10-K 1 t81348_10k.htm FORM 10-K



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
 
 
FORM 10-K
 
 
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended December 31, 2014
 
OR
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from _____ to _____.
 
Commission file number: 001-31989
 
INTERNAP CORPORATION
(Exact Name of Registrant as Specified in Its Charter)

Delaware
91-2145721
(State or Other Jurisdiction of
(I.R.S. Employer
Incorporation or Organization)
Identification No.)
   
One Ravinia Drive, Suite 1300
 
Atlanta, Georgia
30346
(Address of Principal Executive Offices)
(Zip Code)

(404) 302-9700
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:

Title of each class
 
Name of exchange on which registered
Common Stock, $0.001 par value
 
The NASDAQ Stock Market LLC
   
(NASDAQ Global Market)
 
Securities registered pursuant to Section 12(g) of the Act: None
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☐ No
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ☒
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
   
Large accelerated filer ☐
Accelerated filer ☒
Non-accelerated filer ☐
Smaller reporting company ☐
(Do not check if a smaller reporting company)
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No
 
The aggregate market value of the registrant’s outstanding common stock held by non-affiliates of the registrant was $238,539,239 based on a closing price of $7.05 on June 30, 2014, as quoted on the NASDAQ Global Market.
 
As of February 2, 2015, 54,473,757 shares of the registrant’s common stock, par value $0.001 per share, were issued and outstanding.
 
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive proxy statement for the registrant’s annual meeting of stockholders to be held May 29, 2015 are incorporated by reference into Part III of this report. Except as expressly incorporated by reference, the registrant’s Proxy Statement shall not be deemed to be a part of this report on Form 10-K.
 


 
 

 


TABLE OF CONTENTS
         
       
Page
       
   
1
   
5
   
17
   
17
   
17
   
17
         
       
   
17
   
19
   
20
   
30
   
31
   
31
   
31
   
31
         
       
   
31
   
32
   
32
   
32
   
32
         
       
   
32
         
     
35
 
- i -
 

 

 
FORWARD-LOOKING STATEMENTS
 
This Annual Report on Form 10-K, particularly Management’s Discussion and Analysis of Financial Condition and Results of Operations set forth below, and notes to our accompanying audited consolidated financial statements, contain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include statements regarding industry trends, our future financial position and performance, business strategy, revenues and expenses in future periods, projected levels of growth and other matters that do not relate strictly to historical facts. These statements are often identified by words such as “may,” “will,” “seeks,” “anticipates,” “believes,” “estimates,” “expects,” “projects,” “forecasts,” “plans,” “intends,” “continue,” “could” or “should,” that an “opportunity” exists, that we are “positioned” for a particular result, statements regarding our vision or similar expressions or variations. These statements are based on the beliefs and expectations of our management team based on information currently available. Such forward-looking statements are not guarantees of future performance and are subject to risks and uncertainties that could cause actual results to differ materially from those contemplated by forward-looking statements. Important factors currently known to our management that could cause or contribute to such differences include, but are not limited to, those referenced in Item 1A “Risk Factors.” We undertake no obligation to update any forward-looking statements as a result of new information, future events or otherwise.
 
As used herein, except as otherwise indicated by context, references to “we,” “us,” “our,” “Internap” or the “Company” refer to Internap Corporation and our subsidiaries.
 
 
 
Overview
 
Internap’s vision is to help people build and manage the world’s best performing Internet infrastructure. Today, our infrastructure services power many of the applications that shape the way we live, work and play. Internap’s hybrid Internet infrastructure services deliver “performance without compromise” – blending virtual and bare-metal cloud, hosting and colocation services across a global network of data centers, optimized from the application to the end user and backed by our team of dedicated professionals. Many of the world’s most innovative companies rely on Internap to make their applications faster and more scalable.
 
Our Industry
 
Internap competes in the large and fast-growing market for Internet infrastructure services (outsourced data center, compute, storage and network services). Three complementary trends are driving demand for Internet infrastructure services: the growth of the digital economy, the outsourcing of information technology (“IT”) and the adoption of cloud computing.
 
The Growth of the Digital Economy
 
The digital economy continues to impact existing business models with a new generation of networked applications. Widespread adoption of mobile Internet devices combined with rising expectations around the performance and availability of both consumer and business applications places increasing pressure on enterprises to deliver a seamless end-user experience on any device at any time at any location. Simultaneously, Software-as-a-Service (“SaaS”) models have changed data usage patterns with information traditionally maintained on individual machines and back-office servers now being streamed across the Internet. These applications require new diligence and focus on predictable performance and data security. Finally, the growth of big data analytics is giving rise to a new breed of “fast data” applications that collect and analyze massive amounts of data in real time to drive immediate business decisions – for example, real-time ad bidding platforms and personalized e-commerce portals.
 
The Outsourcing of IT
 
As distributed applications, security concerns and compliance issues are placing new burdens on the traditional IT model and driving new costs and complexity, IT organizations are increasingly turning to infrastructure outsourcing to free up valuable internal resources to focus on their core business, improve service levels and lower the overall cost of their IT operations. The macro-economic trends over the past several years have led to a significant reduction of operating and capital budgets. Companies are forced to balance this growing complexity with a cost-cutting culture and staff resource limitations that require they do more with less.
 
The Adoption of Cloud Computing
 
Amidst this environment, the emergence of public cloud Infrastructure-as-a-Service (“IaaS”) offerings has accelerated digital innovation by lowering the barrier to entry for new business creation. IaaS offerings allow new enterprises to procure and pay for infrastructure on an as-needed basis while minimizing upfront operating expenses, reducing complexity and increasing agility.
 
Although most organizations initially rely on cloud services for non-mission critical workloads, such as testing and development, growing adoption and the maturation of cloud platforms have increased confidence in migrating key business applications to the cloud. This, in turn, has led to a new generation of applications that are being architected from the ground up, to run on standardized public cloud infrastructure.
 
- 1 -
 

 

 
Our Business
 
The Internet infrastructure services market comprises a range of infrastructure offerings that have emerged in response to shifting business and technology drivers. Internap competes specifically in the markets for retail colocation, hosting and IaaS. Different customer use cases and business requirements dictate the need for specific services or a combination of services enabled through hybridization.
 
Internap provides high-performance, hybrid Internet infrastructure services that make our customers’ applications faster and more scalable. We offer:
 
 
hybrid infrastructure services: customers can mix and match cloud, hosting and colocation for the optimal combination of services to meet specific application and business requirements;
 
availability across a global network of data centers;
 
patented network services that leverage our proprietary technologies to maximize uptime and minimize latency for customer applications; and
 
a “single-pane-of-glass” customer portal, backed by service level agreements (“SLAs”) and our team of dedicated support professionals.
 
