEUTRALITY. At each P-NAP facility, we have
connections with at least four major backbone providers. In order to provide
one-hop service to a large majority of Internet destinations, we must maintain
high-volume connections with major backbone providers. We plan to continue to do
this as new backbone providers emerge, as existing backbone providers increase
in market size in the metropolitan areas where our P-NAP facilities are located
and as global Internet traffic patterns change. We do not favor one backbone
provider over another, but rather use our proprietary technology to route
packets directly to the backbone on which an Internet destination is located. We
believe this provides substantial benefits to all backbone providers to whom we
connect, because we deliver only packets destined for each backbone provider's
customers, thus improving the efficiencies of their infrastructure.
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CUSTOMERS
We have established a diversified base of customers across a wide range of
industries. As of December 31, 1999, we had approximately 247 customers. The
following is a list of customers whose monthly bill was between $10,000 and
$158,000 for December 1999:
Adforce
Adknowledge
Advanced Radio Telecom
Akamai Technologies
Aladdin Systems
Amazon.com
Apple Computer
Art.com
Beyond.com
Bizrate.com
Cobalt
Commtouch Software
Consumer Financial Network
Data Broadcasting Corporations
Datek Online
Deluxe Payment Protection
Emergent Media
Fidelity Investments
Flycast Network
Go2Net
HomeGrocer.com
Inautix Technologies
Intel Corporation
Internet Shopping Network
The Island ECN
ISP Channel
ITXC
LanMinds Internet Services
MindSpring Enterprises
N2H2
The Nasdaq Stock Market
Net Access Corporation/
Planet.com
Network Associates
OnSite
REI
Seanet
The Seattle Times
Shopping.com
Speakeasy
StarMedia Network
TheStreet.com
Tradescape Online
Travelocity
US Electrodynamics
Warner Bros. Online
Waterhouse Securities
WebTV Networks
WebVision
Won.Net
We offer superior customer service and support from our network operations
center staffed 24 hours a day, seven days a week by highly skilled network
engineers who use our sophisticated traffic management reporting and diagnostic
tools. As of December 31, 1999, we had 156 employees dedicated to customer
service, network support and P-NAP facility engineering. Our customer service
personnel are also available to assist customers whose operations require
specialized procedures.
Our customer contracts generally cover the provision of services for a one
to three year period and may contain service level warranties. To date, none of
our customers has utilized this warranty to receive a credit for a period of
free service. We have had limited contract renewal experience with customers
whose initial service contract terms have expired. From inception through
December 31, 1999, we have identified seven customers that have chosen not to
renew their service with us.
SERVICES
We offer Internet connectivity services to our customers over T-1, DS-3 and
OC-3 telecommunication connections at speeds ranging from 1.5 Mbps to 155 Mbps.
T-1, DS-3 and OC-3 are three of many possible media used to transport Internet
Protocol packets across the Internet. T-1 is a telecommunications standard that
carries voice calls or data at a rate of 1.544 million bits per second over a
communication line. DS-3 carries voice calls or data at a rate of 45 million
bits per second, and OC-3 carries voice calls or data at a rate of 155 million
bits per second. Our list prices for a single connection range from $2,695 to
$193,320 per month depending on the connection purchased. Customers who connect
to a P-NAP facility with a DS-3 or faster connection have a choice of fixed rate
pricing or usage based pricing. Otherwise, customers pay a fixed fee for our
Internet connectivity services. Usage based pricing varies according to the
volume of data sent and received over the connection.
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Customers that have networking equipment or servers located within P-NAP
facilities may connect directly to the P-NAP facility using standard ethernet
connections with speeds ranging from 10 Mbps to 200 Mbps. We also offer our
customers additional value added services, including:
- INTERNAP DIVERSITY PLUS. Our Diversity Plus service allows customers to
maintain multiple connections to InterNAP and other backbone providers
while still taking advantage of the optimal routing capabilities of the
P-NAP facility. In a typical Diversity Plus configuration, the customer
has a connection to a P-NAP facility and to one or more backbone providers
of their choice. The customer's router is configured using our proprietary
routing technology to route packets addressed to Internet destinations
located on the alternate provider's backbone through the customer's direct
connection while other packets are routed to the P-NAP facility. In this
manner, the customer can use redundant Internet connections, while also
taking advantage of the unique features of the P-NAP facility.
- CONNECTIONS TO DATA CENTERS. Many of our customers have their servers
located at third party data centers. We connect to these customers either
by establishing a circuit directly to their routers or through a
connection we have with the network maintained by the third party data
center operator. We have our own data center in our Seattle P-NAP facility
at which a number of our customers have co-located their servers.
- INSTALLATION SERVICES. We perform installation services necessary to
connect our customers' networks to our P-NAP facilities.
TECHNOLOGY
P-NAP FACILITY ARCHITECTURE. The P-NAP facility architecture was engineered
as a reliable and scalable network access point. Multiple routers and multiple
backbone connections provide back-ups in case of the failure of any single P-NAP
facility circuit or device.
The P-NAP facility architecture is designed to grow as our customers'
traffic demands grow and as we add new customers. Our P-NAP facility model
provides for the addition of significant backbone providers as necessary.
InterNAP only deploys P-NAP facilities within central office grade
facilities. All P-NAP facilities are equipped with battery backup and emergency
generators, as well as dual heating, ventilation and air conditioning systems.
ASSIMILATOR ROUTING TECHNOLOGY. ASsimilator technology is a software based
system for Internet Protocol route management that interfaces with the P-NAP
facility infrastructure to provide the high performance routing service
characteristics of the P-NAP facility. The system is a seamless integration of
databases, software programs, router configuration processes and route
verification methods.
ASsimilator periodically downloads the global routing tables being
advertised by all of the backbone networks touching the P-NAP facility. It then
automatically determines exactly which Internet Protocol routes are attached to
which networks and assesses how the world of Internet Protocol addresses are
connected to the Internet. ASsimilator then routes data to its intended
destination backbone in normal instances as well as in failure scenarios. A
verification system also allows ASsimilator to monitor the routing of data, and
if routing is found to be suboptimal, adjustments can be made to optimize
routing. ASsimilator controls both outbound routing to a backbone network from
the P-NAP facility as well as inbound routing from a backbone network. We plan
on beta testing a new version of ASsimilator, which will add further
enhancements to our existing routing technology, by the third quarter of 2000.
DISTRIBUTED NETWORK MANAGEMENT SYSTEM. We have developed a highly scalable
proprietary network management system optimized for monitoring P-NAP facilities.
With the use of our distributed network management system, our network
operations center is capable of real-time monitoring of the backbones
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connected to each P-NAP facility, customer circuits, network devices and servers
24 hours a day, seven days a week. This system provides our network operations
center with proactive trouble notification, allowing for instantaneous
identification and handling of problems, frequently before our customers become
aware of network problems. This system also captures and provides bandwidth
usage reports for billing and customer reports. Data provided by the system is
an integral part of our capacity planning and provisioning process, helping us
to forecast and plan upgrades before capacity becomes strained.
RESEARCH AND DEVELOPMENT COSTS. Our product development costs include
research and development costs, which were approximately $184,000 for the period
from inception May 1, 1996 to December 31, 1996, $389,000 for the year ended
December 31, 1997, $708,000 for the year ended December 31, 1998 and
$3.1 million for the year ended December 31, 1999. We expect our product
development costs to increase as we hire additional engineers and technical
personnel to develop new products and services and upgrade existing ones.
SALES AND MARKETING
Our sales and marketing objective is to achieve broad market penetration and
increase brand name recognition by targeting enterprises that depend upon the
Internet for mission-critical operations. As of December 31, 1999, we had 59
employees engaged in direct sales and sales management, 18 in sales
administration and support, 22 in technical support and 12 in marketing located
in 12 cities.
SALES. We have developed a direct high-end sales organization with managers
who have extensive relevant sales experience and representatives who have many
years of relevant sales experience with a broad range of telecommunications and
technology companies. In addition, our highly trained technical sales engineers
and client interaction engineers, who facilitate optimal routing solutions for
our customers, are responsible for generating recurring sales revenues and serve
to complement our sales force. When we deploy a new P-NAP facility, we set up a
dedicated team of sales representatives and engineers focused exclusively on
that market. We believe this localized direct sales approach allows us to
respond to regional competitive characteristics, educate customers, and identify
and close business opportunities better than a centralized sales force. We are
also developing an indirect sales channel for our products and services through
relationships with content developers, cable companies, DSL service providers,
consulting companies and Internet service providers.
MARKETING. Our marketing efforts are designed to help educate customers in
our targeted vertical markets to understand that a service provider is now
available that can provide a quality of service over the entire Internet that
enables them to launch and execute mission-critical Internet-based applications.
Our marketing activities have included collateral advertising, tradeshows,
direct response programs, new P-NAP facility launch events and management of our
Web site. These programs are targeted at key information technology executives
as well as senior marketing and finance managers. In addition, we conduct
comprehensive public relations efforts focused on cultivating industry analyst
and media relationships with the goal of securing broad media coverage and
public recognition of our proprietary high speed public Internet communications
solutions.
Our marketing organization is responsible for expanding our value added
service offerings into horizontal markets as new bandwidth intensive
applications such as telephone and facsimile transmissions over the Internet,
private networks, multimedia document distribution, audio and video feeds and
other emerging technologies are introduced.
COMPETITION
The Internet-based connectivity services market is extremely competitive and
there are few substantial barriers to entry. We expect that competition will
intensify in the future, and we may not have the financial resources, technical
expertise, sales and marketing abilities or support capabilities to compete
successfully
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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. Our competitors include:
- backbone providers that provide us connectivity services including, AT&T,
Cable & Wireless, USA, Global Crossing, GTE Internetworking, ICG
Communications, Intermedia, PSINet, Qwest Communications International,
Sprint, UUNET and Verio;
- regional Bell operating companies which offer Internet access; and
- global, national and regional Internet service providers.
Because relatively low barriers to entry characterize our market, we expect
other companies to enter our market. In addition, if we are successful in
implementing our international expansion, we will encounter additional
competition from international Internet service providers as well as
international telecommunication companies. As new participants enter the
Internet connectivity services market, we will face increased competition. Such
new competitors could include computer hardware, software, media and other
technology and telecommunications companies. A number of telecommunications
companies and online service providers currently offer, or have announced plans
to offer or expand, their network services. Other companies have expanded their
Internet access products and services as a result of acquisitions. Further, the
ability of some of our 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. In
addition, Internet backbone providers may make technological developments, such
as improved router technology, that will enhance the quality of their services.
We believe that the principal competitive factors in our market are speed
and reliability of connectivity, quality of facilities, level of customer
service and technical support, price, brand recognition, the effectiveness of
sales and marketing efforts, and the timing and market acceptance of new
solutions and enhancements to existing solutions developed by us and our
competitors. We believe that we presently are positioned to compete favorably
with respect to most of these factors. In particular, many of our competitors
have built and must maintain capital-intensive backbone infrastructures that are
highly dependent on traditional public and private peering exchanges. Each
backbone provider tries to offer high quality service within its own network but
is unable to guarantee service quality once data leaves its network, and there
is little incentive to optimize the interoperability of traffic between
networks. We actively route traffic in an optimal manner, thereby providing
customers with a high level of service and increasing the efficiency of the
backbone providers themselves. However, the market for Internet connectivity
services is evolving rapidly, and we cannot assure you that we will compete
successfully in the future. As a result, we may not maintain a competitive
position against current or future competitors. See "Risk Factors - Competition
from More Established Competitors Who Have Greater Revenues Could Decrease Our
Market Share."
INTELLECTUAL PROPERTY
We rely on a combination of patent, copyright, trademark, trade secret and
other intellectual property law, nondisclosure agreements and other protective
measures to protect our proprietary technology. InterNAP and P-NAP are
trademarks of InterNAP which are registered in the United States. The United
States Patent and Trademark Office, or USPTO, issued a patent in September 1999
relating to an initial patent application we filed on September 3, 1997. The
patent is enforceable for a duration of 20 years from the date of filing, or
until September 3, 2017. We have a second application pending and may file
additional applications in the future. Additional claims that were included by
amendment in our initial application have now been included in our second patent
application. Our patent and patent applications relate to our P-NAP facility
technology. In addition, we have filed a corresponding international patent
application under the Patent Cooperation Treaty.
40
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We also enter into confidentiality and invention assignment agreements with
our employees and consultants and control access to and distribution of our
proprietary information. Despite our efforts to protect our proprietary rights,
departing employees and other unauthorized parties may attempt to copy or
otherwise obtain and use our products and technology. Monitoring unauthorized
use of our products and technology is difficult, and we cannot be certain that
the steps we have taken will prevent misappropriation of our technology,
particularly in foreign countries where the laws may not protect our proprietary
rights as fully as in the United States.
From time to time, third parties may assert patent, copyright, trademark and
other intellectual property rights claims or initiate litigation against us or
our suppliers or customers with respect to existing or future products and
services. Although we have not been a party to any claims alleging infringement
or intellectual property rights, we cannot assure you that we will not be
subject to these claims in the future. Further, we may in the future initiate
claims or litigation against third parties for infringement of our proprietary
rights to determine the scope and validity of our proprietary rights or those of
our competitors. Any of these claims, with or without merit, may be
time-consuming, result in costly litigation and diversion of technical and
management personnel or require us to cease using infringing technology, develop
noninfringing technology or enter into royalty or licensing agreements. Such
royalty or licensing agreements, if required, may not be available on acceptable
terms, if at all. In the event of a successful claim of infringement and our
failure or inability to develop noninfringing technology or license the
infringed or similar technology on a timely basis, our business and results of
operations may be seriously harmed.
EMPLOYEES
As of December 31, 1999, we employed 299 full-time persons, 156 of whom were
engaged in engineering and operations, 111 in sales and marketing and 32 in
finance and administration. None of our employees is represented by a labor
union, and we have not experienced any work stoppages to date. We consider our
employee relations to be good.
FACILITIES
Our executive offices are located in Seattle, Washington and consist of
approximately 74,100 square feet that are leased under an agreement that expires
in 2003. We lease facilities for our network operations center, sales offices
and P-NAP facilities in a number of metropolitan areas and specific cities. We
believe that our existing facilities, including the additional space, are
adequate for our current needs and that suitable additional or alternative space
will be available in the future on commercially reasonable terms as needed.
LEGAL PROCEEDINGS
From time to time, we may be involved in litigation relating to claims
arising out of our ordinary course of business. We are not currently involved in
any material legal proceedings.
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<PAGE>
MANAGEMENT
Our executive officers, certain other officers and directors, the positions
held by them and their ages as of December 31, 1999 are as follows:
EXECUTIVE OFFICERS AND DIRECTORS
<TABLE>
<CAPTION>
NAME AGE POSITION
- --------------------------------------- ----------- ------------------------------------------------------------------
<S> <C> <C>
Anthony C. Naughtin*................... 43 Chief Executive Officer, President and Director
Paul E. McBride*....................... 37 Chief Financial Officer, Vice President of Finance and
Administration, and Secretary
Christopher D. Wheeler*................ 32 Chief Technology Officer and Vice President
Charles M. Ortega*..................... 44 Vice President of Sales & Marketing
Mike N. Joseph......................... 52 Vice President of Operations and Field Engineering
Richard Perez.......................... 47 Vice President of Deployment
Richard K. Cotton...................... 39 Vice President of Carrier Relations
Alan D. Norman......................... 41 Vice President of Corporate Development
Eugene Eidenberg....................... 60 Chairman of the Board
William J. Harding(1).................. 51 Director
Fredric W. Harman(1)................... 39 Director
Robert J. Lunday, Jr.(2)............... 60 Director
Kevin L. Ober(1)(2).................... 38 Director
Robert D. Shurtleff, Jr.(2)............ 45 Director
</TABLE>
- ------------------------
* Executive officers.
(1) Member of audit committee.
(2) Member of compensation committee.
ANTHONY C. NAUGHTIN founded InterNAP and has served as our Chief Executive
Officer since May 1996. Mr. Naughtin has also served as our President since
May 1996 and as our director since October 1997. Prior to founding InterNAP, he
was vice president for commercial network services at ConnectSoft, Inc., an
Internet and e-mail software developer, from May 1995 to May 1996. From
February 1992 to May 1995, Mr. Naughtin was the director of sales at
NorthwestNet, an NSFNET regional network. Mr. Naughtin has served as a director
of Fine.com International Corp., a services-computer processing and data
preparation company since December 1996. Mr. Naughtin holds a Bachelor of Arts
in communications from the University of Iowa and is a graduate of the Creighton
School of Law.
PAUL E. MCBRIDE has served as our Vice President of Finance and
Administration since May 1996. He has also served as our Chief Financial Officer
since June 1999. Prior to joining InterNAP, Mr. McBride was Vice President of
Finance and Operations at ConnectSoft, Inc. from February 1995 to March 1996.
From December 1992 to January 1995, he served as Chief Financial Officer and
Vice President of Finance at PenUltimate, Inc., a software developer.
Mr. McBride holds a Bachelor of Arts in Economics and a Bachelor of Science in
Finance from the University of Colorado and holds a Master of Business
Administration from the University of Southern California.
CHRISTOPHER D. WHEELER has served as our Chief Technology Officer and Vice
President since May 1996. Prior to joining InterNAP, Mr. Wheeler was co-founder,
President and Chief Executive Officer of interGlobe Networks, Inc., a TCP/IP
consulting firm, from 1994 to 1996. Mr. Wheeler also worked in advanced
network/Internet technology areas at NorthwestNet, which is now Verio Northwest,
and was responsible for backbone engineering, routing technology design, network
management tools development, network operations and systems engineering at the
University of Washington from 1989 to 1994. Mr. Wheeler holds a Bachelor of
Science in Computer Science from the University of Washington.