Our Segments
 
Data Center Services Segment
 
Our data center services segment includes colocation, hosting and cloud services. Colocation involves providing physical space within data centers and associated services such as power, interconnection, environmental controls, monitoring and security while allowing our customers to deploy and manage their servers, storage and other equipment in our secure data centers. Hosting and cloud services involve the provision and maintenance of hardware, operating system software, management and monitoring software, data center infrastructure and interconnection, while allowing our customers to own and manage their software applications and content.
 
We sell our data center services at 52 data centers across North America, Europe and the Asia-Pacific region. We refer to 16 of these facilities as “company-controlled,” meaning we control the data center operations, staffing and infrastructure and have negotiated long-term leases for the facilities. For company-controlled facilities, in most cases we design the data center infrastructure, procure the capital equipment, deploy the infrastructure and are responsible for the operation and maintenance of the facility. We refer to the remaining 36 data centers as “partner” sites. In these locations, a third party designs and deploys the infrastructure and provides for the operation and maintenance of the facility.
 
Within the data center services segment, we identify between “core” and “partner colocation” revenues. Core revenues are from our company-controlled colocation, hosting and cloud services and include all revenue from iWeb Technologies Inc., formerly known as iWeb Group Inc., (“iWeb”), which we acquired in November 2013. Partner colocation revenues are from our partner sites.
 
Internet Protocol Services Segment
 
Our Internet Protocol (“IP”) services segment includes our patented Performance IP™ service, content delivery network (“CDN”) services and IP routing hardware and software platform. By intelligently routing traffic with redundant, high-speed connections over multiple, major Internet backbones, our IP services provide high-performance and highly-reliable delivery of content, applications and communications to end users globally. We deliver our IP services through 88 IP service points around the world.
 
Our patented and patent-pending network route optimization technologies address inherent weaknesses of the Internet, allowing businesses to take advantage of the convenience, flexibility and reach of the Internet to connect to customers, suppliers and partners, and to adopt new IT delivery models in a scalable, reliable and predictable manner.
 
Our CDN services enable our customers to quickly and securely stream and distribute rich media and content, such as video, audio software and applications, to audiences across the globe through strategically located points of presence (“POPs”). Providing capacity-on-demand to handle large events and unanticipated traffic spikes, we deliver scalable high-quality content distribution and audience-analytic tools.
 
Additional information regarding our segments can be found in note 12 to the accompanying consolidated financial statements.
 
- 2 -
 

 

 
Data Centers, Private Network Access Points and CDN POPs

Our data centers and private network access points (“P-NAPs”) feature multiple direct high-speed connections to major Internet service providers (“ISPs”). We have data centers, P-NAPs and CDN POPs in the following markets, some of which have multiple sites:
 
             
   
Domestic sites operated
 
International sites operated
Internap operated
 
under third party agreements
 
under third party agreements
Atlanta
 
Atlanta
Orange County
 
Amsterdam
Paris
Boston
 
Boston
San Diego
 
Frankfurt
Singapore
Dallas
 
Chicago
Philadelphia
 
Hong Kong
Sydney
Houston
 
Dallas
Phoenix
 
London
Tokyo(1)
Los Angeles
 
Denver
San Francisco
 
Osaka(1)
Toronto
Montreal
 
Los Angeles
San Jose
     
New York Metro
 
Miami
Santa Clara
     
Santa Clara
 
New York Metro
Seattle
     
Seattle
 
Oakland
Washington DC
     

   
(1)
Through our joint venture in Internap Japan Co., Ltd. (“Internap Japan”) with NTT-ME Corporation and Nippon Telegraph and Telephone Corporation (“NTT Holdings”).
 
Financial Information about Geographic Areas
 
During December 31, 2014, we derived more than 10% of our total revenues from operations outside the United States. During each of the two years ended December 31, 2013 and 2012, we derived less than 10% of our total revenues from operations outside the United States. We summarize our geographic information in note 12 to the accompanying consolidated financial statements.
 
Research and Development
 
Research and development costs, including product development costs, are included in general and administrative costs and are expensed as incurred. These costs primarily relate to our development and enhancement of IP routing technology, hosting and cloud technologies and network engineering costs associated with changes to the functionality of our services. Research and development costs were $2.8 million, $2.1 million and $2.0 million during the years ended December 31, 2014, 2013 and 2012, respectively. These costs do not include $8.5 million, $7.5 million and $6.7 million of software costs capitalized during the years ended December 31, 2014, 2013 and 2012, respectively.
 
Customers
 
As of December 31, 2014, we had approximately 12,000 customers in various industries. We serve the following key industries: software and Internet, including advertising technology; media and entertainment, including gaming; business services; hosting and IT infrastructure; health care technology infrastructure and telecommunications. Our customer base is not concentrated in any particular industry; in each of the past three years, no single customer accounted for 10% or more of our revenues.
 
Competition
 
The market for Internet infrastructure services is intensely competitive, remains highly fragmented and is characterized by rapid innovation, steady price erosion and consolidation. We believe that the principal factors of competition for service providers in our target markets include breadth of product offering, product features and performance, level of customer service and technical support, price and brand recognition. We believe that we can compete on the basis of these factors to varying degrees. Our current and potential competition primarily consists of:
 
 
colocation, hosting and cloud providers, including Equinix, Inc.; Rackspace, Inc.; Amazon Web Services; Telx Group, Inc.; CyrusOne; CenturyLink, Inc.; Softlayer (IBM); and QTS Realty Trust, Inc.; and
 
ISPs that provide connectivity services and storage solutions, including AT&T Inc.; Sprint Nextel Corporation; Verizon Communications Inc.; Level 3 Communications, Inc.; Akamai Technologies, Inc. and Zayo Group, LLC.
 
Our Competitive Differentiation
 
Internap aims to be the partner of choice for people developing the world’s most innovative applications by creating and operating the best-performing Internet infrastructure. We are uniquely positioned to help our customers make their applications faster and more scalable in the following ways:
 
Our High-Performance Service Offering
 
Providing the best performing infrastructure services is in Internap’s DNA. The company was founded in 1996 to provide a better way to deliver packets across the Internet and, today, our Performance IP™ service is a leading standard for business Internet connectivity. As we have expanded and evolved our business, delivering the best performance has remained a central value starting with the design of company-controlled data centers, which are the foundation for our hybrid infrastructure services and feature industry-leading power densities and complete infrastructure redundancy to efficiently support business growth while minimizing downtime.
 
- 3 -
 

 

 
Similarly, we have designed our public cloud offering to support high-performance workloads with bare-metal and virtual computing options built atop the open-source OpenStack cloud computing platform. Our bare-metal cloud supports big data applications better than virtualized cloud alternatives by delivering faster throughput and processing, more consistent performance by removing the “noisy neighbor effect” and more efficient price to performance – with significant cost savings over nominal virtual equivalents.
 
Our Hybrid Approach to Internet Infrastructure and Hosting Venue Interoperability
 
We believe the breadth of our services offering provides additional compelling differentiation. Customers require a range of infrastructure offerings to support specific workload, business and compliance, and we are unique in our ability to allow customers to easily mix and match colocation, cloud and hosting (virtual and physical, managed and unmanaged environments) to create the best-fit infrastructure for their application and business requirements.
 
Our infrastructure services seamlessly interconnect via a single unified network to enable hybridized IT environments for maximum scalability, efficiency and flexibility. Our unified customer portal provides a single pane of glass view into customers’ hybrid infrastructure, allowing them to provision, manage and monitor colocation, hosting and cloud environments through a single, robust interface. This simplifies management of the colocation footprint, minimizes expensive trips to the data center and enables customers to easily leverage cloud-to-colocation hybridization for immediate access to elastic, on-demand resources.
 
Our Customer Support
 
Ultimately, our services are only as strong as the people behind them. Internap’s award-winning, fully-redundant Network Operations Centers (“NOCs”) deliver outstanding service and act as a virtual extension of our customers’ infrastructure teams. Our NOCs are staffed by experienced engineers who proactively monitor our services and network to resolve issues before problems arise. The performance and availability of our services is mission-critical to our customer businesses and we guarantee those services with a competitive SLA, which features proactive alerts and credits.
 
Intellectual Property
 
Our success and ability to compete depend in part on our ability to develop and maintain the proprietary aspects of our IT infrastructure services and operate without infringing on the proprietary rights of others. We rely on a combination of patent, trademark, trade secret and contractual restrictions to protect our proprietary technology. As of December 31, 2014, we had 21 patents (16 issued in the United States and five issued internationally) that extend to various dates between 2017 and 2031, and 14 registered trademarks in the United States. Although we believe the protection afforded by our patents, trademarks and trade secrets has value, the rapidly changing technology in our industry and uncertainties in the legal process make our future success dependent primarily on the innovative skills, technological expertise and management abilities of our employees rather than on the protection afforded by patent, trademark and trade secret laws. We seek to limit disclosure of our intellectual property by requiring employees and consultants with access to our proprietary information to execute confidentiality agreements with us.

Employees
 
As of December 31, 2014, we had approximately 700 employees. None of our employees are represented by a labor union, and we have not experienced any work stoppages. We consider the relationships with our employees to be good.
 
Additional Information
 
We make available through our company web site, free of charge, our company filings with the Securities and Exchange Commission (the “SEC”) as soon as reasonably practicable after we electronically file them with, or furnish them to the SEC. These include our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, proxy statements, registration statements and any amendments to those documents. Our web site is www.internap.com and the link to our SEC filings is http://ir.internap.com/financials.cfm. Our principal executive offices are located at One Ravinia Drive, Suite 1300, Atlanta, Georgia 30346, and our telephone number is (404) 302-9700. We incorporated in Washington in 1996 and reincorporated in Delaware in 2001. Our common stock trades on the Nasdaq Global Market under the symbol “INAP.”

The public may read and copy any materials that we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. The public may access information about the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information filed electronically with the SEC, at http://www.sec.gov.
 
- 4 -
 

 

 

We operate in a changing environment that involves numerous known and unknown risks and uncertainties that could have a materially adverse impact on our operations. The risks described below highlight some of the factors that have affected, and in the future could affect, our operations. You should carefully consider these risks. These risks are not the only ones we may face. Additional risks and uncertainties of which we are unaware or that we currently deem immaterial also may become important factors that affect us. If any of the events or circumstances described in the following risks occurs, our business, consolidated financial condition, results of operations, cash flows or any combination of the foregoing could be materially and adversely affected.

Our risks are described in detail below; however, the more significant risks we face can be summarized into several broad categories, including:

The future evolution of the technology industries in which we operate is difficult to predict, highly competitive and requires continual innovation and development, strategic planning, capital investment, demand planning and space utilization management to remain viable. We face on-going challenges to develop new services and products to maintain current customers and obtain new ones. In addition, technological advantages can rapidly decrease value, creating constant pressure on pricing and cost structures and hindering our ability to maintain or increase margins.

We are dependent on numerous suppliers, vendors and other third-party providers across a wide spectrum of products and services to operate our business. These include real estate, network capacity and access points, network equipment and supplies, power and other vendors. In many cases the suppliers of these products and services are not only vendors, they are also competitors. While we maintain contractual agreements with these suppliers, we have limited ability to guarantee they will meet their obligations, or that we will be able to continue to obtain the products and services necessary to operate our business in sufficient supply, or at an acceptable cost.

Our business model involves designing, deploying and maintaining a complex set of network infrastructures at considerable capital expense. We invest significant resources to help maintain the integrity of our infrastructure and support our customers; however, we face constant challenges related to our infrastructure, including capital forecasting, demand planning, space utilization management, physical failures, obsolescence, maintaining redundancies, physical and electronic security breaches, power demand and other risks.

Our financial results have fluctuated over time and we have a history of losses, including in each of the past three years. We have also incurred significant charges related to impairments and restructuring efforts, which, along with other factors, may contribute to volatility in our stock price.

Risks Related to our Industries

We cannot predict with certainty the future evolution of the IT infrastructure market in which we compete, and may be unable to respond effectively or on a timely basis to rapid technological change.

The IT infrastructure market in which we compete is characterized by rapidly changing technology, industry standards and customer needs, as well as by frequent new product and service introductions. As evidenced by our investment in and offering to our enterprise customers of a full portfolio of IT infrastructure solutions, innovative new IT technologies and evolving industry standards have the potential to become the “new normal,” either replacing or providing efficient, potentially lower-cost alternatives to other, more traditional, IT communications services. The adoption of such new technologies or industry standards could render our existing services obsolete and unmarketable.

Our failure to anticipate new technology trends that may eventually may become the preferred technology choice of our customers, to adapt our technology to any changes in the prevailing industry standards (or, conversely, for there to be an absence of generally accepted standards) could materially and adversely affect our business. Our pursuit of and investment in necessary technological advances may require substantial time and expense, but will not guarantee that we can successfully adapt our network and services to alternative access devices and technologies. Technological advances in computer processing, storage, capacity, component size or power management could result in a decreased demand for our data center and hosting services. Likewise, if the Internet backbone becomes subject to a form of central management or gatekeeping control, or if ISPs establish an economic settlement arrangement regarding the exchange of traffic between Internet networks that is passed on to Internet users, the demand for our IP and CDN services could be materially and adversely affected.

If we are unable to develop new and enhanced services and products that achieve widespread market acceptance, or if we are unable to improve the performance and features of our existing services and products or adapt our business model to keep pace with industry trends, our business and operating results could be adversely affected.

The market in which we compete is constantly evolving. The process of expending research and development to create new services and products, and the technologies that support them is expensive, time and labor intensive and uncertain. We may not understand the market demand for new services and products or not be able to overcome technical problems with new services and products. The demand for top research and development talent is high, and there is significant competition for these scarce resources.
 