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<PAGE>
CHARLES M. ORTEGA has served as our Vice President of Sales and Marketing
since April 1998. Prior to joining InterNAP, Mr. Ortega was Director of Sales
for Global and Corporate National Accounts at MCI Communications Corporation
from 1989 to April 1998. Prior to MCI, he held senior sales management positions
with Wang Laboratories and Hewlett Packard. Mr. Ortega holds a Bachelor of
Science degree in Kinesiology from UCLA, and a Master of Business Administration
from the John Anderson School of Business at UCLA.
MIKE N. JOSEPH has served as our Vice President of Operations and Field
Engineering since August 1999. He served as our Vice President of Operations
from June 1999 to August 1999 and as our Director of Corporate Engineering
Operations from September 1998 to June 1999. Prior to joining InterNAP,
Mr. Joseph served as Director, and later Vice President of Technical Services of
Cellular Technical Services, a manufacturer of clone detection products, from
July 1996 to June 1998. Prior to that, Mr. Joseph was Director of Operational
System Support for AT&T Wireless, a wireless services provider, from
August 1995 to May 1996. From July 1994 to August 1995, Mr. Joseph was Manager
of Global Engineering at Cable & Wireless, a global voice and Internet
connectivity company. Mr. Joseph attended the University of Houston.
RICHARD PEREZ has served as our Vice President of Deployment since
August 1999 and as our Vice President of Deployment, Field Engineering and
Provisioning from December 1998 to August 1999. Prior to joining InterNAP,
Mr. Perez worked for 17 years at MCI Communications Corporation, serving in
various managerial and technical positions. Mr. Perez attended the University of
Maryland and is a past Advisory Board member of the University of Washington's
Data Communications Extension.
RICHARD K. COTTON has served as our Vice President of Carrier Relations
since September 1999. From September 1996 to September 1999, Mr. Cotton served
as Vice President and General Counsel, then as Senior Vice President in charge
of site acquisition and network planning at WinStar Communications, a national
telecommunications company. From April 1993 to September 1996, Mr. Cotton served
as Senior Attorney and subsequently Director of Law and Public Policy at MCI
Telecommunications Corporation. Mr. Cotton holds a Bachelor of Science from New
York University and is a graduate of the Brooklyn Law School.
ALAN D. NORMAN has served as our Vice President of Corporate Development
since August 1999. From May 1996 to August 1999, Mr. Norman served as Vice
President, General Manager of New Business Development at Etak, a unit of Sony
Corporation. From September 1992 through April 1996, Mr. Norman served as Vice
President, General Manager of the Automotive Business Unit for Etak, then owned
by News Corporation. Mr. Norman holds a Master of Science in Business from
Stanford University and a Bachelor of Science from Stanford University.
EUGENE EIDENBERG has served as a director and chairman of InterNAP since
November 1997. Mr. Eidenberg has served as a Principal of Hambrecht & Quist
Venture Associates since 1998 and was an advisory director at the San Francisco
investment banking firm of Hambrecht & Quist from 1995 to 1998. Mr. Eidenberg
served for 12 years in a number of senior management positions with MCI
Communications Corporation. His positions at MCI included Senior Vice President
for Regulatory and Public Policy, President of MCI's Pacific Division, Executive
Vice President for Strategic Planning and Corporate Development and Executive
Vice President for MCI's international businesses. Mr. Eidenberg is currently a
director of AAPT Ltd. and several private companies. Mr. Eidenberg holds a Ph.D.
and a Master of Arts from Northwestern University and a Bachelor of Arts from
the University of Wisconsin.
WILLIAM J. HARDING has served as a director of InterNAP since January 1999.
Since 1994, Dr. Harding has been an employee of and is a Managing Director of
Morgan Stanley Dean Witter. In addition, Dr. Harding has served as a managing
member of Morgan Stanley Venture Partners, L.L.C., the general partner of Morgan
Stanley Dean Witter Venture Partners. Prior to joining Morgan Stanley Dean
Witter, he was a General Partner of several venture capital partnerships
affiliated with J.H. Whitney & Co. Dr. Harding was associated with Amdahl
Corporation from 1976 to 1985, serving in various technical and
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business positions. He is currently a director of Persistence Software, Inc.,
Commerce One, Inc. and several private companies. Dr. Harding holds a Ph.D. in
engineering from Arizona State University and a Master of Science in systems
engineering and Bachelor of Science in engineering mathematics from the
University of Arizona.
FREDRIC W. HARMAN has served as a director of InterNAP since January 1999.
Since 1994, Mr. Harman has served as a Managing Member of the General Partners
of venture capital funds affiliated with Oak Investment Partners. Mr. Harman
served as a General Partner of Morgan Stanley Venture Capital, L.P. from 1991 to
1994. Mr. Harman serves as a director of Inktomi Corporation, ILOG, S.A., Primus
Knowledge Solutions, Quintus Corporation and several privately held companies.
Mr. Harman holds a Bachelor of Science and a Master of Science in electrical
engineering from Stanford University and a Master of Business Administration
from Harvard University.
ROBERT J. LUNDAY, JR. has served as a director of InterNAP since inception.
Mr. Lunday has served as President of Lunday Communications, Inc., an investment
company, since 1973. He was a founder of Commnet Cellular, Inc. and served on
its board of directors from 1983 to 1989.
KEVIN L. OBER has served as a director of InterNAP since October 1997. Since
February 2000, Mr. Ober has been a founding General Partner of a new venture
capital fund. Mr. Ober was a member of the investment team at Vulcan Ventures
Incorporated between November 1993 and January 2000. Prior to working at Vulcan
Ventures, Mr. Ober served in various positions at Conner Peripherals, Inc., a
computer hard disk drive manufacturer. Mr. Ober holds a Master of Business
Administration from Santa Clara University and Bachelor of Science in business
administration from St. John's University.
ROBERT D. SHURTLEFF, JR. has served as a director of InterNAP since
January 1997. In 1999, Mr. Shurtleff founded S.L. Partners, a strategic
consulting group focused on early stage companies. From 1988 to 1998,
Mr. Shurtleff held various positions at Microsoft Corporation, including Program
Management and Development Manager and General Manager Workgroup Solutions
Product Unit. Mr. Shurtleff is currently a director of two private companies and
also serves on technical advisory boards of several private companies. Prior to
working at Microsoft Corporation, Mr. Shurtleff worked at Hewlett Packard
Company from 1979 to 1988. Mr. Shurtleff holds a Bachelor of Arts in computer
science from the University of California at Berkeley.
BOARD COMPOSITION
We have authorized a range of directors from five to nine. In accordance
with the terms of our amended and restated articles of incorporation, the terms
of office of the board of directors are divided into three classes:
- Class I directors, whose term will expire at the annual meeting of
shareholders to be held in 2000;
- Class II directors, whose term will expire at the annual meeting of
shareholders to be held in 2001; and
- Class III directors, whose term will expire at the annual meeting of
shareholders to be held in 2002.
Our Class I directors are Robert J. Lunday, Jr. and Robert D. Shurtleff,
Jr., our Class II directors are Fredric W. Harman and Kevin L. Ober, and our
Class III directors are Eugene Eidenberg, William J. Harding and Anthony C.
Naughtin. Mr. Lunday does not intend to stand for reelection at our 2000 annual
meeting of shareholders. We are in the process of identifying a nominee to stand
for election to Class I of our board of directors at our 2000 annual meeting of
shareholders. At each annual meeting of shareholders, the successors to
directors whose terms then expire will be elected to serve from the time of
election and qualification until the third annual meeting following election.
Any additional directorships resulting from an increase in the number of
directors will be distributed among the three classes so that, as nearly as
possible, each class will consist of one-third of the directors. Because this
system of electing and removing
44
<PAGE>
directors generally makes it more difficult for shareholders to replace a
majority of the board of directors, it may discourage a third party from making
a tender offer or otherwise attempting a gain control and may maintain the
incumbency of the board of directors.
COMMITTEES OF THE BOARD OF DIRECTORS
Our audit committee consists of Kevin L. Ober, Fredric W. Harman and William
J. Harding. The audit committee reviews our internal accounting procedures and
consults with and reviews the services provided by our independent accountants.
Our compensation committee consists of Kevin L. Ober, Robert J. Lunday, Jr.
and Robert D. Shurtleff, Jr. The compensation committee reviews and recommends
to the board of directors the compensation and benefits of all our officers and
establishes and reviews general policies relating to compensation and benefits
for our employees.
BOARD COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
None of our executive officers serves as a member of the board of directors
or compensation committee of any entity that has one or more executive officers
serving as a member of our board of directors or compensation committee.
DIRECTOR COMPENSATION
Our directors currently do not receive any cash compensation for their
services on the board of directors or any committees of the board. They are
reimbursed for certain expenses in connection with attendance at board and
committee meetings. From time to time, certain non-employee directors have
received grants of options to purchase shares of our common stock. In
March 1998, Messrs. Eidenberg and Ober each were granted an option to purchase
400,000 shares of our common stock at an exercise price of $.03 per share. Upon
the closing of our initial public offering, non-employee directors received an
initial option to purchase 80,000 shares of common stock and are expected to
receive and an annual option to purchase 20,000 shares of common stock under our
1999 non-employee directors' stock option plan.
EXECUTIVE COMPENSATION
The table below sets forth summary information concerning compensation paid
by us during the fiscal years ended December 31, 1999, 1998 and 1997,
respectively, to (a) our Chief Executive Officer and President and (b) four of
our other officers, other than the Chief Executive Officer, whose salaries and
bonuses for fiscal year 1999 exceeded $100,000 and who served as an executive
officer during fiscal year 1999:
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<PAGE>
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
ANNUAL COMPENSATION COMPENSATION
---------------------------------------------------- -------------
ALL OTHER SECURITIES ALL OTHER
ANNUAL UNDERLYING COMPENSATION
NAME AND PRINCIPAL POSITION YEAR SALARY ($) BONUS ($) COMPENSATION ($) OPTIONS (#) ($)
- ------------------------------------------ --------- ---------- ----------- ---------------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Anthony C. Naughtin....................... 1999 $ 171,239 $ 58,500 $ -- 600,000 $ --
Chief Executive Officer and President 1998 123,750 -- -- -- --
1997 125,000 -- -- -- --
Paul E. McBride........................... 1999 137,996 54,000 -- 400,000 --
Chief Financial Officer and Vice 1998 113,750 -- -- -- --
President 1997 115,000 -- -- -- --
Christopher D. Wheeler.................... 1999 137,500 54,000 -- 400,000 --
Chief Technical Officer and Vice 1998 113,750 -- -- -- --
President 1997 115,000 -- -- -- --
Charles M. Ortega(2)...................... 1999 137,996 30,000 82,500 110,000 --
Vice President of Sales and Marketing 1998 81,658 20,000 30,000 720,000 12,000(1)
Richard Perez(2).......................... 1999 125,701 48,500 -- 40,000 --
Vice President of Deployment 1998 39,583 -- -- 300,000 --
</TABLE>
- ------------------------
(1) Consists of living expenses.
(2) Messrs. Ortega and Perez joined us in 1998.
STOCK OPTION GRANTS AND EXERCISES IN LAST FISCAL YEAR
The following table sets forth information regarding options granted to
certain of our officers during the fiscal year ended December 31, 1999.
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS
---------------------------------------------------- POTENTIAL REALIZABLE
TOTAL VALUE AT ASSUMED
OPTIONS ANNUAL RATES OF STOCK
SHARES GRANTED TO APPRECIATION FOR OPTION
UNDERLYING EMPLOYEES EXERCISE TERM ($)
OPTIONS IN FISCAL PRICE PER EXPIRATION ------------------------
NAME GRANTED (#) YEAR (%) SHARE ($) DATE 5% 10%
- ------------------------------------------- ----------- ------------- ----------- ----------- ---------- ------------
<S> <C> <C> <C> <C> <C> <C>
Anthony C. Naughtin........................ 600,000 5.65% $ 2.00 6/18/09 $ 754,674 $ 1,912,491
Paul E. McBride............................ 400,000 3.76 2.00 6/18/09 503,116 1,274,994
Christopher D. Wheeler..................... 400,000 3.76 2.00 6/18/09 503,116 1,274,994
Charles M. Ortega.......................... 110,000 1.03 2.00 6/18/09 138,357 350,623
Richard Perez.............................. 40,000 * 2.00 6/18/09 50,312 127,499
</TABLE>
- ------------------------
* Less than 1%.
Twenty-five percent of these options vest on the first anniversary of the
date of hire and the remainder vest in equal installments each month over the
three-year period following the first anniversary of the date of hire. Options
were granted at an exercise price equal to the fair market value of our common
stock, as determined by the board of directors on the date of grant.
The 5% and 10% assumed annual rates of compounded stock price appreciation
are mandated by rules of the SEC. There can be no assurance provided to any
executive officer or any other holder of our securities that the actual stock
price appreciation over the option term will be at the assumed 5% and 10% levels
or at any other defined level.
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<PAGE>
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR-END OPTION VALUES
The following table sets forth information as of December 31, 1999 regarding
options held by certain of our officers. There were no stock appreciation rights
outstanding at December 31, 1999:
<TABLE>
<CAPTION>
NUMBER OF SHARES
UNDERLYING VALUE OF UNEXERCISED
SHARES UNEXERCISED OPTIONS AT IN-THE-MONEY OPTIONS AT
ACQUIRED ON DECEMBER 31, 1999 (#) DECEMBER 31, 1999 ($)
EXERCISE VALUE --------------------------- ---------------------------
NAME (#) REALIZED ($) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ---- ----------- ------------ ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Anthony C. Naughtin............ -- -- -- 600,000 $ -- $50,700,000
Paul E. McBride................ -- -- -- 400,000 -- 33,800,000
Christopher D. Wheeler......... -- -- -- 400,000 -- 33,800,000
Charles M. Ortega.............. 255,000 -- 45,000 530,000 3,891,150 45,612,400
Richard Perez.................. -- -- 91,667 248,333 7,922,320 21,385,179
</TABLE>
In the table above, the value of unexercised in-the-money options is based
on the fair market value of our common stock, based upon the last reported sales
price of our common stock on December 31, 1999 of $86.50, minus the per share
exercise price multiplied by the number of shares.
EMPLOYMENT AGREEMENTS
We have entered into employment letter agreements with several of our
officers, including Anthony C. Naughtin, Paul E. McBride, Christopher D. Wheeler
and Charles M. Ortega. Each letter agreement sets forth the officer's
compensation level. Under each letter agreement the officer serves at-will and
employment may be terminated by us or by the officer at any time, with or
without cause and with or without notice. Each employment agreement contains a
noncompetition covenant one year in duration.
INCENTIVE STOCK PLANS
1998 STOCK OPTION/STOCK ISSUANCE PLAN. We have reserved a total of
10,070,000 shares for issuance under our 1998 Stock Option/Stock Issuance Plan.
As of February 29, 2000, 9,760,498 options were granted under the 1998 Plan and
options to purchase 6,738,481 shares were outstanding, with 687,891 shares
reserved for future grants or purchases. Options currently outstanding under the
1998 Plan will continue in full force and effect under the terms of the 1998
Plan until these outstanding options are exercised or terminated.
The 1998 Plan provides for grants of incentive stock options that qualify
under Section 422 of the Internal Revenue Code of 1986, nonstatutory stock
options and common stock awards to employees, directors and consultants.
Incentive stock options may be granted only to employees.
The 1998 Plan is administered by a committee appointed by the board. This
committee determines the terms of awards granted, including the exercise price,
the number of shares subject to the award and the exercisability of awards. The
exercise price of incentive stock options granted under the 1998 Plan must be at
least equal to the fair market value of our common stock on the date of grant.
However, for any employee holding more than 10% of the voting power of all
classes of our stock, the exercise price of incentive stock options must be
equal to at least 110% of the fair market value. The exercise price of
nonstatutory stock options is set by the administrator of the 1998 Plan. The
maximum term of options granted under the 1998 Plan is ten years.
An optionee whose relationship as an employee, director or consultant with
us or any related corporation ceases for any reason, other than for death, total
and permanent disability or "for cause," may exercise options in the three-month
period following the cessation, or such other period of time as determined by
the administrator, unless such options terminate or expire sooner, or later, by
their terms.
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<PAGE>
The three-month period is extended to 12 months for terminations due to total
and permanent disability or death. Options terminate immediately upon an
optionee's termination "for cause." Generally, the optionholder may not transfer
a stock option other than by will or the laws of descent or distribution.
In the event of specific corporate transactions, the board of directors may,
in its sole discretion,
- accelerate the vesting of outstanding options under the 1998 Plan;
- arrange for outstanding options to be assumed or substituted for similar
options by a successor corporation;
- arrange for outstanding options to be replaced by a comparable cash
incentive program of the successor corporation; or
- take no action with respect to outstanding options, in which case such
options will terminate upon the completion of the corporate transaction.
The 1998 Plan will terminate on the earlier of ten years from its adoption
by the board or the date all shares have been issued.
AMENDED 1999 EQUITY INCENTIVE PLAN. As of February 29, 2000, an aggregate
of 13,000,000 shares of common stock have been authorized for issuance under our
Amended 1999 Equity Incentive Plan. As of February 29, 2000, 9,084,500 options
were granted under the Incentive Plan and options to purchase 9,022,500 shares
were outstanding, with 3,977,500 shares reserved for future grants or purchases.