- 5 -
 

 

 
Our future success may depend on our ability to respond to the rapidly changing needs of our customers by expending research and development in a cost-effective manner to acquire talent, develop and introduce new services, products and upgrades on a timely basis. New product development and introduction involves a significant commitment of time and resources and is subject to a number of risks and challenges, including:

 
sourcing, identifying, obtaining and maintaining qualified research and development staff with the appropriate skill and expertise;
 
managing the length of the development cycle for new products and product enhancements, which historically has been longer than expected;
 
identifying and adapting to emerging and evolving industry standards and to technological developments by our competitors’ and customers’ services and products;
 
developing or expanding efficient sales channels;
 
entering into new or unproven markets where we have limited experience;
 
managing new service and product service strategies and integrating them with our existing services and products;
 
incorporating acquired products and technologies;
 
trade compliance issues affecting our ability to ship new products to international markets; and
 
obtaining required technology licenses and technical access from operating system software vendors on reasonable terms to enable the development and deployment of interoperable products.

In addition, if we cannot adapt our business models to keep pace with industry trends, our revenue could be negatively impacted. If we are not successful in managing these risks and challenges, or if our new services, products and upgrades are not technologically competitive or do not achieve market acceptance, we may experience a decrease in our revenues and earnings.

Our capital investment strategy for data center and IT infrastructure services expansion may contain erroneous assumptions causing our return on invested capital to be materially lower than expected.

Our strategic decision to invest capital in expanding our data center and IT infrastructure services is based on, among other things, significant assumptions related to expected growth of these markets, our competitors’ plans and current and expected server utilization and data center occupancy rates. We have no way of ensuring the data or models we use to deploy capital into existing markets, or to create new markets, has been or will be accurate. Errors or imprecision in these estimates, especially those related to customer demand, could cause actual results to differ materially from expected results and could adversely affect our business, consolidated financial condition, results of operations and cash flows.

We may experience difficulties in executing our capital investment strategy to expand our IT infrastructure services, upgrade existing facilities or establish new facilities, products, services or capabilities.

As part of our strategy, we may continue to expand our IT infrastructure services and may encounter challenges and difficulties in implementing our expansion plans. This could cause us to grow at a slower pace than projected in our capital investment modeling. These challenges and difficulties relate to our ability to:

 
identify and obtain the use of locations meeting our selection criteria on competitive terms;
 
estimate costs and control delays;
 
obtain necessary permits on a timely basis, if at all;
 
generate sufficient cash flow from operations or through current or additional debt or equity financings to support these expansion plans;
 
establish key relationships with IT infrastructure providers;
 
hire, train, retain and manage sufficient operational and technical employees and supporting personnel;
 
obtain the necessary power density and supply from local utility companies;
 
avoid labor issues impacting our suppliers, such as a strike; and
 
identify and obtain contractors that will not default on the agreed upon contract performance.

If we encounter greater than anticipated difficulties in implementing our expansion plans, are unable to deploy new IT infrastructure services or do not adequately control expenses associated with the deployment of new IT infrastructure services, it may be necessary to take additional actions, which could divert management’s attention and strain our operational and financial resources. We may not successfully address any or all of these challenges, and our failure to do so would adversely affect our business, consolidated financial condition, results of operations and cash flows.

Our estimation of future data center space needs may be inaccurate, leading to missed sales opportunities or additional expenses through unnecessary carrying costs.

Adding data center space involves significant capital outlays well ahead of planned usage. Although we believe we can accurately project future space needs in particular markets, these plans require significant estimates and assumptions based on available market data. Errors or imprecision in these estimates or the data on which the estimates are based could result in either an oversupply or undersupply of space in a particular market and cause actual results to differ materially from expected results and correspondingly have a material adverse impact on our business, consolidated financial condition, results of operations and cash flows.
 
- 6 -
 

 

 
Pricing pressure may continue to decrease our revenue for certain services such as Internet connectivity, data transit and/or data storage services.

Pricing for Internet connectivity, data transit and data storage services has declined significantly in recent years and may continue to decline, which would continue to impact our IP services segment. By bundling their services and reducing the overall cost of their service offerings, certain of our competitors may be able to provide customers with reduced costs in connection with their Internet connectivity, data transit and data storage services or private network services, thereby significantly increasing the pressure on us to decrease our prices. Increased price competition, significant price deflation and other related competitive pressures have eroded, and could continue to erode, our revenue and could materially and adversely affect our results of operations if we are unable to control or reduce our costs. Because we rely on ISPs to deliver our services and have agreed with some of these providers to purchase minimum amounts of service at predetermined prices, our profitability could be adversely affected by competitive price reductions to our customers even if accompanied with an increased number of customers.

The market in which we operate is highly competitive and has experienced recent consolidation which may continue, and we may lack the financial and other resources, expertise or capability necessary to capture increased market share or maintain our market share.

We compete in the IT infrastructure services market, which is rapidly evolving, highly competitive and likely to be characterized by overcapacity, industry consolidation and continued pricing pressure. A number of our competitors have recently consolidated and such consolidation is likely to continue. In addition, our competitors may acquire software-application vendors or technology providers, enabling them to more effectively compete with us. We believe that participants in this market must grow rapidly and achieve a significant presence to compete effectively. This consolidation could affect prices and other competitive factors in ways that would impede our ability to compete successfully in the IT infrastructure market. Further, our business is not as developed as that of many of our competitors. Many of our competitors have substantially greater financial, technical and market resources, greater name recognition and more established relationships in the industry. Many of our competitors may be able to:

 
develop and expand their IT infrastructure and service offerings more rapidly;
 
adapt to new or emerging technologies and changes in customer requirements more quickly;
 
take advantage of acquisitions and other opportunities more readily; or
 
devote greater resources to the marketing and sale of their services and adopt more aggressive pricing policies than we can.

In addition, IT infrastructure providers may make technological advancements to enhance the quality of their services, which could negatively impact the demand for our IT infrastructure services. We also expect that we will face additional competition as we expand our product offerings, including competition from technology and telecommunications companies and non-technology companies which are entering the market through leveraging their existing or expanded network services and cloud infrastructure. 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 also are exploring the possibility of providing, or are currently providing, high-speed, intelligent data services that use connections to more than one network or use alternative delivery methods, including the cable television infrastructure, direct broadcast satellites and wireless local loops.

We may lack financial and other resources, expertise or capability necessary to maintain or capture increased market share. Increased competition and technological advancements by our competitors could materially and adversely affect our business, consolidated financial condition, results of operations and cash flows.

Failure to retain existing customers or add new customers may cause our revenue to decline.