The Incentive Plan provides for the grant of incentive stock options within
the meaning of Section 422 of the Internal Revenue Code of 1986, nonstatutory
stock options, restricted stock purchase rights and stock bonuses to our
employees, consultants and directors. Incentive stock options may be granted
only to employees. The Incentive Plan is administered by the board of directors
or a committee appointed by the board. The board or committee determines the
terms of awards granted, including the exercise price, the number of shares
subject to the award and the exercisability of awards. The exercise price of
incentive stock options granted under the Incentive Plan must be at least equal
to the fair market value of our common stock on the date of grant. However, for
any employee holding more than 10% of the voting power of all classes of our
stock, the exercise price will be at least equal to 110% of the fair market
value. The exercise price of nonstatutory stock options is set by the
administrator of the Incentive Plan, but can be no less than 85% of the fair
market value. The maximum term of options granted under the Incentive Plan is
ten years.
Unless otherwise provided in an option agreement, an optionee whose
relationship as an employee, director or consultant with us or any related
corporation ceases for any reason, other than for death, total and permanent
disability or "for cause," may exercise options in the three-month period
following this cessation, or such other period of time as determined by the
administrator, unless these options terminate or expire sooner, or later, by
their terms. The three-month period is extended to 12 months for terminations
due to total and permanent disability and 18 months for terminations due to
death. Options terminate immediately upon an optionee's termination "for cause."
Generally, the optionholder may not transfer a stock option other than by will
or the laws of descent or distribution unless the optionholder holds a
nonstatutory stock option that provides for transfer in the stock option
agreement. However, an optionholder may designate a beneficiary who may exercise
the option following the optionholder's death.
A change in control of InterNAP is defined in the Incentive Plan as the sale
of substantially all of our assets or merger with or into another corporation.
If a change in control occurs, any outstanding options held by persons then
performing services for us as an employee, director or consultant may either be
assumed or continued or an equivalent award may be substituted by the surviving
entity. In this situation, if options are not assumed, continued or substituted,
these options will become fully exercisable, including shares as to which they
would not otherwise be exercisable, and restricted stock will become fully
vested. Options also become fully exercisable in the event of a securities
acquisition representing 50% or more of
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<PAGE>
the combined voting power of our securities or if a participant's service is
terminated by a surviving corporation for any reason other than "for cause"
within 13 months following a change in control.
Upon the first nine anniversaries of the adoption date of the Incentive
Plan, an additional number of shares will automatically be added to the number
of shares already reserved for issuance under the Incentive Plan. The additional
number of shares will not be more than the lesser of
- 3 1/2% of the number of shares of our common stock issued and outstanding
on the anniversary date; or
- 13,000,000 shares.
Pursuant to Section 162(m) of the Internal Revenue Code, which denies a
deduction to publicly held corporations for compensation paid to specified
employees in a taxable year to the extent that the compensation exceeds
$1,000,000, no person may be granted options under the Incentive Plan covering
more than 6,000,000 shares of common stock in any calendar year.
Restricted stock purchase awards are granted under the Incentive Plan in
accordance with a vesting schedule determined by the board or a committee
appointed by the board. These restricted stock purchase awards are subject to a
right of repurchase by us. The price of a restricted stock purchase award under
the Incentive Plan cannot be less than 85% of the fair market value of the stock
subject to the award on the date of grant. Stock bonuses may be awarded for past
services without a purchase payment. Unless otherwise specified, rights under a
stock bonus or restricted stock bonus agreement generally may not be transferred
other than by will or the laws of descent and distribution as long as the stock
awarded pursuant to an agreement remains subject to the agreement.
Subject to shareholder approval, as necessary, our board of directors may
amend the Incentive Plan at any time. The Incentive Plan will terminate on the
day before the 10th anniversary of its adoption by the board.
1999 EMPLOYEE STOCK PURCHASE PLAN. A total of 3,000,000 shares of common
stock have been reserved for issuance under our 1999 Employee Stock Purchase
Plan. Upon the first nine anniversaries of the adoption date of the purchase
plan, the number of shares reserved for issuance under the purchase plan will
automatically be increased by 2% of the total number of shares of common stock
then outstanding or, if less, by 3,000,000 shares. The purchase plan is intended
to qualify as an employee stock purchase plan within the meaning of Section 423
of the Code.
The purchase plan provides a means by which employees may purchase common
stock of InterNAP through payroll deductions. The purchase plan is implemented
by offering rights to eligible employees. Under the purchase plan, we may
specify offerings with a duration of not more than 27 months, and may specify
shorter purchase periods within each offering. The first offering began on
September 29, 1999 and will terminate on September 30, 2001. Purchase dates
occur each March 31 and September 30.
Employees who participate in an offering under the purchase plan may have up
to 15% of their earnings withheld. The amount withheld is then used to purchase
shares of the common stock on specified dates determined by the board of
directors. The price of common stock purchased under the purchase plan is equal
to 85% of the lower of the fair market value of the common stock at the
commencement date of each offering period or the relevant purchase date.
Employees may end their participation in an offering at any time during the
offering except during the 15 day period immediately prior to a purchase date.
Employees' participation in all offerings ends automatically on termination of
their employment with us or one of our subsidiaries.
Unless otherwise determined by our board of directors, employees are
eligible to participate in the purchase plan only if they are customarily
employed by us, or one of our subsidiaries designated by the board of directors,
for at least 20 hours per week and five months per calendar year. No employee
may be granted rights under the purchase plan if immediately after the rights
are granted, the employee will have
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<PAGE>
voting power over 5% or more of our outstanding capital stock. Eligible
employees may be granted rights only if the rights together with any other
rights granted under employee stock purchase plans, do not permit an employee's
rights to purchase our stock to accrue at a rate which exceeds $25,000 of fair
market value of our stock for each calendar year in which our rights are
outstanding.
Upon a change in control of InterNAP, our board of directors has discretion
to provide that each right to purchase common stock:
- will be assumed;
- an equivalent right substituted by the successor corporation; or
- all sums collected by payroll deductions to be applied to purchase stock
immediately prior to the change in control.
The board of directors has the authority to amend or terminate the purchase
plan, but no such action may adversely affect any outstanding rights to purchase
common stock.
1999 NON-EMPLOYEE DIRECTORS' STOCK OPTION PLAN. Our 1999 Non-Employee
Directors' Stock Option Plan provides for the automatic grant of options to
purchase shares of common stock to non-employee directors of InterNAP. The
directors' plan is administered by our compensation committee. An aggregate of
1,000,000 shares of common stock may be issued pursuant to options granted under
the directors' plan. As of February 29, 2000, options to purchase an aggregate
of 400,000 shares were outstanding under the directors' plan and 520,000 shares
were currently available for future grant of stock awards under the directors'
plan. Each of our non-employee directors was granted an initial grant to
purchase 80,000 shares of common stock upon the closing of our initial public
offering. Also, each person who is appointed or elected for the first time as a
non-employee director will be granted an initial grant to purchase 80,000 shares
of common stock upon such election or appointment. In addition, on the day
following each annual meeting of our shareholders, each non-employee director
who has served as a non-employee director for at least six months and who
continues to serve as a non-employee director of ours is automatically granted
an option to purchase 20,000 shares of common stock. Each option granted under
the directors' plan is fully vested on the date it is granted. No option granted
under the directors' plan may be exercised more than ten years from the date on
which it was granted. The exercise price of options under the directors' plan
equals the fair market value of the common stock on the date of grant. A
non-employee director whose service as a non-employee director or employee of or
consultant to us or any of our affiliates ceases for any reason other than death
or permanent and total disability may exercise vested options in the three-month
period following the cessation unless the options terminate or expire sooner by
their terms. Vested options may be exercised during the 12-month period after a
non-employee director's service ceases due to disability and during the 18-month
period after such service ceases due to death. The directors' plan will
terminate in July 2009, unless terminated earlier by our board of directors.
Upon specific changes in control of InterNAP, all outstanding stock awards
under the directors' plan may be assumed by the surviving entity or replaced
with similar stock awards granted by the surviving entity.
401(k) PLAN. We have established a tax-qualified employee savings and
retirement plan, the 401(k) Plan, for eligible employees. Eligible employees may
elect to defer a percentage of their pre-tax gross compensation in the 401(k)
Plan, subject to the statutorily prescribed annual limit. We may make matching
contributions on behalf of all participants in the 401(k) Plan in an amount
determined by our board of directors. We may also make additional discretionary
profit sharing contributions in such amounts as determined by the board of
directors, subject to statutory limitations. Effective January 1, 2000, the
Company began matching 50% of employee contributions, up to a maximum of 6% of
each employee's gross wage. Matching and profit-sharing contributions are
subject to a vesting schedule; all other contributions are at all times fully
vested. We intend the 401(k) Plan, and the accompanying trust, to qualify under
Sections 401(k) and 501 of the Internal Revenue Code so that contributions to
the 401(k) Plan by our
50
<PAGE>
employees or by us, and income earned on plan contributions, are not taxable to
employees until withdrawn from the 401(k) Plan, and so that we will be able to
deduct our contributions, when made. The trustee under the 401(k) Plan, at the
direction of each participant, invests the assets of the 401(k) Plan in any of a
number of investment options.
LIMITATIONS ON DIRECTORS' AND OFFICERS' LIABILITY AND INDEMNIFICATION
Our amended and restated articles of incorporation limit the liability of
directors to the fullest extent permitted by the Washington Business Corporation
Act as it currently exists or as it may be amended in the future. Consequently,
subject to the Washington Business Corporation Act, no director will be
personally liable to us or our shareholders for monetary damages resulting from
his or her conduct as a director of InterNAP, except liability for:
- acts or omissions involving intentional misconduct or knowing violations
of law;
- unlawful distributions; or
- transactions from which the director personally receives a benefit in
money, property or services to which the director is not legally entitled.
Our amended and restated articles of incorporation also provide that we may
indemnify any individual made a party to a proceeding because that individual is
or was a director or officer of ours, and this right to indemnification will
continue as to an individual who has ceased to be a director or officer and will
inure to the benefit of his or her heirs, executors or administrators. Any
repeal of or modification to our amended and restated articles of incorporation
may not adversely affect any right of a director or officer of ours who is or
was a director or officer at the time of such repeal or modification. To the
extent the provisions of our amended and restated articles of incorporation
provide for indemnification of directors or officers for liabilities arising
under the Securities Act of 1933, those provisions are, in the opinion or the
Securities and Exchange Commission, against public policy as expressed in the
Securities Act and they are therefore unenforceable.
Our bylaws provide that we will indemnify our directors and officers and may
indemnify our other officers and employees and other agents to the fullest
extent permitted by law.
We have entered into agreements to indemnify our directors and certain
officers, in addition to indemnification provided for in our amended and
restated articles of incorporation or bylaws. These agreements, among other
things, indemnify our directors and certain officers for certain expenses,
including attorneys' fees, judgments, fines and settlement amounts incurred by
any such person in any action or proceeding, including any action by us arising
out of such person's services as our director or officer or any other company or
enterprise to which the person provides services at our request. We believe that
these provisions and agreements are necessary to attract and retain qualified
persons as directors and officers. We also currently maintain liability
insurance for our officers and directors.
CHANGE OF CONTROL ARRANGEMENTS
Under the 1998 Stock Option/Stock Issuance Plan, if specific corporate
transactions occur, including the sale of substantially all of our assets or a
merger with or into another corporation, the plan administrator may, in its sole
discretion,
- accelerate the vesting of outstanding options under the 1998 Plan;
- arrange for outstanding options to be assumed or substituted for similar
options by a successor corporation;
- arrange for outstanding options to be replaced by a comparable cash
incentive program of the successor corporation; or
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<PAGE>
- take no action with respect to outstanding options, in which case the
options will terminate upon the completion of the corporate transaction.
Under the Amended 1999 Equity Incentive Plan, if a change in control occurs,
including the sale of substantially all of our assets or a merger with or into
another corporation, any outstanding options held by persons then performing
services for us as an employee, director or consultant may,
- either be assumed or continued;
- an equivalent award may be substituted by the surviving entity; or
- if the options are not assumed, continued or substituted, the options will
become fully exercisable, including shares as to which they would not
otherwise be exercisable, and restricted stock will become fully vested.
Options also become fully exercisable upon the occurrence of a securities
acquisition representing 50% or more of the combined voting power of our
securities, or if a participant's service is terminated by a surviving
corporation for any reason other than "for cause" within 13 months following a
change in control.
52
<PAGE>
CERTAIN TRANSACTIONS
Since January 1, 1999, we have issued and sold securities to the persons
listed in the following table who are our executive officers, directors or
principal shareholders. You may find more details about shares held by these
purchasers in the "Principal and Selling Shareholders" section.
The per share purchase price for our Series C preferred stock was $0.54.
Upon closing of our initial public offering, each previously outstanding share
of our preferred stock, including the Series C preferred stock, converted into
common stock on a one-for-one basis.
<TABLE>
<CAPTION>
SERIES C
PREFERRED
INVESTOR STOCK
- ---------------------------------------------------------------------------------------------------- ------------
<S> <C>
Robert D. Shurtleff, Jr............................................................................. 714,320
H&Q InterNAP Investors L.P.(1)...................................................................... 3,733,916
Morgan Stanley Dean Witter Venture Partners(2)...................................................... 18,518,518
Oak Investment Partners VIII, L.P.(3)............................................................... 12,037,038
TI Ventures L.P.(4)................................................................................. 3,519,112
Vulcan Ventures Incorporated........................................................................ 4,472,142
</TABLE>
- ------------------------
(1) Mr. Eidenberg, the chairman of our board of directors, is sole trustee of a
manager of the investment general partner of H&Q InterNAP Investors, L.P.
(2) Consists of 1,560,000 shares of Series C preferred stock held by Morgan
Stanley Venture Investors III, L.P., 710,834 shares of Series C preferred
stock held by The Morgan Stanley Venture Partners Entrepreneur Fund, L.P.
and 16,247,684 shares of Series C preferred stock held by Morgan Stanley
Venture Partners III, L.P. The Series C preferred stock converted into
shares of our common stock on a one-for-one basis upon the closing of our
initial public offering. Dr. Harding, one of our directors, is a managing
member of the general partner of the Morgan Stanley Dean Witter Venture
Partners Funds. The institutional managing member of the general partner of
each of the Morgan Stanley Dean Witter Venture Partners Funds is a
wholly-owned subsidiary of Morgan Stanley Dean Witter & Co., the parent of
Morgan Stanley & Co. Incorporated.
(3) Consists of 11,808,334 shares of Series C preferred stock held by Oak
Investment Partners VIII, L.P. and 228,704 shares of Series C preferred
stock held by Oak VIII Affiliates Fund, L.P. The Series C preferred stock
converted into shares of our common stock on a one-for-one basis upon the
closing of our initial public offering. Mr. Harman, one of our directors, is
a managing member of the general partner of venture capital funds affiliated
with Oak Investment Partners.
(4) Consists of 3,519,112 shares of Series C preferred stock issued to TI
Ventures L.P. of which 176,094 were subsequently transferred to other
shareholders. The Series C preferred stock converted into shares of our
common stock on a one-for-one basis upon the closing of our initial public
offering. Mr. Eidenberg, the chairman of our board of directors, is a
managing member of the principal manager of the general partner of TI
Ventures L.P. and also is individually a manager of the general partner of
TI Ventures L.P.
In addition, we have granted options to our executive officers and certain
other officers. See "Management - Executive Compensation."
Big Sandy Telecommunications, Inc., a company owned by Robert J.
Lunday, Jr., and Anthony C. Naughtin and Paul E. McBride executed a lease
guarantee in 1996 covering one of our office leases. Big Sandy was the primary
guarantor, and Messrs. Naughtin and McBride were secondary guarantors as
corporate officers of InterNAP. The secondary guarantees terminated in 1999, and
the primary guarantee terminated in 2000.
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<PAGE>
Pursuant to a shareholder agreement, dated October 1, 1997, among InterNAP,
Robert J. Lunday, Jr., and some of our founders, including Anthony C. Naughtin,
Paul E. McBride and Christopher D. Wheeler, Mr. Lunday granted to each founder
an option to purchase, under conditions set out in the shareholder agreement,
his or her pro rata share (as that term is defined in the shareholder agreement)
of 10,000,000 of the 13,333,334 shares of Series A preferred stock, or common
stock upon conversion, owned by Mr. Lunday at the date of the shareholder
agreement at a price of $0.63 per share. In January 2000, Mr. Lunday sold an
aggregate of 1,051,276 shares of common stock to two founders pursuant to the
shareholders agreement. The option remains outstanding with respect to
8,948,724 shares. Mr. Lunday, one of our directors, is father-in-law of
Mr. McBride, our Chief Financial Officer and Vice President of Finance and
Administration.
On January 11, 1999, Lunday Communications, Inc. loaned $500,000 to us,
represented by a promissory note that bore interest at the rate of prime plus 2%
and had a maturity date of February 15, 1999. We repaid the outstanding
principal and accrued interest on the loan in February 1999 from the proceeds of
our Series C financing. The Series C preferred stock converted into shares of
common stock on a one-for-one basis upon the closing of our initial public
offering.
On January 13, 1999, Robert D. Shurtleff, Jr., one of our directors, loaned
$600,000 to us, represented by a promissory note that bore interest at the rate
of prime plus 2% and had a maturity date of February 15, 1999. We repaid the
outstanding principal and accrued interest on the loan in February 1999 from the
proceeds of our Series C financing. The Series C preferred stock converted into
shares of common stock on a one-for-one basis upon the closing of our initial
public offering.
On January 28, 1999 and February 26, 1999, we sold an aggregate of
59,259,260 shares of Series C preferred stock to 44 investors, including Robert
D. Shurtleff, Jr., one of our directors, and H&Q InterNAP Investors, L.P.,
Morgan Stanley Dean Witter Venture Partners, Oak Investment Partners VIII, L.P.,
TI Ventures L.P. and Vulcan Ventures Incorporated, five of our principal
shareholders, at an aggregate purchase price of $32,000,000, or $0.54 per share.
The Series C preferred stock converted into shares of common stock on a
one-for-one basis upon the closing of our initial public offering.
We have entered into employment letter agreements with several of our key
employees, including Anthony C. Naughtin, Paul E. McBride, Charles M. Ortega and
Christopher D. Wheeler. These agreements are described in "Management -
Employment Agreements."
We have entered into indemnification agreements with our directors and
executive officers for the indemnification of and advancement of expenses to
such persons to the fullest extent permitted by law. We also intend to enter
into these agreements with our future directors and executive officers.
On September 7, 1999, we entered into a letter agreement with Richard K.
Cotton under which 100,000 shares of common stock underlying his option grant
fully vest and he will receive severance pay equal to six months of his
compensation, including employee benefits, in the event of his termination for
reasons other than his voluntary resignation, death or for cause.
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 million prior to the
earlier of maturity or December 31, 1999, but we did not draw any amounts on
this facility prior to maturity. In connection with this facility, we issued
warrants to purchase 200,000 shares of common stock with exercise prices of
$10.00 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 interest expense for the year ended December 31, 1999.
On October 4, 1999, we sold an aggregate of 2,150,537 shares of common stock
in a private placement to Inktomi Corp, at an aggregate purchase price of
$20,000,000, or $9.30 per share, resulting in proceeds of $19.0 million, net of
a private placement fee of $1.0 million paid to Morgan Stanley & Co.
Incorporated. We also issued to Inktomi a warrant to purchase 1,075,268
additional shares of our common stock at an
54
<PAGE>
exercise price of $13.95 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 stock for a period of two years. On
November 24, 1999, Inktomi exercised its warrant in part through a cashless
exercise, and received 397,250 shares of our common stock.
Pursuant to a letter agreement dated March 10, 2000 among Morgan Stanley
Venture Investors III, L.P., Morgan Stanley Venture Partners III, L.P., The
Morgan Stanley Venture Partners Entrepreneur Fund, L.P., collectively, the
Morgan Stanley Dean Witter Venture Partners, and us, the Morgan Stanley Dean
Witter Venture Partners have irrevocably agreed with us to vote all shares of
our common stock they beneficially own in excess of 9.9% of our outstanding
common stock in proportion to votes cast by all other shareholders, as
determined by us and excluding all shares of common stock beneficially owned by
the Morgan Stanley Dean Witter Venture Partners.
We believe that the foregoing transactions were in our best interest and
were made on terms no less favorable to us than could have been obtained from
unaffiliated third parties. All future transactions between us and any of our
officers, directors or principal shareholders will be approved by a majority of
the independent and disinterested members of our board of directors, will be on
terms no less favorable to us than could be obtained from unaffiliated third
parties and will be in connection with our bona fide business purposes.
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<PAGE>
PRINCIPAL AND SELLING SHAREHOLDERS
The following table sets forth information known to us with respect to the
beneficial ownership of our common stock as of February 29, 2000 and as adjusted
to reflect this offering:
- each shareholder who we know to own beneficially more than five percent of
our common stock;
- each of our directors;
- each of our executive officers;
- each shareholder who is selling shares of our common stock in this
offering; and
- all directors and executive officers as a group.
Except as indicated, and subject to community property laws where
applicable, the persons or institutions named have sole voting and investment
power with respect to all shares of our common stock shown as beneficially owned
by them. Percentages of beneficial ownership indicated are based on 132,981,682
shares of common stock outstanding as of February 29, 2000 and assume no
exercise of the underwriters' over-allotment option in connection with the
selling shareholders. If the underwriters' over-allotment option is exercised in
full, the selling shareholders will sell up to an aggregate of 5,175,000 shares
of common stock and up to 136,431,682 shares of common stock will be outstanding
after the completion of this offering.
The number of shares beneficially owned by each shareholder is determined
under rules promulgated by the SEC, and the information is not necessarily
indicative of beneficial ownership for any other purpose. Under these rules,
beneficial ownership includes any shares as to which the individual or entity
has sole or shared voting power or investment power and any shares as to which
the individual or entity has the right to acquire beneficial ownership within
60 days after February 29, 2000 through the exercise of any stock option or
other right. The inclusion in this table of these shares, however, does not
constitute an admission that the named shareholder is a direct or indirect
beneficial owner of, or receives the economic benefit from these shares.
Unless otherwise indicated in the table set forth below and with the
exception of the selling shareholders, each person or entity named below has an
address in care of our principal executive offices.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY
OWNED PRIOR TO SHARES BENEFICIALLY
OFFERING OWNED AFTER OFFERING
--------------------- SHARES BEING ---------------------
NAME AND ADDRESS OF BENEFICIAL OWNER NUMBER PERCENT OFFERED NUMBER PERCENT
- ------------------------------------ ---------- -------- ------------ ---------- --------
<S> <C> <C> <C> <C> <C>
Morgan Stanley Dean Witter
Venture Partners (1)
c/o Morgan Stanley Dean Witter
Venture Partners
1221 Avenue of the Americas
New York, NY 10020...................... 18,598,518 14.0% 1,070,275 17,528,243 12.9%
William J. Harding (1).................... 18,598,518 14.0 1,070,275 17,528,243 12.9
H&Q InterNAP Investors, L.P. (2)
One Bush Street
San Francisco, CA 94104................. 14,260,268 10.7 796,428 13,463,840 9.9
TI Ventures L.P. (2)
One Bush Street
San Francisco, CA 94104................. 14,260,268 10.7 796,428 13,463,840 9.9
Eugene Eidenberg (2)...................... 14,260,268 10.7 796,428 13,463,840 9.9
</TABLE>
56
<PAGE>
<TABLE>
<CAPTION>
SHARES BENEFICIALLY
OWNED PRIOR TO SHARES BENEFICIALLY
OFFERING OWNED AFTER OFFERING
--------------------- SHARES BEING ---------------------
NAME AND ADDRESS OF BENEFICIAL OWNER NUMBER PERCENT OFFERED NUMBER PERCENT
- ------------------------------------ ---------- -------- ------------ ---------- --------
<S> <C> <C> <C> <C> <C>
Oak Investment Partners VIII, L.P. (3)
c/o Oak Investment Partners VIII, L.P.
525 University Avenue, Suite 1300
Palo Alto, CA 94301..................... 12,296,668 9.3% 688,720 11,607,948 8.5%
Fredric W. Harman (3)..................... 12,296,668 9.3 688,720 11,607,948 8.5
Robert J. Lunday, Jr. (4)................. 10,686,788 8.0 -- 10,686,788 7.9
Vulcan Ventures Incorporated
110 - 100(th) Avenue Northeast, Suite
550
Bellevue, WA 98004...................... 9,472,142 7.1 547,439 8,924,703 6.6
Kevin L. Ober (5)......................... 480,000 * -- 480,000 *
Paul E. McBride (6)....................... 5,379,608 4.0 192,562 5,187,046 3.8
Anthony C. Naughtin (7)................... 4,602,760 3.4 158,985 4,443,775 3.2
Christopher D. Wheeler (8)................ 4,584,760 3.4 158,985 4,425,775 3.2
Robert D. Shurtleff, Jr. (9).............. 1,888,296 1.4 57,280 1,831,016 1.3
Charles M. Ortega (10).................... 358,950 * -- 358,950 *
All directors and executive officers as a
group
(10 persons)(11)........................ 64,884,048 48.2 3,123,235 61,760,813 44.9
SELLING SHAREHOLDERS:
Bocinsky Family L.L.C..................... 580,000 * 33,521 546,479 *
Stacy Burk................................ 904 * 52 852 *
Dennis Cuccia............................. 101,094 * 5,842 95,252 *
Peter Cuccia.............................. 35,098 * 2,029 33,069 *
The Cuccia Limited Partnership............ 80,000 * 4,623 75,377 *
Thomas J. Cuccia.......................... 55,692 * 3,210 52,473 *
Thomas J. Cuccia & Victoria Adams-Cuccia
JT TEN.................................. 61,406 * 3,549 57,857 *
Doll Technology Affiliates Fund, LP....... 275,612 * 14,400 261,212 *
Doll Technology Investment Fund........... 4,684,302 3.5 240,000 4,444,302 3.3
Doll Technology Side Fund, LP............. 179,422 * 10,000 169,422 *
Donna Hayataka............................ 1,204 * 70 1,134 *
Tim Hinderliter........................... 855,664 * 30,379 825,285 *
Thomas S. Huseby.......................... 106,224 * 6,139 100,085 *
Kirlan I.................................. 1,666,666 1.3 96,324 1,570,342 1.2
Alan D. Norman (12)....................... 171,312 * 9,901 161,411 *
Phoenix Leasing Incorporated.............. 149,360 * 8,632 140,728 *
Joe Pruskowski............................ 342,620 * 19,802 322,818 *
PS Capital Holdings, LP................... 3,333,334 2.5 192,649 3,140,685 2.3
PS Capital Ventures, LP................... 1,851,852 1.4 107,027 1,744,825 1.3
Ophir Ronen............................... 809,350 * 30,379 778,971 *
Mark Smith................................ 186,666 * 10,789 175,877 *
</TABLE>
- ------------------------
* Represents beneficial ownership of less than 1%.
(1) Shares beneficially owned prior to this offering consists of 1,560,000
shares held by Morgan Stanley Venture Investors III, L.P., 710,834 shares
held by The Morgan Stanley Venture Partners Entrepreneur Fund, L.P., and
16,247,684 shares held by Morgan Stanley Venture Partners III, L.P.,
collectively Morgan Stanley Dean Witter Venture Partners, and 80,000 shares
issuable upon the exercise of options held by Mr. Harding exercisable within
60 days of February 29, 2000. The institutional
57
<PAGE>
managing member of the general partner of Morgan Stanley Dean Witter Venture
Partners is a wholly-owned subsidiary of Morgan Stanley Dean Witter & Co.,
the parent of Morgan Stanley & Co. Incorporated. Dr. William J. Harding, one
of our directors, is a managing member of the general partner of Morgan
Stanley Dean Witter Venture Partners. Dr. Harding disclaims beneficial
ownership of the shares held by Morgan Stanley Dean Witter Venture Partners,
except to the extent of his proportionate interest therein. Morgan Stanley
Dean Witter Venture Partners have entered into a letter agreement with us
that restricts their voting of shares they hold in excess of 9.9% of our
outstanding common stock.
Shares being offered consists of 41,082 shares being offered by The Morgan
Stanley Venture Partners Entrepreneur Fund, L.P., 90,161 shares being
offered by Morgan Stanley Ventures Investors III, L.P. and 939,032 shares
being offered by Morgan Stanley Venture Partners III, L.P.
(2) Shares beneficially owned prior to this offering consists of 7,103,916
shares held by H&Q InterNAP Investors, L.P., 6,676,352 shares held by TI
Ventures L.P., 313,333 shares issuable upon exercise of vested options that
are held by Mr. Eugene Eidenberg and 166,667 shares issuable upon exercise
of options held by Mr. Eidenberg that are exercisable within 60 days of
February 29, 2000 but subject to repurchase by InterNAP under terms set
forth in a notice of grant of stock option. Mr. Eidenberg, the chairman of
our board of directors, is sole trustee of a manager of the investment
general partner of H&Q InterNAP Investors, L.P. Mr. Eidenberg is also a
managing member of the principal manager of the general partner of TI
Ventures L.P. and also is individually a manager of the general partner of
TI Ventures L.P. Mr. Eidenberg disclaims beneficial ownership of the shares
held by H&Q InterNAP Investors, L.P. and TI Ventures L.P.
Shares being offered consists of 410,569 shares being offered by H&Q
InterNAP Investors, L.P. and 385,859 shares being offered by TI Ventures
L.P.
(3) Shares beneficially owned prior to this offering consists of 12,063,032
shares held by Oak Investment Partners VIII, L.P., 233,636 shares held by
Oak VIII Affiliates Fund L.P. Mr. Fredric W. Harman, one of our directors,
is a managing member of the general partners of venture capital funds
affiliated with Oak Investment Partners. Mr. Harman disclaims beneficial
ownership of the shares held by Oak Investment Partners VIII, L.P. and Oak
VIII Affiliates Fund L.P.
Shares being offered consists of 675,635 shares being offered by Oak
Investment Partners VIII, L.P. and 13,085 shares being offered by Oak VIII
Affiliates Fund L.P.
(4) Includes 10,000,000 shares subject to an option under a Shareholders
Agreement dated October 1, 1997, in favor of original Class A Members of
InterNAP Network Services, L.L.C., including Paul E. McBride, Anthony C.
Naughtin and Christopher D. Wheeler, 80,000 shares issuable upon the
exercise of options exercisable within 60 days of February 29, 2000, and
9,500 shares issuable upon exercise of warrants exercisable within 60 days
of February 29, 2000. The shares beneficially owned by Mr. Lunday include an
aggregate of 1,051,276 shares Mr. Lunday sold to two original Class A
members of InterNAP Network Services LLC in January 2000.
(5) Includes 166,667 shares that are subject to repurchase by InterNAP under the
terms set forth in the notice of grant of stock option, and 80,000 shares
issuable upon the exercise of options exercisable within 60 days of
February 29, 2000.
(6) Shares beneficially owned prior to this offering includes 500,000 shares
held by the McBride Trust, 221,712 shares held, as of February 11, 2000, by
Mr. McBride as trustee of the McBride Grandchildren's Trust No. 1, 221,712
shares held, as of February 11, 2000, by Mr. McBride as trustee of the
McBride Grandchildren's Trust No. 2, 221,712 shares held by Mr. McBride's
wife in her own name, and 2,750,856 shares that may be purchased from
Mr. Robert J. Lunday, Jr. upon exercise of an outstanding option under a
Shareholder Agreement, dated October 1, 1997. Mr. Lunday is Mr. McBride's
father-in-law.
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<PAGE>
Shares being offered consists of 158,985 shares being offered by
Mr. McBride, 7,949 shares being offered by the McBride Trust, 12,814 shares
being offered by Mr. McBride as trustee for the McBride Grandchildren's
Trust No. 1, and 12,814 shares being offered by Mr. McBride as trustee of
McBride Grandchildren's Trust No. 2.
(7) Shares beneficially owned prior to this offering includes 1,800,000 shares
held by Crossroads Associates LLC, 6,000 shares held by Mr. Naughtin as
Trustee of the Eric Weaver Gift Protection Trust, 6,000 shares held by
Mr. Naughtin as Trustee of the Hugh Naughtin Gift Protection Trust, 6,000
shares held by Mr. Naughtin as Trustee of the Rose Naughtin Gift Protection
Trust and 2,750,856 shares that may be purchased from Mr. Robert J. Lunday,
Jr. upon exercise of an outstanding option under a Shareholder Agreement,
dated October 1, 1997. Mr. Naugthin disclaims beneficial ownership with
respect to the 18,000 shares held in trust for the benefit of his niece and
nephews.
Shares being offered consists of 2,939 shares being offered by Mr. Naughtin
and 156,046 shares being offered by Crossroads Associates, LLC.
(8) Shares beneficially owned prior to this offering includes 2,750,856 shares
that may be purchased from Mr. Robert J. Lunday, Jr. upon exercise of an
outstanding option under a Shareholder Agreement, dated October 1, 1997, and
183,390 shares held by the CDW Limited Partnership.
Shares being offered consists of 127,188 shares being offered by
Mr. Wheeler and 31,797 shares being offered by the CDW Limited Partnership.
(9) Shares beneficially owned prior to this offering includes 650,700 shares
issuable upon exercise of warrants exercisable within 60 days of
February 29, 2000 and 80,000 shares issuable upon the exercise of options
held by Mr. Shurtleff exercisable within 60 days of February 29, 2000.
(10) Includes 105,000 shares issuable upon exercise of options exercisable
within 60 days of December 31, 1999.
(11) Includes 905,000 shares subject to options and 660,200 shares subject to
warrants, which are exercisable within 60 days of February 29, 2000, but
does not give effect to the exercise of options by Messrs. Naughtin, McBride
and Wheeler held on 8,252,568 shares held by Robert J. Lunday, Jr. As of
February 4, 2000, Mr. Ober resigned as a member of the investment team at
Vulcan Ventures Incorporated.
(12) Mr. Norman is our Vice President of Corporate Development.
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<PAGE>
DESCRIPTION OF CAPITAL STOCK
We have authorized capital stock consisting of 500,000,000 shares of common
stock, $.001 par value per share, and 10,000,000 shares of preferred stock,
$.001 par value per share. The following description of our capital stock does
not purport to be complete and is subject to and qualified in its entirety by
our amended and restated articles of incorporation and bylaws and by the
applicable provisions of Washington law.
COMMON STOCK
As of February 29, 2000, we had 132,981,682 shares of our common stock
outstanding. The holders of our common stock are entitled to one vote per share
on all matters to be voted on by the shareholders. Subject to preferences that
may be applicable to any outstanding shares of preferred stock, holders of
common stock are entitled to receive ratably such dividends as may be declared
by the board of directors out of funds legally available therefor. In the event
of a liquidation, dissolution or winding up, holders of common stock are
entitled to share ratably in all assets remaining after payment of liabilities
and the liquidation preferences of any outstanding shares of preferred stock.