In addition to adding new customers, we must sell additional services to existing customers and encourage them to increase their usage levels to increase our revenue. If our existing and prospective customers do not perceive our services to be of sufficiently high value and quality, we may not be able to retain our current customers or attract new ones. Our customers have no obligation to renew their agreements for our services after the expiration of their initial commitment, and these agreements may not be renewed at the same price or level of service, if at all. Due to the significant upfront costs of implementing IT infrastructure services, if our customers do not renew or cancel their agreements, we may not be able to recover the initial costs associated with bringing additional infrastructure on-line.

Our customers’ renewal rates may decline or fluctuate as a result of a number of factors, including:
 
 
their level of satisfaction with our services;
 
our ability to provide features and functionality demanded by our customers;
 
- 7 -
 

 

 
 
the prices of our services compared to our competitors;
 
technological advances that allow customers to meet their needs with fewer infrastructure resources;
 
mergers and acquisitions affecting our customer base; and
 
reduction in our customers’ spending levels.

If our customers do not renew their agreements with us or if they renew on less favorable terms, our revenue would decline and our business may suffer. Similarly, our customer agreements may provide for minimum commitments that may be significantly below our customers’ historical usage levels. Consequently, these customers could significantly curtail their usage without incurring any incremental fees under our agreements. In this event, our revenue would be lower than expected and our operating results could suffer.

We have a long sales cycle for our IT infrastructure services and the implementation efforts required by customers to activate them can be substantial.

Our IT infrastructure services are complex and require substantial sales efforts and technical consultation to implement. A customer’s decision to outsource some or all of its IT infrastructure typically involves a significant commitment of resources. Some customers may be reluctant to purchase our services due to their inability to accurately forecast future demand, delay in decision-making or inability to obtain necessary internal approvals to commit resources. We may expend time and resources pursuing a particular sale or customer that does not result in revenue. Delays due to the length of our sales cycle may harm our ability to meet our forecasts and materially and adversely affect our revenues and operating results.

We may lose customers if they elect to develop or maintain some or all of their IT infrastructure services internally.

Our current and potential customers may decide to develop or maintain their own IT infrastructure rather than outsource to service providers like us. These in-house IT infrastructure services could be perceived to be superior or more cost effective compared to our services. If we fail to offer IT infrastructure services that compete favorably with in-sourced services or if we fail to differentiate our IT infrastructure services, we may lose customers or fail to attract customers that may consider pursuing this in-sourced approach, and our business, consolidated financial condition and results of operations would suffer as a result.

In addition, our customers’ business models may change in ways that we do not anticipate and these changes could reduce or eliminate our customers’ needs for our services. If this occurs, we could lose customers or potential customers, and our business and financial results would suffer. As a result of these or similar potential developments in the future, it is possible that competitive dynamics in our market may require us to reduce our prices, which could harm our revenue, gross margin and operating results.

If governments modify or increase regulation of the Internet, or goods or services necessary to operate the Internet or our IT infrastructure, our services could become more costly.

International bodies and federal, state and local governments have adopted a number of laws and regulations that affect the Internet and are likely to continue to seek to implement additional laws and regulations. In addition, federal and state agencies have adopted or are actively considering regulation of various aspects of the Internet and/or IP services, including taxation of transactions, regulation of broadband providers and ISPs, enhanced data privacy and retention legislation and various energy regulations, as well as law enforcement surveillance and anti-terrorism initiatives targeting instant messaging applications, for example. Additionally, potential laws and regulations not specifically directed at the Internet, but targeted at goods or services necessary to operate the Internet, could have a negative impact on us. These factors may impact the delivery of our services by driving up the cost of power, which is a significant cost of operating our data centers and other service points.

We face the risk that the Federal Communications Commission (“FCC”) may regulate broadband Internet access services or that Congress or one or more states will approve legislation significantly affecting our Internet customers, and thus, our business. Beginning in 2010, the FCC adopted Open Internet rules which were vacated by the U.S. Court of Appeals for the DC Circuit in early 2014. Following another FCC rulemaking in 2014, at the time of preparation of this report, the FCC is scheduled to vote on FCC Chairman Wheeler’s proposal for new “Open Internet” rules, at the FCC’s February 26, 2015 Open Meeting (“Open Meeting”). The rules would include a potentially significant reclassification of broadband Internet access, and potentially, a classification of edge provider connections to broadband Internet access, both as regulated Title II “telecommunications services” rather than deregulated information services, which broadband has historically been. Title II regulation would subject ISPs to common carrier regulation, including prohibiting “unjust and unreasonable practices” and discriminatory practices under Sections 201 and 202 of the Communications Act, regulation of consumer privacy under Section 222 and other common carrier regulation(s).

As “bright line rules” the proposed rules would prohibit (a) blocking, (b) throttling (impairing or degrading lawful Internet traffic on the basis of content, applications or services), and (c) paid prioritization or “fast lanes,” including for ISP affiliates. The rules would allow for reasonable network management, which must be tailored to achieve a legitimate network management purpose, not a commercial one. The proposed rules would also enhance the transparency requirements for broadband services and would set a standard of conduct for ISPs. Under the proposed framework, the FCC would not enforce certain Title II provisions by forbearing from imposing, among other things, rate regulation and Universal Service contributions or “any new taxes or fees” on broadband providers, though an FCC Commissioner has issued a public statement in opposition. As such, there is lingering uncertainty about what the final approved rules will be, and whether the rules will make broadband more expensive for end users, which would impact Internap’s customers and Internap’s business. As of the preparation of this report, the comprehensive proposal has not been released, and further details, including possible changes to the Chairman’s proposed rules prior to the February 26 vote, will likely emerge later. Litigation is almost certain, and at least one leading U.S. carrier and a major cable television trade association have announced that litigation challenges to the Open Internet rules are likely.

While future actions are difficult to predict, the regulatory reclassification of broadband services as telecommunications services under Title II should directly benefit edge providers, though the as-yet uncertain impact on taxes, fees and other costs for broadband Internet access could negatively impact our customers and, in turn, impact our business. The same is true of any possible congressional rewrite of the Communications Act which results in new regulation of broadband providers as common carriers. Companies like ours, whose business involves providing enterprise networks for cloud computing and other Internet-based business applications, could have their operations and costs impacted by a top-to-bottom review of broadband access principles. On the other hand, it remains unclear what impact these new regulations will have on the costs that businesses like ours that pay for broadband access services will face in the absence of a statutory or regulatory prohibition. Any of these developments could significantly impact our business.
 
- 8 -
 

 

 
A recently proposed legislative amendment that Congress is considering to the Communications Act poses other potential risks. Senate and House Committees held hearings on January 21, 2015 to consider draft majority party legislation that would amend the Communications Act to expressly (a) classify broadband as an information service; (b) allow ISPs to offer “specialized services” or “services other than broadband Internet access service that are offered over the same network”; and (c) prohibit blocking of lawful content, throttling data and paid prioritization. The proposed legislative reforms would apply to both wireless and wireline broadband services. The draft legislation appears to be based on the FCC’s Open Internet rules that were partially overturned by the DC Circuit Court of Appeals in early 2014. If this proposed legislation or similar legislation is enacted which does not treat broadband Internet access or the service interconnecting Internet content edge providers with ISPs as a telecommunications service, it could disadvantage our edge provider customers and adversely impact our business.