Holders of common stock have no preemptive, conversion, subscription or other
rights. There are no redemption or sinking fund provisions applicable to our
common stock.
PREFERRED STOCK
We have authorized 10,000,000 shares of undesignated preferred stock. There
are no shares of preferred stock outstanding. The board has the authority,
without further action by shareholders, to issue the preferred stock in one or
more series and to fix the rights, preferences, privileges, qualifications and
restrictions granted to or imposed upon such preferred stock, including dividend
rights, conversion rights, voting rights, rights and terms of redemption,
liquidation preference and sinking fund terms, any or all of which may be
greater than the rights of our common stock. The issuance of preferred stock
could adversely affect the voting power of holders of our common stock and
reduce the likelihood that such holders will receive dividend payments and
payments upon liquidation. Such issuance could have the effect of decreasing the
market price of our common stock. The issuance of preferred stock could have the
effect of delaying, deferring or preventing a change in control over our board
of directors or senior management. We have no present plans to issue any shares
of preferred stock.
WARRANTS
As of February 29, 2000, warrants to purchase an aggregate of 951,278 shares
of common stock were outstanding at an exercise price of $.30 per share,
warrants to purchase an aggregate of 200,000 shares of common stock were
outstanding at an exercise price of $10.00 per share and warrants to purchase an
aggregate of 537,634 shares of common stock were outstanding at an exercise
price of $13.95 per share. Each warrant contains provisions for the adjustment
of the exercise price and the aggregate number of shares issuable upon the
exercise of the warrant in the event of stock dividends, stock splits,
reorganizations and reclassifications and consolidations.
REGISTRATION RIGHTS
After this offering and giving effect to the sale by the selling
shareholders of 4,500,000 shares of common stock, other than the shares of
common stock held by Inktomi, the holders of 99,873,978 shares of common stock,
including shares issuable upon exercise of warrants, or their permitted
transferees, are entitled to certain rights with respect to the registration of
such shares under the Securities Act. If we propose to register any of our
securities under the Securities Act for our own account or the account of any of
our shareholders other than the holders of the registrable shares, holders of
the registrable shares are entitled, subject to certain limitations and
conditions, to notice of this registration and are, subject to
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<PAGE>
certain conditions and limitations, entitled to include registrable shares in
the registration, provided, among other conditions, that the underwriters of any
such offering have the right to limit the number of shares included in the
registration. In addition, beginning March 28, 2000, we may be required to
prepare and file a registration statement under the Securities Act at our
expense if requested to do so by the holders of at least 102,421,766 of the
registrable shares, provided the reasonably expected aggregate offering price
will equal or exceed $5,000,000 and subject to certain other conditions and
limitation. We are required to use our best efforts to effect such registration,
subject to certain conditions and limitations. We are not obligated to effect
more than two of these shareholder-initiated registrations. Further, holders of
registrable securities may require us to file additional registration statements
on Form S-3, subject to certain conditions and limitations.
In addition, Inktomi holds rights in connection with 2,547,788 shares of
common stock and a warrant to purchase 537,634 shares of common stock that
require us to register its shares for future sale under certain circumstances.
Commencing March 28, 2000, if Inktomi requests that we file a registration
statement, we must use our best efforts to cause such shares to be registered as
long as the aggregate offering price is not less than $5,000,000 and subject to
certain additional conditions and limitations. We are not obligated to effect
more than one of these Inktomi-initiated registrations. If we deliver notice to
Inktomi within 30 days after any registration request of our intent to file a
registration statement within 90 days, then Inktomi will be permitted to
participate in such registration on the same terms as our other existing holders
of registration rights. Furthermore, Inktomi may require us to file two
additional registration statements on Form S-3, subject to certain conditions
and limitations.
We are required to bear substantially all costs incurred in connection with
any of the registrations described above, other than underwriting discounts and
commissions. The registration rights described above could result in substantial
future expenses and adversely affect any future equity or debt offerings.
VOTING RIGHTS
Pursuant to a letter agreement dated March 10, 2000 among Morgan Stanley
Venture Investors III, L.P., Morgan Stanley Venture Partners III, L.P., The
Morgan Stanley Venture Partners Entrepreneur Fund, L.P., collectively Morgan
Stanley Dean Witter Venture Partners, and us, Morgan Stanley Dean Witter Venture
Partners have irrevocably agreed with us to vote all shares of our common stock
they beneficially own in excess of 9.9% of our outstanding common stock in
proportion to votes cast by all other shareholders, as determined by us and
excluding all shares of common stock beneficially owned by Morgan Stanley Dean
Witter Venture Partners.
ANTI-TAKEOVER EFFECTS OF CERTAIN PROVISIONS OF AMENDED AND RESTATED ARTICLES OF
INCORPORATION, BYLAWS AND WASHINGTON LAW
Our board of directors, without shareholder approval, has authority under
our amended and restated articles of incorporation to issue preferred stock with
rights superior to the rights of the holders of our common stock. As a result,
our board could issue preferred stock quickly and easily, which could adversely
affect the rights of holders of our common stock and which our board could issue
with terms calculated to delay or prevent a change in control or make removal of
management more difficult.
ELECTION AND REMOVAL OF DIRECTORS. Our amended and restated articles of
incorporation provide for the division of our board of directors into three
classes, as nearly as equal in number as possible. The directors in each class
serve for a term of up to three years and one class is elected each year by our
shareholders. The Class I term expires at the annual meeting of shareholders to
be held in 2000; the Class II term expires at the annual meeting of shareholders
to be held in 2001; and the Class III term expires at the annual meeting of
shareholders to be held in 2002. At each annual meeting of shareholders after
the initial classification, the successors to directors whose terms will then
expire will be elected to serve from the time of election and qualification
until the third annual meeting following election. Because
61
<PAGE>
this system of electing and removing directors generally makes it more difficult
for shareholders to replace a majority of the board of directors, it may
discourage a third party from making a tender offer or otherwise attempting to
gain control of our board of directors.
SHAREHOLDER MEETINGS. Our bylaws, as amended, provide that, except as
otherwise required by law or by our amended and restated articles of
incorporation, special meetings of the shareholders can only be called pursuant
to a resolution adopted by our board of directors, our chairman of the board or
president. These provisions of our amended and restated articles of
incorporation and bylaws, as amended, could discourage potential acquisition
proposals and could delay or prevent a change in control. These provisions are
intended to enhance the likelihood of continuity and stability in the
composition of the board of directors and in the policies formulated by the
board of directors and to discourage certain types of transactions that may
involve an actual or threatened change of control. These provisions are designed
to reduce our vulnerability to an unsolicited acquisition proposal and are to
discourage certain tactics that may be used in proxy fights. However, such
provisions could have the effect of discouraging others from making tender
offers for our shares, and as a consequence, they also may inhibit fluctuations
in the market price of our shares that could result from actual or rumored
takeover attempts. Such provisions also may have the effect of preventing
changes in our management.
Washington law also imposes restrictions on certain transactions between a
corporation and certain significant shareholders. Chapter 23B.19.040 of the
Washington Business Corporation Act prohibits a "target corporation," with
certain exceptions, from engaging in certain significant business transactions
with an "acquiring person," which is defined as a person or group of persons
that beneficially owns 10% or more of the voting securities of the target
corporation, for a period of five years after such acquisition, unless the
transaction or acquisition of shares is approved by a majority of the members of
the target corporation's board of directors prior to the time of acquisition.
Such prohibited transactions include, among other things:
- a merger or consolidation with, disposition of assets to, or issuance or
redemption of stock to or from, the acquiring person;
- termination of 5% or more of the employees of the target corporation as a
result of the acquiring person's acquisition of 10% or more of the shares;
or
- allowing the acquiring person to receive any disproportionate benefits as
a shareholder.
After the five-year period, a "significant business transaction" may occur,
as long as it complies with certain "fair price" provisions of the statute. A
corporation may not "opt out" of this statute. This provision may have the
effect of delaying, deferring or preventing a change in control of our board of
directors or senior management.
TRANSFER AGENT
The transfer agent and registrar for the shares of our common stock is
American Stock Transfer & Trust Company.
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<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
Future sales of substantial amounts of common stock in the public market
could adversely affect the market price of the common stock.
Upon completion of this offering, we will have outstanding 135,981,682
shares of common stock, after the issuance of 3,000,000 shares of common stock
offered in this prospectus and no exercise of options or warrants after
February 29, 2000. Of these shares, the shares sold in this offering, together
with 30,229,582 shares, will be freely tradable without restriction or further
registration under the Securities Act. However, if these shares are purchased by
"affiliates," as that term is defined in Rule 144 under the Securities Act,
sales of these shares would be subject to certain limitations and restrictions
described below.
Except for the 21,850,000 shares sold in our initial public offering, we
issued and sold the remaining 110,570,422 shares of common stock held by
existing shareholders as of December 31, 1999, in reliance on exemptions from
the registration requirements of the Securities Act. Of these shares,
104,785,678 shares are subject to 180-day lock-up agreements entered into in
connection with our initial public offering which expire March 28, 2000. In
addition, 83,593,532 shares will be subject to lock-up agreements entered into
by our officers and directors and the selling shareholders in connection with
this offering and which will expire 90 days from the date of this prospectus.
Morgan Stanley & Co. Incorporated, the lead managing underwriter for our initial
public offering, has agreed to release the 22,230,132 shares of our common stock
as subject to the 180-day lock-up agreements on March 20, 2000. These shares are
not subject to the 90-day lock-up agreements and will become eligible for sale,
subject in most cases to the limitations of Rule 144. Upon expiration of the
90-day lock-up agreements, 83,593,532 shares will become eligible for sale,
subject in most cases to the limitations of Rule 144.
In addition, holders of stock options and warrants could exercise their
options and warrants and sell the shares issued upon exercise as described
below. As of February 29, 2000, there were a total of 1,688,912 shares of common
stock that could be issued upon exercise of outstanding warrants, of which all
are subject to lock-up agreements. As of February 29, 2000, there were a total
of 16,160,981 shares of common stock subject to outstanding options under our
stock plans, 1,915,099 of which were vested. However, all of these shares are
subject to the 180-day lock-up agreements. The officers, directors and certain
of our shareholders have agreed not to sell or otherwise dispose of any of their
shares for a period ending on March 28, 2000. In addition, our officers and
directors and the selling shareholders have agreed not to sell or otherwise
dispose of any of their shares of a period ending 90 days from the date of this
prospectus. Morgan Stanley & Co. Incorporated, however, may in its sole
discretion, at any time and in most cases without notice to anyone, release all
or any portion of the shares subject to the 180-day and the 90-day lock-up
agreements.
RULE 144
In general, under Rule 144 as currently in effect, a person who has
beneficially owned shares of our common stock for at least one year would be
entitled to sell, within any three-month period, a number of shares that does
not exceed the greater of:
- 1% of the number of shares of our common stock then outstanding, which
will equal approximately 1,359,817 shares immediately after the effective
date of this offering; or
- the average weekly trading volume of our common stock on the Nasdaq
National Market during the four calendar weeks preceding the filing of a
notice on Form 144 with respect to such sale.
Sales under Rule 144 are also subject to other requirements regarding the
manner of sale, notice filing and the availability of current public information
about us.
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REGISTRATION RIGHTS
The holders of 100,732,854 shares of our common stock and of warrants
exercisable for 1,688,912 shares of our common stock will, under certain
circumstances, have rights to require us to register their shares for future
sale. See "Description of Capital Stock - Registration Rights" for more
information about registration rights in our shares of stock.
LOCK-UP AGREEMENTS
In connection with our initial public offering, all officers and directors
and certain holders of common stock, options and warrants to purchase common
stock agreed pursuant to certain lock-up agreements that they will not offer,
sell, contract to sell, pledge, grant any option to sell, or otherwise dispose
of, directly or indirectly, any shares of common stock or warrants or other
rights to purchase common stock for a 180-day period ending March 28, 2000
without the prior written consent of Morgan Stanley & Co. Incorporated. Morgan
Stanley has agreed to release approximately 22.2 million shares of our common
stock held by various shareholders, excluding officers, directors and the
selling shareholders in this offering, from the 180-day lock-up agreements on
March 20, 2000.
In connection with this offering, our officers and directors and the selling
shareholders have agreed pursuant to lock-up agreements that they will not
offer, sell, contract to sell, pledge, grant any option to sell, or otherwise
dispose of, directly or indirectly, any shares of common stock or warrants or
other rights to purchase common stock for a period ending 90 days from the date
of this prospectus.
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UNDERWRITERS
Under the terms and subject to the conditions contained in the underwriting
agreement dated the date of this prospectus, the underwriters named below, for
whom Morgan Stanley & Co. Incorporated, Credit Suisse First Boston Corporation,
Donaldson, Lufkin & Jenrette Securities Corporation, Chase Securities Inc., and
Salomon Smith Barney Inc. are acting as representatives, have severally agreed
to purchase, and we and the selling shareholders have agreed to sell to them an
aggregate of 7,500,000 shares of common stock. The number of shares of common
stock that each underwriter has agreed to purchase is set forth opposite its
name below:
<TABLE>
<CAPTION>
NUMBER OF
NAME SHARES
- ---- ---------
<S> <C>
Morgan Stanley & Co. Incorporated........................... 1,170,000
Credit Suisse First Boston Corporation...................... 1,170,000
Donaldson, Lufkin & Jenrette Securities Corporation......... 1,170,000
Chase Securities Inc........................................ 1,170,000
Salomon Smith Barney Inc.................................... 1,170,000
Robert W. Baird............................................. 150,000
Dain Rauscher Wessels....................................... 150,000
A.G. Edwards & Sons, Inc.................................... 150,000
First Union Capital Markets................................. 150,000
Janney Montgomery Scott..................................... 150,000
Edward Jones & Co........................................... 150,000
McAdams Wright Ragen, Inc................................... 150,000
Pacific Crest Securities.................................... 150,000
Brad Peery.................................................. 150,000
Wasserstein Perella Securities.............................. 150,000
Thomas Weisel Partners LLC.................................. 150,000
---------
Total................................................... 7,500,000
=========
</TABLE>
The underwriters are offering the shares subject to their acceptance of the
shares from us and the selling shareholders and subject to prior sale. The
shares of common stock will be sold by the underwriters at a price established
by the pricing committee of our board of directors. The underwriting agreement
provides that the obligations of the several underwriters to pay for and accept
delivery of the shares of common stock offered by this prospectus are subject to
the approval of certain legal matters by their counsel and to certain other
conditions. The underwriters are obligated to take and pay for all of the shares
of common stock offered by this prospectus if any shares are taken. However, the
underwriters are not required to take or pay for the share covered by the
underwriters over-allotment option described below.
The underwriters initially propose to offer part of the shares of common
stock directly to the public at the public offering price set forth on the cover
page of this prospectus and part to certain dealers at a price that represents a
concession not in excess of $1.24 a share under the public offering price. After
the initial offering of the shares of common stock, the offering price and other
selling terms may from time to time be varied by the representatives of the
underwriters.
Pursuant to the underwriting agreement, we and the selling shareholders have
granted to the underwriters an option, exercisable for 30 days from the date of
this prospectus, to purchase up to an aggregate of 1,125,000 additional shares
of common stock at the public offering price listed on the cover page of this
prospectus, less underwriting discounts and commissions. The underwriters may
exercise such option solely for the purpose of covering over-allotments, if any,
made in connection with the offering of the shares of common stock offered by
this prospectus. To the extent such option is exercised, each underwriter will
become obligated, subject to certain conditions, to purchase approximately the
same
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percentage of the additional shares of common stock as the number listed next to
such underwriter's name in the preceding table bears to the total number of
shares of common stock listed next to the names of all underwriters in the
preceding table. If the underwriter's over-allotment option is exercised in
full, the total price to the public would be $375,187,500, the total
underwriters' discounts and commissions would be $17,819,250 and the total net
proceeds to us would be $142,187,300.
We, our executive officers, directors and the selling shareholders have
agreed that, without the prior written consent of Morgan Stanley & Co.
Incorporated on behalf of the underwriters, each of us will not, during the
period ending 90 days from the date of this prospectus:
- offer, pledge, sell, contract to sell, sell any option or contract to
purchase, purchase any option or contract to sell, grant any option, right
or warrant to purchase, lend or otherwise transfer or dispose of, directly
or indirectly, any shares of common stock or any securities convertible
into or exercisable or exchangeable for common stock; or
- enter into any swap or other arrangement that transfers to another, in
whole or in part, any of the economic consequences of ownership of common
stock
whether any such transaction described above is to be settled by delivery of
common stock or such other securities, in cash or otherwise.
The restrictions described in the previous paragraph do not apply to:
- the sale of shares to the underwriters of the shares of common stock under
the underwriting agreement;
- transactions by any person other than InterNAP relating to shares of
common stock or other securities acquired in open market transactions
after the completion of the offering of the shares of common stock;
- transfers of any shares of the common stock by an individual either during
his or her lifetime or on death by will or intestacy to his or her
immediate family or to a trust the beneficiaries of which are exclusively
a member or members of his or her immediate family; or
- transfers by a corporation or a partnership of shares of common stock as a
distribution to partners or shareholders of the corporation or
partnership.
In order to facilitate the offering of the common stock, the underwriters
may engage in transactions that stabilize, maintain or otherwise affect the
price of the common stock. Specifically, the underwriters may over-allot in
connection with the offering, creating a short position in the common stock for
their own account. In addition, to cover over-allotments or to stabilize the
price of the common stock, the underwriters may bid for, and purchase, shares of
common stock in the open market. Finally, the underwriting syndicate may reclaim
selling concessions allowed to an underwriter or a dealer for distributing the
common stock in the offering if the syndicate repurchases previously distributed
shares of common stock in transactions to cover syndicate short positions, in
stabilization transactions or otherwise. Any of these activities may stabilize
or maintain the market price of the common stock above independent market
levels. The underwriters are not required to engage in these activities and may
end any of these activities at any time.
Upon consummation of this offering, affiliates of Morgan Stanley & Co.
Incorporated will own 12.9% of the common stock (12.7% if the over-allotment
option granted to the underwriters is exercised in full). Currently,
Dr. Harding, a Managing Director of Morgan Stanley & Co. Incorporated, is a
member of our board of directors. See "Management."
From time to time, certain of the underwriters have provided, and may
continue to provide, investment banking services to us.
We, the selling shareholders and the underwriters have agreed to indemnify
each other against certain liabilities, including liabilities under the
Securities Act.
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LEGAL MATTERS
The legality of the shares of common stock offered hereby will be passed
upon for us by Cooley Godward LLP, Kirkland, Washington. An investment
partnership of Cooley Godward attorneys directly owns an aggregate of 92,592
shares of our common stock and beneficially owns 54,818 shares of our common
stock through H&Q Internap Investors, LP. Cooley Godward attorneys beneficially
own approximately 12,000 shares of our common stock. Certain legal matters will
be passed upon for the underwriters by Morrison & Foerster LLP, San Francisco,
California.
EXPERTS
The financial statements of InterNAP Network Services Corporation as of
December 31, 1998 and 1999, and for each of the three years in the period ended
December 31, 1999, included in this prospectus, have been so included in
reliance on the report of PricewaterhouseCoopers LLP, independent accountants,
given on the authority of said firm as experts in auditing and accounting.
WHERE YOU CAN FIND MORE INFORMATION
We have filed with the SEC a registration statement on Form S-1 under the
Securities Act, with respect to the common stock offered by this prospectus. As
permitted by the rules and regulations of the SEC, this prospectus, which is a
part of the registration statement, omits certain information, exhibits,
schedules and undertakings included in the registration statement. For further
information pertaining to us and the common stock offered by this prospectus,
reference is made to the registration statement and its exhibits and schedules.
Statements contained in this prospectus regarding the contents or provisions of
any contract or other document referred to in this prospectus are not
necessarily complete, and in each instance reference is made to the copy of such
contract or other document filed as an exhibit to the registration statement,
with each statement being qualified in all respects by the reference to a
document or contract. A copy of the registration statement may be inspected
without charge at the office of the SEC at 450 Fifth Street, NW, Washington,
D.C. 20549, and at the SEC's regional offices located at the Northwest Atrium
Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661 and Seven
World Trade Center, 13th Floor, New York, New York 10048. Copies of all or any
part of the registration statement may be obtained from these offices upon the
payment of the fees prescribed by the SEC. The public may obtain information on
the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330.
In addition, registration statements and other filings made with the SEC through
its Electronic Data Gathering, Analysis and Retrieval, or EDGAR, system are
publicly available through the SEC's Web site on the Internet's World Wide Web,
located at http://www.sec.gov. The registration statement, including all
exhibits and amendments to the registration statement, was filed with the SEC
through EDGAR.
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INTERNAP NETWORK SERVICES CORPORATION
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
--------
<S> <C>
Report of Independent Accountants........................... F-2
Balance Sheet............................................... F-3
Statement of Operations..................................... F-4
Statement of Shareholders' Equity (Deficit)................. F-5
Statement of Cash Flows..................................... F-6
Notes to Financial Statements............................... F-7
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders
InterNAP Network Services Corporation
In our opinion, the accompanying balance sheet and the related statements of
operations, of shareholders' equity (deficit) and of cash flows present fairly,
in all material respects, the financial position of InterNAP Network Services
Corporation at December 31, 1998 and 1999 and the results of its operations and
its cash flows for each of the three years in the period ended December 31,
1999, in conformity with accounting principles generally accepted in the United
States. These financial statements are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these statements in
accordance with auditing standards generally accepted in the United States,
which require that we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
Seattle, Washington
January 22, 2000
F-2
<PAGE>
INTERNAP NETWORK SERVICES CORPORATION
BALANCE SHEET
(IN THOUSANDS, EXCEPT PAR VALUE DATA)
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1998 1999
-------- --------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 275 $155,184
Short-term investments.................................... -- 50,168
Accounts receivable, net of allowance of $65, and $206,
respectively............................................ 766 4,084
Prepaid expenses and other assets......................... 280 1,144
------- --------
Total current assets.................................. 1,321 210,580
Property and equipment, net................................. 5,828 28,811
Patents and trademarks, net................................. 48 142
Investments................................................. -- 5,050
Deposits and other assets, net.............................. 290 963
------- --------
Total assets.......................................... $ 7,487 $245,546
======= ========
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable.......................................... $ 2,603 $ 7,278
Accrued liabilities....................................... 713 4,209
Deferred revenue.......................................... 284 22
Note payable, current portion............................. -- 1,021
Line of credit............................................ 650 1,525
Capital lease obligations, current portion................ 1,331 6,613
------- --------
Total current liabilities............................. 5,581 20,668
Note payable, less current portion.......................... -- 2,861
Capital lease obligations, less current portion............. 2,342 11,517
------- --------
Total liabilities..................................... 7,923 35,046
------- --------
Commitments and contingencies
Shareholders' equity (deficit):
Convertible preferred stock, $.001 par value, authorized
100,139 and 10,000 shares, respectively; 39,291 and no
shares issued and outstanding, respectively; aggregate
liquidation preference of $8,466 and $0, respectively... 39 --
Common stock, $.001 par value, authorized 100,000 and
500,000 shares, respectively; 6,673, and 132,089 shares
issued and outstanding, respectively.................... 7 132
Additional paid-in capital................................ 9,553 287,054
Deferred stock compensation............................... (494) (17,228)
Accumulated deficit....................................... (9,541) (59,458)
------- --------
Total shareholders' equity (deficit).................. (436) 210,500
------- --------
Total liabilities and shareholders' equity
(deficit)......................................... $ 7,487 $245,546
======= ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-3
<PAGE>
INTERNAP NETWORK SERVICES CORPORATION
STATEMENT OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1997 1998 1999
-------- -------- --------
<S> <C> <C> <C>
Revenues.................................................... $ 1,045 $ 1,957 $ 12,520
------- ------- --------
Costs and expenses:
Cost of network and customer support...................... 1,092 3,216 27,412
Product development....................................... 389 754 3,919
Sales and marketing....................................... 261 2,822 17,523
General and administrative................................ 713 1,910 8,328
Amortization of deferred stock compensation............... -- 205 7,569
------- ------- --------
Total operating costs and expenses.................... 2,455 8,907 64,751
------- ------- --------
Loss from operations...................................... (1,410) (6,950) (52,231)
Other income (expense):
Interest income........................................... 36 169 3,388
Interest and financing expense............................ (235) (90) (1,074)
Loss on disposal of assets................................ -- (102) --
------- ------- --------
Net loss.............................................. $(1,609) $(6,973) $(49,917)
======= ======= ========
Basic and diluted net loss per share........................ $ (.24) $ (1.04) $ (1.31)
======= ======= ========
Weighted average shares used in computing basic and diluted
net loss per share........................................ 6,666 6,673 37,994
======= ======= ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-4
<PAGE>
INTERNAP NETWORK SERVICES CORPORATION
STATEMENT OF SHAREHOLDERS' EQUITY (DEFICIT)
FROM JANUARY 1, 1997 TO DECEMBER 31, 1999
(IN THOUSANDS)
<TABLE>
<CAPTION>
CONVERTIBLE
CLASS A AND PREFERRED COMMON
B UNITS STOCK STOCK
------------------- ------------------- ------------------- ADDITIONAL
PAR PAR PAR PAID-IN
UNITS VALUE SHARES VALUE SHARES VALUE CAPITAL
-------- -------- -------- -------- -------- -------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
Balances, January 1, 1997................... 12,000 $12 -- $-- -- $ -- $ 990
Exchange of Class A Units for common stock
at an exchange ratio of 1:1.667........... (4,000) (4) -- -- 6,666 7 (3)
Exchange of Class B Units for Series A
preferred stock at an exchange ratio of
1:1.667................................... (8,000) (8) 13,333 13 -- -- (5)
Convertible notes payable and accrued
interest converted to Series B preferred
stock..................................... -- -- 1,855 2 -- -- 555
Value ascribed to bridge financing
warrants.................................. -- -- -- -- -- -- 124
Issuance of Series B preferred stock, net of
issuance costs of $47..................... -- -- 19,203 19 -- -- 5,695
Net loss.................................... -- -- -- -- -- -- --
------ --- ------- --- ------- ---- --------
Balances, December 31, 1997................. -- -- 34,391 34 6,666 7 7,356
Issuance of Series B preferred stock, net of
issuance costs of $21..................... -- -- 4,667 4 -- -- 1,374
Issuance of common stock to an employee..... -- -- -- -- 7 -- 1
Value ascribed to lease financing
warrants.................................. -- -- -- -- -- -- 54
Exercise of warrants to purchase Series B
preferred stock........................... -- -- 233 1 -- -- 69
Deferred compensation related to grants of
stock options............................. -- -- -- -- -- -- 699
Amortization of deferred stock
compensation.............................. -- -- -- -- -- -- --
Net Loss.................................... -- -- -- -- -- -- --
------ --- ------- --- ------- ---- --------
Balances, December 31, 1998................. -- -- 39,291 39 6,673 7 9,553
Issuances of Series C preferred stock, net
of issuance costs of $85.................. -- -- 59,260 60 -- -- 31,850
Issuance of common stock, net of issuance
costs of $17,866.......................... -- -- -- -- 24,000 24 220,616
Exercise of warrants to purchase Series B
preferred stock........................... -- -- 402 -- -- -- 120
Exercise of employee stock options.......... -- -- -- -- 2,065 2 76
Deferred compensation related to grants of
stock options............................. -- -- -- -- -- -- 24,303
Amortization of deferred stock
compensation.............................. -- -- -- -- -- -- --
Value ascribed to standby credit facility
warrants.................................. -- -- -- -- -- -- 536
Conversion of preferred stock to common
stock..................................... -- -- (98,953) (99) 98,953 99 --
Cashless exercise of warrants to purchase
common stock.............................. -- -- -- -- 398 -- --
Net loss.................................... -- -- -- -- -- -- --
------ --- ------- --- ------- ---- --------
Balances, December 31, 1999................. -- $-- -- $-- 132,089 $132 $287,054
====== === ======= === ======= ==== ========
<CAPTION>
DEFERRED
STOCK ACCUMULATED
COMPENSATION DEFICIT TOTAL
------------- ------------ --------
<S> <C> <C> <C>
Balances, January 1, 1997................... $ -- $ (959) $ 43
Exchange of Class A Units for common stock
at an exchange ratio of 1:1.667........... -- -- --
Exchange of Class B Units for Series A
preferred stock at an exchange ratio of
1:1.667................................... -- -- --
Convertible notes payable and accrued
interest converted to Series B preferred
stock..................................... -- -- 557
Value ascribed to bridge financing
warrants.................................. -- -- 124
Issuance of Series B preferred stock, net of
issuance costs of $47..................... -- -- 5,714
Net loss.................................... -- (1,609) (1,609)
-------- -------- --------
Balances, December 31, 1997................. -- (2,568) 4,829
Issuance of Series B preferred stock, net of
issuance costs of $21..................... -- -- 1,378
Issuance of common stock to an employee..... -- -- 1
Value ascribed to lease financing
warrants.................................. -- -- 54
Exercise of warrants to purchase Series B
preferred stock........................... -- -- 70
Deferred compensation related to grants of
stock options............................. (699) -- --
Amortization of deferred stock
compensation.............................. 205 -- 205
Net Loss.................................... -- (6,973) (6,973)
-------- -------- --------
Balances, December 31, 1998................. (494) (9,541) (436)
Issuances of Series C preferred stock, net
of issuance costs of $85.................. -- -- 31,910
Issuance of common stock, net of issuance
costs of $17,866.......................... -- -- 220,640
Exercise of warrants to purchase Series B
preferred stock........................... -- -- 120
Exercise of employee stock options.......... -- -- 78
Deferred compensation related to grants of
stock options............................. (24,303) -- --
Amortization of deferred stock
compensation.............................. 7,569 -- 7,569
Value ascribed to standby credit facility
warrants.................................. -- -- 536
Conversion of preferred stock to common
stock..................................... -- -- --
Cashless exercise of warrants to purchase
common stock.............................. -- -- --
Net loss.................................... -- (49,917) (49,917)
-------- -------- --------
Balances, December 31, 1999................. $(17,228) $(59,458) $210,500
======== ======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-5
<PAGE>
INTERNAP NETWORK SERVICES CORPORATION
STATEMENT OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1997 1998 1999
-------- -------- --------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss.................................................. $(1,609) $(6,973) $(49,917)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization........................... 297 725 4,808
Loss on disposal of assets.............................. -- 102 --
Non-cash interest and financing expense................. 146 7 553
Provision for doubtful accounts......................... 27 140 212
Non-cash compensation expense........................... -- 205 7,569
Changes in operating assets and liabilities:
Accounts receivable..................................... (224) (678) (3,531)
Prepaid expenses and other assets....................... 38 (391) (1,762)
Accounts payable........................................ 82 721 6,016
Deferred revenue........................................ 84 200 (262)
Accrued liabilities..................................... 37 619 2,496
------- ------- --------
Net cash used in operating activities................. (1,122) (5,323) (33,818)
------- ------- --------
Cash flows from investing activities:
Purchases of property and equipment....................... (93) (794) (12,905)
Deposits on property and equipment........................ -- (58) --
Purchase of investments................................... -- -- (65,214)
Redemption of investments................................. -- -- 9,995
Payments for patents and trademarks....................... (48) (3) 104
------- ------- --------
Net cash used in investing activities................. (141) (855) (68,020)
------- ------- --------
Cash flows from financing activities:
Proceeds from shareholder loan and line of credit......... 180 -- 1,100
Repayment of shareholder loan and line of credit.......... (180) -- (1,100)
Issuance of notes payable................................. -- -- 4,237
Principal payments on note payable........................ (34) (34) (355)
Net increase (decrease) in line of credit................. -- 650 875
Payments on capital lease obligations..................... (327) (534) (2,186)
Proceeds from equipment leaseback financing............... -- 153 428
Proceeds from exercise of stock options................... -- -- 78
Proceeds from issuance of convertible notes payable....... 660 -- --
Principal payments on convertible note payable............ (125) -- --
Proceeds from issuance of and exercise of warrants to
purchase preferred stock, net of issuance costs......... 5,714 1,448 32,030
Proceeds from issuance of common stock, net of issuance
costs................................................... -- -- 221,640
------- ------- --------
Net cash provided by financing activities............. 5,888 1,683 256,747
------- ------- --------
Net increase (decrease) in cash and cash equivalents........ 4,625 (4,495) 154,909
Cash and cash equivalents at beginning of period............ 145 4,770 275
------- ------- --------
Cash and cash equivalents at end of period.................. $ 4,770 $ 275 $155,184
======= ======= ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest, net of amounts capitalized........ $ 103 $ 82 $ 413
======= ======= ========
Purchase of property and equipment financed with capital
leases.................................................. $ 260 $ 3,606 $ 15,857
======= ======= ========
Purchase of property and equipment included in accounts
payable................................................. $ -- $ 1,537 $ 196
======= ======= ========
Conversion of convertible notes to Series B preferred
stock................................................... $ 535 $ -- $ --
======= ======= ========
Conversion of preferred stock to common stock............. $ -- $ -- $ 99
======= ======= ========
Value ascribed to warrants................................ $ 124 $ 54 $ 536
======= ======= ========
Accrued private placement fee............................. $ -- $ -- $ 1,000
======= ======= ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-6
<PAGE>
INTERNAP NETWORK SERVICES CORPORATION
NOTES TO FINANCIAL STATEMENTS
1. SUMMARY OF THE COMPANY AND SIGNIFICANT ACCOUNTING POLICIES:
THE COMPANY
InterNAP Network Services Corporation (the "Company") was originally
incorporated in the State of Washington as a limited liability company ("LLC")
in May 1996. The Company was re-incorporated in the State of Washington in
October 1997 as a C corporation without changing its ownership. The Articles of
Incorporation were amended in January and October 1999 to change the amount of
authorized common and preferred stock. In December 1999, the Company
incorporated a wholly-owned subsidiary in the United Kingdom, InterNAP Network
Services U.K. Limited, however there was no activity in the subsidiary through
December 31, 1999. In December 1999, a 100% stock dividend was declared on the
Company's common stock to be paid in January 2000. Accordingly, the number of
shares disclosed in the financial statements and related notes have been
adjusted to reflect the latest amendment and stock dividend for all periods
presented.
The Company is 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 the Company's Private-Network Access Points facilities ("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.
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.
CASH, CASH EQUIVALENTS AND INVESTMENTS
The Company generally considers any highly liquid investments purchased with
an original or remaining maturity of three months or less at the date of
purchase to be cash equivalents.