In another pending rulemaking, the FCC is proposing to regulate Internet-based video programming providers as multi-channel video programming distributors (“MVPDs”) as it currently does established cable television providers and satellite providers. The FCC has tentatively concluded that the traditional definition of MVPD requiring ownership of the video transmission path should be expanded to a more flexible definition that would include Internet-based video programmers. As proposed, this new definition would apply to any provider of multiple streams of pre-scheduled programming, but not video on demand. There are a host of legal obligations imposed on and rights extended to MVPDs that currently do not apply to IP-based video distribution networks, including closed captioning, EEO and Emergency Alert System requirements. Conversely, there are rights to enter into good faith negotiations for retransmission consent agreements with broadcast networks that Internet-based video programmers would gain as MVPDs. The FCC has requested comments in March 2015. This proceeding could directly impact the ability to compete for video programming of a number of Internap’s customers, and thereby impact the future use of Internap’s services.

In addition, laws relating to the liability of private network operators and information carried on or disseminated through their networks are unsettled, both in the U.S. and abroad. The nature of any new laws and regulations and the interpretation of applicability to the Internet of existing laws governing intellectual property ownership and infringement, copyright, trademark, trade secret, national security, law enforcement, obscenity, libel, employment, personal privacy, consumer protection and other issues are uncertain and developing. We may become subject to legal claims such as defamation, invasion of privacy or copyright infringement in connection with content stored on or distributed through our network. We cannot predict the impact, if any, that future regulation or regulatory changes may have on our business.

One of our subsidiaries offers metro connect Ethernet data transmission services to customers colocated at our data centers to enable expanded connectivity. These are regulated telecommunications services, which require our subsidiary to obtain regulatory certification(s) and maintain an approved tariff in most states in which these services are offered. There are various regulatory compliance requirements to operate as a telecommunications carrier, such as the filing of tariffs, annual reports and universal service reports, all of which must be satisfied to continue to offer these services, and avoid any enforcement actions by federal or state regulators. We also must ensure that we are in compliance with state consumer protection laws in every state in which the subsidiary offers such services. Failure to comply with any of these requirements could negatively impact our business.

Risks Related to our Business

We depend on third-party suppliers for key elements of our IT infrastructure services. If we are unable to obtain these elements on a cost-effective basis, or at all, or if such services are interrupted, limited or terminated, our growth prospects and business operations may be adversely affected.

In delivering our services, we rely on a number of Internet networks, many of which are built and operated by third parties. To provide high performance connectivity services through our network access points, we purchase connections from several ISPs. We can offer no assurances that these ISPs will continue to provide service to us on a cost-effective basis or on competitive terms, if at all, or that these providers will provide us with additional capacity to adequately meet customer demand or to expand our business. Consolidation among ISPs limits the number of vendors from which we obtain service, possibly resulting in higher network costs to us. We may be unable to establish and maintain relationships with other ISPs that may emerge or that are significant in geographic areas, such as Asia and Europe, in which we may locate our future network access points. Any of these situations could limit our growth prospects and materially and adversely affect our business.

We also depend on other companies to supply various key elements of our network infrastructure, including the network access loops between our network access points and our ISP, local loops between our network access points and our customers’ networks and certain end-user access networks. Pricing for such network access loops and local loops has risen significantly over time and operators of these networks may take measures that could degrade, disrupt or increase the cost of our or our customers’ access to certain of these end-user access networks by restricting or prohibiting the use of their networks to support or facilitate our services, or by charging increased fees. Some of our competitors have their own network access loops and local loops and are, therefore, not subject to similar availability and pricing issues.
 
- 9 -
 

 

 
For data center and hosting facilities, we rely on a number of vendors to provide physical space, convert or build space to our specifications, provide power, internal cabling and wiring, climate control, physical security and system redundancy. We typically obtain physical space through long-term leases. We utilize multiple other vendors to perform leasehold improvements necessary to make the physical space available for occupancy. The demand for premium data center and hosting space in several key markets has outpaced supply over recent years and the imbalance is projected to continue over the near term. This has limited our physical space options and increased, and will continue to increase, our costs to add capacity. If we are not able to procure space through renewing our existing leases or entering into new leases, or are not able to contain costs for physical space, or are not able to pass these costs on to our customers, our results will be adversely affected.

In addition, we currently purchase infrastructure equipment such as servers, routers, switches and storage components from a limited number of vendors. We do not carry significant inventories of the equipment we purchase, and we have no guaranteed supply arrangements with our vendors. A loss of a significant vendor could delay any build-out of our infrastructure and increase our costs. If our limited source of suppliers fails to provide products or services that comply with evolving Internet standards or that interoperate with other products or services we use in our network infrastructure, we may be unable to meet all or a portion of our customer service commitments, which could materially and adversely affect our results.

Any failure of our physical IT infrastructure could lead to significant costs and disruptions that could harm our business reputation, consolidated financial condition, results of operations and cash flows.

Our business depends on providing customers with highly-reliable service. We must protect our IT infrastructure and our customers’ data and their equipment located in our data centers. The services we provide in each of our data centers are subject to failure resulting from numerous factors, including:

 
human error;
 
physical or electronic security breaches;
 
fire, earthquake, hurricane, flood, tornado and other natural disasters;
 
improper maintenance of the buildings in which our data centers are located;
 
water damage, extreme temperatures, fiber cuts;
 
power loss or equipment failure;
 
sabotage and vandalism; and
 
failures experienced by underlying service providers upon which our business relies.

Problems at one or more of our company-controlled facilities or our partner sites, whether or not within our control, could result in service interruptions or significant equipment damage. Most of our customers have SLAs that require us to meet minimum performance obligations and to provide service credits to customers if we do not meet those obligations. If a service interruption impacts a significant portion of our customer base, the amount of service credits we are required to provide could adversely impact our business and financial condition. Also, if we experience a service interruption and we fail to provide a service credit under an SLA, we could face claims related to such failures, which could adversely impact our business and financial condition. Because our data centers are critical to our customers’ businesses, service interruptions or significant equipment damage in our data centers also could result in lost profits or other indirect or consequential damages to our customers. We cannot guarantee that a court would enforce any contractual limitations on our liability in the event that a customer brings a lawsuit against us as the result of a problem at one of our data centers.

Any loss of services, equipment damage or inability to meet performance obligations in our SLAs could reduce the confidence of our customers and could result in lost customers or an inability to attract new customers, which would adversely affect both our ability to generate revenues and our operating results.