The Company classifies, at the date of acquisition, its marketable
securities into categories in accordance with the provisions of Statement of
Financial Accounting Standards No. 115, "Accounting for Certain Investments in
Debt and Equity Securities." Currently, the Company classifies its securities as
available-for-sale which are reported at fair market value with the related
unrealized gains and losses included in shareholders' equity (deficit). Realized
gains and losses and declines in value of securities judged to be other than
temporary are included in other income (expense). Interest and dividends on all
securities are included in interest income. The fair value of the Company's
investments are based on quoted market prices. The carrying value of those
investments approximates their fair value. At December 31, 1999, investments
consisted of commercial paper and government securities.
The Company invests its cash and cash equivalents in deposits with two
financial institutions that may, at times, exceed federally insured limits.
Management believes that the risk of loss is minimal. To date, the Company has
not experienced any losses related to temporary cash investments.
F-7
<PAGE>
INTERNAP NETWORK SERVICES CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF THE COMPANY AND SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
ACCOUNTS RECEIVABLE AND CONCENTRATION OF CREDIT RISK
The Company extends trade credit terms to its customers based upon a credit
analysis performed by management. Further credit reviews are done on a periodic
basis as necessary. Generally, collateral is not required on accounts
receivable, however, advance deposits are collected for accounts considered
credit risks.
The Company had no customers representing over 10% of its 1999 revenues or
10% of its accounts receivable at December 31, 1999. The Company had two
significant customers representing approximately 13.6% and 9.6% of 1998 revenues
and 9.9% and 11.0% of accounts receivable at December 31, 1998. Additionally,
the Company had a single customer which is billed for its quarterly services in
advance and, as a result, comprised 23.4% of accounts receivable at
December 31, 1998. During 1997, the Company had a significant customer
representing 18.1% of revenues. In addition, a significant customer that
represented 20.8% of 1997 revenues declared bankruptcy during 1998.
Consequently, the Company did not recognize significant revenue from this
customer during 1998 and the accounts receivable balance at December 31, 1997,
for which a reserve was provided for in the allowance for doubtful accounts, was
written off during 1998 when it was determined that the Company would not be
able to recover the balance.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company's financial instruments, including cash and cash equivalents,
short-term investments, accounts receivable, accounts payable, capital lease
obligations, and the line of credit are carried at cost. 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 as the interest rates approximate current
market rates of similar debt or investments.
PROPERTY AND EQUIPMENT
Property and equipment consists principally of routers, telecommunications
equipment and other computer equipment. Network equipment and furniture and
equipment are carried at original acquisition cost and depreciated or amortized
on a straight-line basis over the estimated useful lives of the assets which
range from three to seven years. Leasehold improvements are amortized on a
straight-line basis over the shorter of their estimated useful lives or the term
of the related lease. Additions and improvements that increase the value or
extend the life of an asset are capitalized. Maintenance and repairs are
expensed as incurred. Gains or losses from asset disposals are charged to
operations in the year of disposition.
Direct construction costs of each P-NAP facility, including equipment and
labor costs, are capitalized during the construction period. In addition, the
Company capitalizes interest costs as part of the cost of its P-NAP facilities
when the P-NAP facilities require an extended period of time to ready them for
their intended use. During 1998 and 1999, the Company capitalized approximately
$78,000 and $177,000 of labor costs and $34,000 and $108,000 of interest costs,
respectively, related to the construction of several P-NAP facilities. These
costs are included as part of the cost of the network equipment.
The Company currently purchases the majority of its network equipment from
one vendor. The Company does not carry significant inventory of such equipment.
Failure to obtain the network equipment when required could negatively impact
the Company's operating results until an alternative supply source is
established. Although there are a limited number of other suppliers, there can
be no assurance that such equipment would be available and on comparable terms.
F-8
<PAGE>
INTERNAP NETWORK SERVICES CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF THE COMPANY AND SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
COSTS OF COMPUTER SOFTWARE DEVELOPED OR OBTAINED FOR INTERNAL USE
Costs of computer software developed or obtained for internal use are
capitalized while in the application development stage and are expensed while in
the preliminary stage and the post-implementation stage. During 1998 and 1999,
the Company capitalized approximately $76,000 and $230,000 of internal
development costs incurred during the application development stage of certain
software. These costs are included as part of the cost of network equipment.
PATENTS AND TRADEMARKS
Capitalized patent and trademark costs represent professional fees incurred
for patent and trademark filings and are capitalized at cost. Patents and
trademarks are amortized over 15 years. At December 31, 1998 and 1999, $47,797
and $142,154 of capitalized patent and trademark costs, net of accumulated
amortization of $3,698 and $9,872, are included in the Company's financial
statements.
VALUATION OF LONG-LIVED ASSETS
The Company periodically evaluates the carrying value of its long-lived
assets, including, but not limited to, property and equipment, patents and
trademarks, and other assets. The carrying value of a long-lived asset is
considered impaired when the undiscounted cash flow from such asset is
separately identifiable and is estimated to be less than its carrying value. In
that event, a loss is recognized based on the amount by which the carrying value
exceeds the fair market value of the long-lived asset. Fair market value is
determined primarily using the anticipated cash flows discounted at a rate
commensurate with the risk involved. Losses on long-lived assets to be disposed
of would be determined in a similar manner, except that fair market values would
be reduced by the cost of disposal.
INCOME TAXES
The Company accounts for income taxes under the liability method. Deferred
tax assets and liabilities are determined based on differences between financial
reporting and tax bases of assets and liabilities and are measured using the
enacted tax rates and laws that will be in effect when the differences are
expected to reverse. The Company provides a valuation allowance, if necessary,
to reduce deferred tax assets to their estimated realizable value.
DEBT ISSUED WITH STOCK PURCHASE WARRANTS
Proceeds from debt issued with stock purchase warrants are allocated between
the debt and the warrants based on their relative fair values. The value
ascribed to the warrants is based on the Black-Scholes option pricing model. The
portion of the proceeds allocated to the warrants is amortized to interest
expense over the term of the related debt using the effective interest method.
When the Company issues stock purchase warrants in conjunction with obtaining a
lease financing line of credit, the fair value of the warrants, based on the
Black-Scholes option pricing model, is included as a deferred financing cost in
deposits and other assets and is amortized to interest expense over the term of
the lease line using the straight-line method. At December 31, 1998 and 1999,
$46,934 and $29,469 of deferred financing costs, net of accumulated amortization
of $7,525 and $24,990, are included in deposits and other assets, net.
F-9
<PAGE>
INTERNAP NETWORK SERVICES CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF THE COMPANY AND SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
STOCK-BASED COMPENSATION
Employee stock options are accounted for under the intrinsic value method
prescribed by Accounting Principles Board Opinion No. 25 ("APB 25") "Accounting
for Stock Issued to Employees" and related interpretations.
REVENUE RECOGNITION
The Company recognizes service revenues as they are earned. Revenues from
initial installation of customer network connections are recognized when
installations are complete. Customers are billed on the first day of each month
either on a usage or a flat-rate basis. The usage based billing relates to the
month prior to the month in which the billing occurs, whereas certain flat rate
billings relate to the month in which the billing occurs. Deferred revenues
consist of revenues for services to be delivered in the future and consist
primarily of advance billings for flat rate customers.
PRODUCT DEVELOPMENT COSTS
Product development costs are primarily related to network engineering costs
associated with changes to the functionality of the Company's proprietary
services and network architecture. Such costs that do not qualify for
capitalization are expensed as incurred. Research and development costs are
expensed as incurred. Included in product development costs are research and
development costs which for the years ended December 31, 1997, 1998 and 1999
amounted to approximately $389,000, $708,000 and $3,079,000, respectively.
ADVERTISING COSTS
The Company expenses advertising costs as they are incurred. Advertising
expense for 1997, 1998 and 1999 was $16,000, $63,000 and $1,790,000,
respectively.
COMPREHENSIVE INCOME
The Company has adopted the provisions of Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income" ("SFAS No. 130") effective
January 1, 1998. SFAS No. 130 requires the disclosure of comprehensive income
and its components in a full set of general-purpose financial statements.
Comprehensive income is the change in equity from transactions and other events
and circumstances other than those resulting from investments by owners and
distributions to owners. SFAS No. 130 had no impact on the Company and,
accordingly, a separate statement of comprehensive income has not been
presented.
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 outstanding 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.
F-10
<PAGE>
INTERNAP NETWORK SERVICES CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF THE COMPANY AND SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
The following table presents the calculation of basic and diluted net loss
per share (in thousands, except per share data):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1997 1998 1999
-------- -------- --------
<S> <C> <C> <C>
Net loss....................................... $ (1,609) $ (6,973) $(49,917)
======== ======== ========
Basic and diluted:
Weighted average shares of common stock
outstanding used in computing basic and
diluted net loss per share................. 6,666 6,673 37,994
======== ======== ========
Basic and diluted net loss per share......... $ (.24) $ (1.04) $ (1.31)
======== ======== ========
Antidilutive securities not included in
diluted net loss per share calculation:
Convertible preferred stock................ 34,391 39,291 --
Options to purchase common stock........... -- 6,823 15,441
Warrants to purchase common and Series B
preferred stock.......................... 1,572 1,588 1,924
Unvested shares of common stock subject to
repurchase............................... -- -- 54
-------- -------- --------
35,963 47,702 17,419
======== ======== ========
</TABLE>
SEGMENT INFORMATION
The Company has adopted Statement of Financial Accounting Standards No. 131
("SFAS No. 131") "Disclosures about Segments of an Enterprise and Related
Information," which is effective for fiscal years beginning after December 31,
1997. SFAS No. 131 supersedes SFAS No. 14, "Financial Reporting for Segments of
a Business Enterprise," replacing the "industry segment" approach with the
"management" approach. The management approach designates the internal
organization that is used by management for making operating decisions and
assessing performance as the source of the Company's reportable segments. SFAS
No. 131 also requires disclosures about products and services, geographic areas,
and major customers. The Company's operations consist of Internet connectivity
services, other ancillary services, such as co-location, web hosting and server
management, and installation services. Management uses one measurement of
profitability and does not disaggregate its business for internal reporting.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133 ("SFAS No. 133"), "Accounting for
Derivative Instruments and Hedging Activities," which establishes accounting and
reporting standards for derivative instruments and hedging activities. SFAS
No. 133, which will be effective for the Company for fiscal years and quarters
beginning after June 15, 2000, requires that an entity recognize all derivatives
as either assets or liabilities in the statement of financial position and
measure those instruments at fair value. The Company is assessing the
requirements of SFAS No. 133 and the effects, if any, on the Company's financial
position, results of operations and cash flows.
F-11
<PAGE>
INTERNAP NETWORK SERVICES CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF THE COMPANY AND SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
In December 1999, the Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition," which
provides guidance on the recognition, presentation and disclosure of revenue in
financial statements filed with the SEC. SAB 101 outlines the basic criteria
that must be met to recognize revenue and provides guidance for disclosures
related to revenue recognition policies. Management believes that the impact of
SAB 101 would have no material effect on the financial position or results of
operations of the Company.
2. PROPERTY AND EQUIPMENT:
Property and equipment consists of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1998 1999
-------- --------
<S> <C> <C>
Network equipment.......................................... $1,150 $ 4,665
Network equipment under capital lease...................... 4,465 20,095
Furniture, equipment and software.......................... 424 6,717
Furniture, equipment and software under capital lease...... 142 1,164
Leasehold improvements..................................... 688 2,009
------ -------
6,869 34,650
Less: Accumulated depreciation and amortization ($952 and
$4,851 related to capital leases at December 31, 1998 and
1999, respectively)...................................... (1,041) (5,839)
------ -------
Property and equipment, net................................ $5,828 $28,811
====== =======
</TABLE>
Depreciation and amortization expense for the years ended December 31, 1997,
1998 and 1999 amounted to $297,000, $721,000 and $4,798,000, respectively.
Assets under capital leases are pledged as collateral for the underlying lease
agreements.
3. ACCRUED LIABILITIES:
Accrued liabilities consist of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1998 1999
-------- --------
<S> <C> <C>
Compensation payable........................................ $567 $2,729
Taxes payable............................................... 95 49
Private placement fee....................................... -- 1,000
Other....................................................... 51 431
---- ------
$713 $4,209
==== ======
</TABLE>
4. FINANCING ARRANGEMENTS:
During 1997, the Company entered into a series of convertible notes payable
(the "Bridge Financing Agreements") to finance working capital equipment
requirements prior to the sale of Series B preferred stock. The total amount
borrowed under the Bridge Financing Agreements was $660,000. The Bridge
F-12
<PAGE>
INTERNAP NETWORK SERVICES CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
4. FINANCING ARRANGEMENTS: (CONTINUED)
Financing Agreements had various due dates within 1997, with interest at 9% per
year. The Bridge Financing Agreements were either converted to Series B
preferred stock or repaid during 1997 and there were no amounts outstanding at
December 31, 1997. In connection with the Bridge Financing Agreements, the
Company issued warrants to purchase 1,571,158 shares of Series B preferred stock
at a price of $.30 per share, which resulted in financing expense of $124,310.
The Company also entered into an agreement during 1997 with a shareholder to
provide a $250,000 working capital line of credit. During 1997, the Company
borrowed $180,000 on the line and recorded interest expense of $5,020. All
amounts borrowed under the working capital line of credit were repaid during
1997.
At December 31, 1997, the Company had a note payable due to a lessor for
leasehold improvements in the amount of $34,444, which was repaid in full during
1998. The note included interest at 10% and was guaranteed by certain
shareholders and officers of the Company.
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 was repaid in full, plus
accrued interest, during February of 1999.
During November 1997, the Company entered into a line of credit agreement
(the "Line") with a bank allowing aggregate borrowings of up to $750,000 for the
purchase of equipment and for working capital. The Line was collateralized by
the assets of the Company and interest was payable at prime plus 1%. The Line
required interest only payments monthly and matured in May 1999. At
December 31, 1998, the Company had $650,000 outstanding on the Line.
During July 1999, the Company amended the 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 1.0% (9.5% at December 31, 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. During 1999,
the Company refinanced $650,000 outstanding under the New Line and borrowed an
additional $875,000 under the New Line during 1999.
The bank line of credit agreement requires that the Company provide audited
financial statements prior to March 31 of each year. The December 31, 1998
financial statements were issued subsequent to March 31, 1999 and, accordingly,
resulted in a violation of this covenant. The Company has obtained a waiver for
this violation from the bank.
During August 1999, the Company entered into an equipment financing
arrangement with a finance company which allows 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 7.5% plus an index rate based on
the yield of 4-year U.S. Treasury Notes (13.7% at December 31, 1999). Loans
under the $1,500,000 sublimit require monthly principal and interest payments
over a term of 36 months. This
F-13
<PAGE>
INTERNAP NETWORK SERVICES CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
4. FINANCING ARRANGEMENTS: (CONTINUED)
facility bears interest at 7.9% plus an index rate based on the yield of 3-year
U.S. Treasury Notes (14.0% at December 31, 1999). Borrowings under each sublimit
must be prior to May 1, 2000. During 1999, the Company borrowed approximately
$3,882,000, net of principal repayments of $355,000, 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, with interest at prime
plus 2% and 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. In connection with the standby credit facility, the Company
issued warrants to purchase 200,000 shares of common stock with exercise prices
of $10.00 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 interest expense for the year ended December 31, 1999.
5. CAPITAL LEASES:
The Company has leases for a significant portion of its property and
equipment which are classified as capital leases. Interest on equipment and
furniture leases range from 4% to 20%, expire through 2003 and generally include
an option allowing the Company to purchase the equipment or furniture at the end
of the lease term for fair market value.
Future minimum capital lease payments together with the present value of the
minimum lease payments are as follows as of December 31, 1999 (in thousands):
<TABLE>
<CAPTION>
YEARS ENDING DECEMBER 31,
- -------------------------
<S> <C>
2000........................................................ $ 7,435
2001........................................................ 7,072
2002........................................................ 4,771
2003........................................................ 44
-------
Total minimum lease payments.......................... 19,322
Less: amount representing interest.......................... (1,192)
-------
Present value of minimum lease payments..................... 18,130
Less: current portion....................................... (6,613)
-------
Capital lease obligations, less current portion............. $11,517
=======
</TABLE>
In November 1999, the Company amended an existing lease credit facility with
a vendor which increased the available line by $17,500,000 to $35,500,000
through November 2000. Approximately $18,389,000 was available under this
facility at December 31, 1999.
6. INCOME TAXES:
Prior to the re-incorporation of the Company in October 1997, the Company
operated as an LLC and was not subject to income taxes.
F-14
<PAGE>
INTERNAP NETWORK SERVICES CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
6. INCOME TAXES: (CONTINUED)
As of December 31, 1999, the Company has net operating loss carryforwards of
approximately $50,300,000, expiring through 2019. The Company has placed a
valuation allowance against its deferred tax assets due to the uncertainty
surrounding the realization of such assets. Management evaluates, on a quarterly
basis, the recoverability of the deferred tax asset and the level of the
valuation allowance. At such time as it is determined that it is more likely
than not that the deferred tax assets are realizable, the valuation allowance
will be reduced.
The Company's ability to use its net operating losses to offset future
income is subject to restrictions in the Internal Revenue Code which could limit
the Company's future use of its net operating losses if certain stock ownership
changes occur. The Company's deferred tax assets and liabilities are as follows
(in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1998 1999
-------- --------
<S> <C> <C>
Deferred income tax assets:
Net operating loss carryforwards......................... $ 2,680 $ 19,117
Allowance for doubtful accounts.......................... 24 78
Accrued compensation..................................... -- 402
Other.................................................... -- 4
------- --------
2,704 19,601
Deferred income tax liabilities:
Property and equipment................................... (58) (775)
------- --------
2,646 18,826
Valuation allowance...................................... (2,646) (18,826)
------- --------
Net deferred tax assets.................................. $ -- $ --
======= ========
</TABLE>
The following is a reconciliation of the income tax benefit to the amount
calculated based on the statutory federal rate of 34% and the estimated state
apportioned rate, net of the federal tax benefit, as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1997 1998 1999
-------- -------- --------
<S> <C> <C> <C>
Federal income tax benefit at statutory rates......... (34%) (34%) (34%)
State income tax benefit at statutory rates........... (3%) (4%)
Non-taxable LLC losses................................ 25% -- --
Change in valuation allowance......................... 9% 37% 38%
---- ---- ----
Effective tax rate.................................... --% --% --%
==== ==== ====
</TABLE>
F-15
<PAGE>
INTERNAP NETWORK SERVICES CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
7. EMPLOYEE RETIREMENT PLAN:
During March 1998, the Company established a 401(k) Retirement Plan (the
"Plan") which covers substantially all eligible employees. The Plan is a
qualified salary reduction plan in which all eligible participants may elect to
have a percentage of their pre-tax compensation contributed to the Plan, subject
to certain guidelines issued by the Internal Revenue Service. The Company can
contribute to the Plan at the discretion of the Board of Directors. To date, no
contributions have been made by the Company. Effective January 1, 2000, the
Company began matching 50% of employee contributions, up to a maximum of 6% of
each employee's gross wages.
8. COMMITMENTS AND CONTINGENCIES:
OPERATING LEASES
The Company has entered into leasing arrangements relating to office space
and P-NAP facility rental space which are classified as operating. Future
minimum lease payments on non-cancelable operating leases are as follows at
December 31, 1999 (in thousands):
<TABLE>
<CAPTION>
YEARS ENDING DECEMBER 31,
- -------------------------
<S> <C>
2000........................................................ $ 4,038
2001........................................................ 4,172
2002........................................................ 3,855
2003........................................................ 3,199
2004........................................................ 874
Thereafter.................................................. 878
-------
$17,016
=======
</TABLE>
Rent expense was approximately, $111,000, $571,000 and $3,381,000 for the
years ended December 31, 1997, 1998 and 1999, respectively.
SERVICE COMMITMENTS
The Company has entered into service commitment contracts with backbone
service providers to provide interconnection services. Minimum payments under
these service commitments are as follows at December 31, 1999 (in thousands):
<TABLE>
<CAPTION>
YEARS ENDING DECEMBER 31,
- -------------------------
<S> <C>
2000........................................................ $ 3,300
2001........................................................ 12,880
2002........................................................ 9,868
-------
$26,048
=======
</TABLE>
9. SHAREHOLDERS' EQUITY (DEFICIT):
In January and October 1999, the articles of incorporation were amended to
change the authorized amount of common and preferred stock. In December 1999, a
100% share dividend was declared on the Company's common stock to be distributed
in January 2000. Accordingly, the disclosures in the financial
F-16
<PAGE>
INTERNAP NETWORK SERVICES CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
9. SHAREHOLDERS' EQUITY (DEFICIT): (CONTINUED)
statements and related notes have been adjusted to reflect the October 1999
amendment to the Articles of Incorporation and the stock dividend for all
periods presented.
CONVERTIBLE PREFERRED STOCK
At December 31, 1998, preferred stock consisted of the following (in
thousands):
<TABLE>
<CAPTION>
ADDITIONAL COMMON STOCK
SHARES ISSUED AND PAID-IN CAPITAL RESERVED FOR LIQUIDATION
SERIES DESIGNATED OUTSTANDING PAR VALUE (NET) CONVERSION PREFERENCE
- ------ ---------- ----------- --------- --------------- ------------ -----------
<S> <C> <C> <C> <C> <C> <C>
A 13,333 13,333 $13 $ 987 13,333 $ 680
B 27,546 25,958 26 7,693 25,958 7,786
C 59,260 -- -- -- -- --
------- ------ --- ------ ------ ------
100,139 39,291 $39 $8,680 39,291 $8,466
======= ====== === ====== ====== ======
</TABLE>
In February 1999, the Company sold 59,259,260 shares of Series C preferred
stock at a price of $.54 per share, resulting in gross proceeds of approximately
$32,000,000, prior to deducting issuance costs. In addition, during 1999 several
warrant holders exercised warrants to purchase 402,008 shares of Series B
preferred stock, resulting in net proceeds to the Company of $120,303. Upon the
closing of the Company's initial public offering on October 4, 1999, all shares
of preferred stock outstanding converted into 98,953,050 shares of common stock.
Preferred stock may be issued in one or more series, each with such
designations, preferences, rights, qualifications, limitations and restrictions
as the Board of Directors of the Company may determine at the time of issuance.
During 1997, the Board of Directors authorized 30,000,000 shares of preferred
stock. As a result of the amendment to the Articles of Incorporation in
January 1999, the number of shares authorized for preferred stock was increased
to 100,139,230 shares. As a result of the amendment to the Articles of
Incorporation in October 1999, the number of shares authorized for preferred
stock was decreased to 10,000,000.
COMMON STOCK
As a result of the January 1999 amendment, the number of shares of common
stock authorized was increased to 100,000,000 from 70,000,000. In July 1999, the
Board of Directors increased the authorized shares of common stock to
300,000,000 and, in October 1999 upon the closing of the Company's initial
public offering, the authorized shares of common stock were increased to
500,000,000 shares.
On September 29, 1999, the Company sold 19,000,000 shares of its common
stock in an initial public offering at a price of $10.00 per share for net
proceeds of $176,700,000. On October 1, 1999, the underwriters exercised their
over-allotment option, resulting in the sale of an additional 2,850,000 shares
of common stock at $10.00 per share for additional net proceeds of $26,505,000.
Concurrent with the closing of its initial public offering, the Company sold
2,150,537 shares of common stock to Inktomi Corporation for $9.30 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 1,075,268 shares of common stock at an exercise price of $13.95 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. The
F-17
<PAGE>
INTERNAP NETWORK SERVICES CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
9. SHAREHOLDERS' EQUITY (DEFICIT): (CONTINUED)
Company intends to complete a joint technical and marketing agreement with
Inktomi. On November 24, 1999, Inktomi exercised 50% of these warrants through a
cashless exercise, resulting in the issuance of 397,250 shares of common stock
to Inktomi.
CLASS A AND B UNITS
During 1996, conducting business as an LLC, the Company issued 4,000,000
Class A units to its founding members upon incorporation and subsequently sold
8,000,000 Class B units. All units were exchanged for preferred and common stock
during 1997 as part of the re-incorporation.
WARRANTS TO PURCHASE SERIES B PREFERRED STOCK AND COMMON STOCK
During 1997, the Company issued warrants to purchase up to 1,571,518 shares
of Series B preferred stock at $.30 per share in conjunction with its bridge
financing. During 1998, the Company issued warrants to purchase up to 250,002
shares of Series B preferred stock at $.30 per share in connection with various
lease financings. The warrants to purchase Series B preferred stock converted to
warrants to purchase common stock upon the closing of the Company's initial
public offering. Outstanding warrants to purchase shares of common stock at
December 31, 1999, including the warrants issued to Inktomi and in connection
with the standby loan agreements, are as follows (shares in thousands):
<TABLE>
<CAPTION>
YEAR OF EXERCISE
EXPIRATION PRICE SHARES
- ---------- -------- --------
<S> <C> <C>
2001........................................................ $13.95 538
2002........................................................ .30 936
2004........................................................ 10.00 200
2008........................................................ .30 250
-----
1,924
=====
</TABLE>
10. STOCK-BASED COMPENSATION PLANS:
In March 1998, the Company's Board of Directors adopted the 1998 Stock
Option/Stock Issuance Plan (the "1998 Plan"), which provides for the issuance of
incentive stock options ("ISOs") and non-qualified options to eligible
individuals responsible for the management, growth and financial success of the
Company. The Company has applied the accounting principles discussed below to
stock option commitments made by the Company. Shares of common stock reserved
for the 1998 Plan in March 1998 totaled 8,070,000 and were increased to
10,070,000 in January 1999.
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 December 31, 1999, 13,000,000 shares of common stock have been reserved for
the 1999 Plan. Upon the first nine anniversaries of the adoption date of the
1999 Plan, the number of shares reserved for issuance under the 1999 Plan will
automatically be increased by 3.5% of the total shares of common stock then
outstanding or, if less, by 6,500,000 shares. The terms of the 1999 Plan are the
same as the 1998 Plan with respect to ISO treatment and vesting. During the year
ended December 31, 1999, the Company granted an additional 2,937,000 options
under the 1998 Plan and 7,717,500 options under the
F-18
<PAGE>
INTERNAP NETWORK SERVICES CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
10. STOCK-BASED COMPENSATION PLANS: (CONTINUED)
1999 Plan. As of December 31, 1999, 7,345,442 and 7,655,500 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 Director's 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 1,000,000
shares of the Company's common stock have been reserved for issuance under the
Director Plan. Under the terms of the Director Plan, 480,000 fully vested
options were granted to existing directors on the effective date of the
Company's initial public offering with an exercise price of $10.00 per share,
all of which remained outstanding at December 31, 1999. Subsequent to the
Company's initial public offering, initial grants, which are fully vested as of
the date of the grant, of 80,000 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 20,000 shares, provided such person
has been a non-employee director of the Company for at least the prior six
months. The options are 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.
ISOs may be issued only to employees of the Company and have a maximum term
of 10 years from the date of grant. The exercise price for ISOs may not be less
than 100% of the estimated fair market value of the common stock at the time of
the grant. In the case of options granted to holders of more than 10% of the
voting power of the Company, the exercise price may not be less than 110% of the
estimated fair market value of the common stock at the time of grant, and the
term of the option may not exceed five years. Options become exercisable in
whole or in part from time to time as determined by the Board of Directors,
which will administer the Plan. Both ISOs and non-qualified options generally
vest over four years.
The Company has elected to account for stock-based compensation using the
intrinsic value method prescribed in APB 25. Accordingly, compensation cost for
stock options is measured as the excess, if any, of the fair value of the
Company's stock at the date of grant over the exercise price to be paid to
acquire the stock.
Option activity for 1998 and 1999 under all of the Company's stock option
plans is as follows (there was no activity in 1997) (shares in thousands):
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
SHARES EXERCISE PRICE
-------- --------------
<S> <C> <C>
Granted................................................ 6,823 $ .05
Exercised.............................................. -- --
Canceled............................................... -- --
------
Balance, December 31, 1998............................. 6,823 $ .05
Granted................................................ 11,135 $5.82
Exercised.............................................. (2,065) $ .04
Cancelled.............................................. (412) $3.92
------
Balance, December 31, 1999............................. 15,481 $4.10
======
</TABLE>
F-19
<PAGE>
INTERNAP NETWORK SERVICES CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
10. STOCK-BASED COMPENSATION PLANS: (CONTINUED)
Options granted during 1998 include 800,000 non-qualified options granted to
members of the Board of Directors ("Directors' Options") which are immediately
exercisable, and upon exercise, are subject to the terms of restricted stock
purchase agreements. The Directors' Options, or if exercised, the related
restricted stock, vest over a period of four years from the vesting commencement
date, as determined by the Board of Directors.
The following table summarizes information about options outstanding at
December 31, 1999 (shares in thousands):
<TABLE>
<CAPTION>
OPTIONS EXERCISABLE
OPTIONS OUTSTANDING (EXCLUDING OPTIONS WHICH SHARES
- --------------------------------------------------- WOULD BE SUBJECT TO THE
WEIGHTED COMPANY'S RIGHT OF REPURCHASE)
AVERAGE --------------------------------
REMAINING WEIGHTED
NUMBER OF CONTRACTUAL LIFE NUMBER OF AVERAGE
EXERCISE PRICES SHARES (IN YEARS) SHARES EXERCISE PRICES
- --------------- --------- ---------------- ------------- ----------------
<S> <C> <C> <C> <C>
$.03--$.03 2,076 8.49 438 $ .03
$.08--$.08 2,542 8.85 515 $ .08
$.22--$.22 690 9.10 30 $ .22
$.40--$.40 2,037 9.24 8 $ .40
$2.00--$2.00 3,440 9.41 -- --
$2.50--$4.00 2,188 9.59 2 $ 4.00
$5.00--$10.00 1,865 9.73 480 $10.00
$28.75--$28.75 104 9.76 -- --
$44.00--$44.00 212 9.84 -- --
$70.06--$70.06 327 9.94 -- --
------ -----
$.03--$70.06 15,481 9.24 1,473 $ 3.31
====== =====
</TABLE>
The Company has adopted the disclosure only provisions of Financial
Accounting Standards No. 123 ("SFAS No. 123"), "Accounting for Stock-Based
Compensation." Pro forma information regarding the net loss is required by SFAS
No. 123, and has been determined as if the Company had accounted for its
employee stock options under the fair value method. The fair value of options
granted in 1998 and in 1999 prior to the Company's initial public offering was
estimated at the date of grant using the minimum value method allowed for
non-public companies assuming no expected dividends and the following weighted-
average assumptions: risk-free interest rate of 6% and 6.75%; volatility of 0%
and 0%; and an expected life of 6 and 5 years, respectively. The fair value of
options granted in 1999 subsequent to the Company's initial public offering was
estimated at the date of grant using the Black-Scholes option pricing model
assuming no expected dividends and the following weighted average assumptions:
risk free interest rate of 6.75%; volatility of 80%; and an expected life of
5 years.
For purposes of the pro forma disclosures, the estimated fair value of
options is amortized to expense over the options' vesting periods. If the
Company had accounted for compensation expense related to stock options under
the fair value method prescribed by SFAS No. 123, the net loss and the basic and
diluted net loss per share for the years ended December 31, 1998 and 1999 would
have been approximately $6,985,000 and $60,372,000 and $1.05 and $1.59,
respectively.
During 1998 and 1999, options to purchase 6,823,498 and 9,854,000 shares of
the Company's common stock, with a weighted-average exercise price of $.05 and
$3.09 per share and a weighted-average option
F-20
<PAGE>
INTERNAP NETWORK SERVICES CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
10. STOCK-BASED COMPENSATION PLANS: (CONTINUED)
fair value of $.12 and $3.69 per share, were granted, respectively, with an
exercise price below the estimated market value at the date of grant.
DEFERRED STOCK COMPENSATION
During 1998, the Company issued stock options to certain employees under the
1998 and 1999 Plans with exercise prices below the deemed fair value of the
Company's common stock at the date of grant. In accordance with the requirements
of APB 25, the Company has recorded deferred stock compensation for the
difference between the exercise price of the stock options and the deemed fair
value of the Company's common stock at the date of grant. This deferred stock
compensation is amortized to expense over the period during which the options or
common stock subject to repurchase vest, generally four years, using an
accelerated method as described in Financial Accounting Standards Board
Interpretation No. 28. As of December 31, 1999, the Company has recorded
deferred stock compensation related to these options in the total amount of
$25,002,000, of which $205,000 and $7,569,000 has been amortized to expense
during 1998 and 1999, respectively. The weighted average exercise price of the
6,823,498 options granted in 1998 to purchase common stock was $.05 and the
weighted average fair value per share was $.15 during 1998. The weighted average
exercise price of the 11,134,500 options granted in 1999 to purchase common
stock was $5.82 and the weighted average fair value per share was $7.98.
EMPLOYEE STOCK PURCHASE PLAN
A total of 3,000,000 shares of common stock have been reserved for issuance
under the Company's 1999 Employee Stock Purchase Plan. Upon the first nine
anniversaries of the adoption date of the purchase plan, the number of shares
reserved for issuance under the purchase plan will automatically be increased by
2% of the total number of shares of common stock then outstanding or, if less,
by 3,000,000 shares. The purchase plan is intended to qualify as an employee
stock purchase plan within the meaning of Section 423 of the Code.
The purchase plan provides a means by which employees may purchase common
stock of the Company through payroll deductions. The purchase plan is
implemented by offering rights to eligible employees. Under the purchase plan,
the Company may specify offerings with a duration of not more than 27 months,
and may specify shorter purchase periods within each offering. The first
offering began on September 29, 1999 and will terminate on September 30, 2001.
Purchase dates occur each March 31 and September 30.
Employees who participate in an offering under the purchase plan may have up
to 15% of their earnings withheld. The amount withheld is then used to purchase
shares of the common stock on specified dates determined by the board of
directors. The price of common stock purchased under the purchase plan is equal
to 85% of the lower of the fair market value of the common stock at the
commencement date of each offering period or the relevant purchase date.
Employees may end their participation in an offering at any time during the
offering except during the 15 day period immediately prior to a purchase date.
Employees' participation in all offerings ends automatically on termination of
their employment with the Company or one of its subsidiaries.
F-21
<PAGE>
INTERNAP NETWORK SERVICES CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
11. EVENTS SUBSEQUENT TO DECEMBER 31, 1999 (UNAUDITED):
On February 22, 2000, pursuant to an investment agreement, the Company
purchased 588,236 shares of Aventail Corporation ("Aventail") Series D preferred
stock at $10.20 per share for a total cash investment of $6,000,007. The Series
D preferred stock is convertible to common stock at a ratio of one share of
preferred stock to one share of common stock, subject to adjustment for certain
equity transactions. Additionally, the Company and Aventail entered into a joint
marketing agreement which, among other things, granted the Company certain
limited exclusive rights to sell Aventail's managed extranet service and granted
Aventail certain rights to sell the Company's services. In return, the Company
committed to either sell Aventail services or pay Aventail, or a combination of
both, which would result in Aventail's recognition of $3,000,000 of revenue over
a two-year period.
F-22
<PAGE>
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