Furthermore, we are dependent upon ISPs and telecommunications carriers in the U.S., Europe and Asia-Pacific region, some of whom have experienced significant system failures and electrical outages in the past. Users of our services may experience difficulties due to system failures unrelated to our systems and services. If, for any reason, these providers fail to provide the required services, our business, consolidated financial condition, results of operations and cash flows could be materially adversely impacted.

Our business operations depend on contracts with vendors and suppliers who may not meet their contractual obligations.

Tracking, monitoring and managing our contracts and vendor relationships is critical to our business operations; however, we have limited control over the vendors’ performance of these contracts. Even if these contracts contain terms favorable to us in the event of a breach, there is no guarantee the damages due us under the contract would cover the losses suffered or would even be paid. Also, each contract contains specific terms and conditions that may change over time based on contract expiration, assignment, assumption or renegotiation. There is no guarantee that these changes would be favorable to us, and to the event they were not, our operations could be materially impacted.
 
- 10 -
 

 

 
These contracts may contain provisions that result in favorable or non-favorable impacts on us depending on actions taken, or not taken. While we would normally pursue all contractual provisions favorable to our business, the appropriate actions under a particular contract may require estimates, judgments and assumptions to be made concerning future events for which we have limited basis for estimation. We cannot guarantee that we will take the appropriate action under a particular contract to maximize the benefit to us, which could have a material adverse impact on operations.

In addition, we license intellectual property rights from third-party owners. If such owners do not properly maintain or enforce the intellectual property underlying such licenses, our competitive position and business prospects could be harmed. Our licensors may fail to maintain these patents or intellectual property registrations, may determine not to pursue litigation against other companies that are infringing these patents or intellectual property registrations or may pursue such litigation less aggressively than we would.

Our inability to renew our data center leases, or renew on favorable terms, and potential unknown costs related to asset retirement obligations could negatively impact our financial results.

Generally, our company-controlled data center leases provide us with the opportunity to renew the leases at our option for periods typically ranging from five to 10 years. Many of these options however, if renewed, provide that rent for the renewal period will be the fair market rental rate at the time of renewal. If the fair market rental rates are significantly higher than our current rental rates, we may be unable to offset these costs by charging more for our services, which could have a negative impact on our financial results. Conversely, if rental rates drop significantly in the near term, we would not be able to take advantage of the drop in rates until the expiration of the lease as we would be bound by the terms of the existing lease.

For the leases that do not contain renewal options, or for which the option to renew has been exhausted or passed, we cannot guarantee the lessor will renew the lease, or will do so at a rate that will allow us to maintain profitability on that particular space. While we proactively monitor these leases, and conduct on-going negotiations with lessors, our ability to renegotiate renewals is inherently limited by the original contract language, including option renewal clauses. If we are unable to renew, we may incur substantial costs to move our infrastructure and/or customers and to restore the property to its required condition, there is no guarantee that our customers will move with us and we may not be able to find appropriate and sufficient space. The occurrence of any of these events could adversely impact our business, financial condition, results of operations and cash flows.

In addition, we have capital lease agreements that require us to decommission the physical space for which we have not yet recorded an asset retirement obligation (“ARO”). Due to the uncertainty of specific decommissioning obligations, timing and related costs, an ARO is not reasonably estimable for these properties and we have not recorded a liability at this time for such properties.

A failure in the redundancies in one or more of our NOCs, P-NAPs or computer systems could cause a significant disruption in Internet connectivity which could impact our ability to serve our customers.

While we maintain multiple layers of redundancy in our operating facilities, if we experience a problem at one or more of our NOCs, including the failure of redundant systems, we may be unable to provide Internet connectivity services to our customers, provide customer service and support or monitor our network infrastructure or P-NAPs, any of which would seriously harm our business and operating results. Also, because we are obligated to provide continuous Internet availability under our SLAs, we may be required to issue a significant amount of service credits as a result of such interruptions in service. These credits could negatively affect our revenues and results of operations. In addition, interruptions in service to our customers could potentially harm our customer relations, expose us to potential lawsuits or necessitate additional capital expenditures.

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

Our business could be harmed by prolonged electrical power outages or shortages, increased costs of energy or general availability of electrical resources.

Our IT infrastructure services are susceptible to regional costs and supply of power, electrical power shortages, planned or unplanned power outages and availability of adequate power resources. Power outages could harm our customers and our business. While we attempt to limit exposure to system downtime by using backup generators, uninterruptible power systems and other redundancies, we may not be able to limit our exposure entirely. Even with these protections in place we have experienced power outages in the past and may in the future. In addition, our energy costs have increased and may continue to increase for a variety of reasons including increased pressure on legislators to pass green legislation. As energy costs increase, we may not be able to pass on to our customers the increased cost of energy, which could harm our business and operating results.
 
- 11 -
 

 

 
In each of our markets, we rely on utility companies to provide a sufficient amount of power for current and future customers. We cannot ensure that these third parties will deliver such power in adequate quantities or on a consistent basis. At the same time, power and cooling requirements are growing on a per-unit basis. As a result, some customers are consuming an increasing amount of power per square foot of space utilized. Inability to increase power capacity to meet increased customer demands would limit our ability to grow our business, which could have a negative impact on our relationships with our customers and our consolidated financial condition, results of operations and cash flows.

Our network and software are subject to potential security breaches and similar threats that could result in liability and harm our reputation.

A number of widespread and disabling attacks on public and private networks have occurred. The number and severity of these attacks may increase in the future as network assailants take advantage of outdated software, security breaches or incompatibility between or among networks. Computer viruses, intrusions and similar disruptive problems could cause us to be liable for damages under agreements with our customers and fines and penalties to governmental or regulatory agencies, and our reputation could suffer, thereby resulting in a loss of current customers and deterring potential customers from working with us. Security problems or other attacks caused by third parties could lead to interruptions and delays or to the cessation of service to our customers. Furthermore, inappropriate use of the network by third parties could also jeopardize the security of confidential information stored in our computer systems and in those of our customers and could expose us to liability under unsolicited commercial e-mail, or “spam,” regulations. In the past, third parties have occasionally circumvented some of these industry-standard measures. We can offer no assurance that the measures we implement will not be circumvented. Our efforts to eliminate computer viruses and alleviate other security problems, or any circumvention of those efforts, may result in increased costs, interruptions, delays or cessation of service to our customers and negatively impact hosted customers’ on-line business transactions. Affected customers might file claims against us under such circumstances, and our insurance may not be available or adequate to cover these claims.

The increased use of high-power density equipment may limit our ability to fully utilize our data centers.

Customers continue to increase their use of high-power density equipment, which has significantly increased the demand for power. The current demand for electrical power may exceed our designed capacity in certain facilities. As electrical power, rather than space, is typically the primary factor limiting capacity in our data centers, our ability to fully utilize our data centers may be limited in these facilities. If we are unable to adequately utilize our data centers, our ability to grow our business cost-effectively could be materially and adversely affected.

Our business requires the continued development of effective and efficient business support systems to support our customer growth and related services.

The growth of our business depends on our ability to continue to develop and successfully implement effective and efficient business support policies, processes and internal systems. This is a complicated undertaking requiring significant resources and expertise. Business support systems are needed for:

 
sourcing, evaluating and targeting potential customers and managing existing customers;
 
implementing customer orders for services;
 
delivering these services;
 
timely billing for these services;
 
budgeting, forecasting, tracking and reporting our results of operations; and
 
providing technical and operational support to customers and tracking the resolution of customer issues.

If the number of customers that we serve or our services portfolio increases, we may need to develop additional business support systems on a schedule sufficient to meet proposed service rollout dates. The failure to continue to develop effective and efficient business support systems, and update or optimize these systems to a level commensurate with the needs of our business and/or our competition, could harm our ability to implement our business plans, maintain competitiveness and meet our financial goals and objectives.

We depend upon our key employees and may be unable to attract or retain sufficient numbers of qualified personnel.

Our future performance depends upon the continued contributions of our executive management team and other key employees. To the extent we are able to expand our operations, we may need to increase our workforce. Accordingly, our future success depends on our ability to attract, hire, train, retain and motivate highly skilled management, technical, sales, research and development, marketing and customer support personnel. Competition for qualified employees is intense, and we compete for qualified employees with companies that may have greater financial resources than we have. We may not be successful in attracting, hiring and retaining the people we need, which would seriously impede our ability to implement our business strategy.
 
- 12 -
 

 

 
Additionally, changes in our senior management team during the past several years, both through voluntary and involuntary separation, have resulted in loss of valuable company intellectual capital and in paying significant severance and hiring costs. With reduced staffing, or staffing new to the organization, we may not be able to maintain an adequate separation of duties in key areas of monitoring, oversight and review functions and may not have adequate succession plans in place to mitigate the impact of future personnel losses. If we continue to experience similar levels of turnover in our senior management team, the execution of our corporate strategy could be affected and the costs and effects of such changes could negatively impact our operations.

Our global operations may not be successful.

We have limited experience operating globally and have only recently begun to achieve some success in our global operations. We currently have locations in Amsterdam, Frankfurt, Hong Kong, London, Montreal, Paris, Singapore, Sydney and Toronto. We also participate in a joint venture with NTT-ME Corporation and NTT Holdings, which operates network access points in Tokyo and Osaka, Japan. We may develop or acquire P-NAPs or complementary businesses in additional global markets. The risks associated with expansion of our global business operations include:

 
challenges in establishing and maintaining relationships with global customers, ISPs and local vendors, including data center and local network operators;
 
challenges in staffing and managing NOCs and P-NAPs across disparate geographic areas;
 
potential loss of proprietary information due to misappropriation or laws that may be less protective of our intellectual property rights than the laws in the U.S.;
 
challenges in reducing operating expense or other costs required by local laws and longer accounts receivable payment cycles and difficulties in collecting accounts receivable;
 
exposure to fluctuations in international currency exchange rates;
 
costs of customizing P-NAPs for foreign countries and customers; and
 
compliance with requirements of foreign laws, regulations and other governmental controls, including trade and labor restrictions and related laws that may reduce the flexibility of our business operations or favor local competition.

We may be unsuccessful in our efforts to address the risks associated with our global operations, which may limit our sales growth and materially and adversely affect our business and results of operations.

We may acquire other businesses, and these acquisitions involve integration and other risks that could harm our business.

We may pursue additional acquisitions of complementary businesses, products, services and technologies to expand our geographic footprint, enhance our existing services, expand our service offerings or enlarge our customer base. If we complete future acquisitions, we may be required to incur or assume additional debt, make capital expenditures or issue additional shares of our common stock or securities convertible into our common stock as consideration, which would dilute our existing stockholders’ ownership interest and may adversely affect our results of operations. If we fail to identify and acquire needed companies or assets, if we acquire the wrong companies or assets, if we fail to address the risks associated with integrating an acquired company or if we do not successfully integrate an acquired company, we would not be able to effectively manage our growth through acquisitions which could adversely affect our results.

In this regard, our acquisition of iWeb in late 2013 may not provide all of the benefits we anticipate and we may not be successful in our integration of iWeb, either of which could negatively impact our business.

Risks Related to our Capital Stock and Other Business Risks

We have a history of losses and may not sustain profitability.

For the years ended December 31, 2014, 2013 and 2012, we incurred net losses of $39.5 million, $19.8 million and $4.3 million, respectively. At December 31, 2014, our accumulated deficit was $1.1 billion. Given the competitive and evolving nature of the industry in which we operate, we may not be able to achieve or sustain profitability, and our failure to do so could materially and adversely affect our business, including our ability to raise additional funds.

Failure to sustain our revenues will cause our business and financial results to suffer.

We have considerable fixed expenses, and we expect to continue to incur significant expenses, particularly with the expansion of our data center facilities. We incur a substantial portion of these expenditures upfront, and are only able to recover these costs over time. Therefore, we must at least sustain revenues to maintain profitability.
 
- 13 -
 

 

 
Numerous factors could affect our ability to sustain revenue, either alone or in combination with other factors, including:

 
failure to sustain sales of our services;
 
pricing pressures;
 
significant increases in cost of goods sold or other operating expenses;
 
failure of our services to operate as expected;
 
loss of customers or inability to attract new customers or loss of existing customers at a rate greater than our increase in new customers;
 
customers’ failure to pay on a timely basis or at all or failure to continue to purchase our IT infrastructure services in accordance with their contractual commitments; or
 
network failures and any breach or unauthorized access to our network.

Our results of operations have fluctuated in the past and likely will continue to fluctuate, which could negatively impact the price of our common stock.

We have experienced fluctuations in our results of operations on a quarterly and annual basis. Fluctuation in our operating results may cause the market price of our common stock to decline. We expect to experience continued fluctuations in our operating results in the foreseeable future due to a variety of factors, including:

 
competition and the introduction of new services by our competitors;
 
continued pricing pressures;
 
fluctuations in the demand and sales cycle for our services;
 
fluctuations in the market for qualified sales and other personnel;
 
the cost and availability of adequate public utilities, including power;
 
our ability to obtain local loop connections to our P-NAPs at favorable prices;
 
general economic conditions; and
 
any impairments or restructurings charges that we may incur in the future.

In addition, fluctuations in our results of operations may arise from strategic decisions we have made or may make with respect to the timing and magnitude of capital expenditures such as those associated with the expansion of our data center facilities, the deployment of additional P-NAPs, the terms of our network connectivity purchase agreements and the cost of servers, storage and other equipment necessary to deploy hosting and cloud services. A relatively large portion of our expenses are fixed in the short-term, particularly with respect to lease and personnel expense, depreciation and amortization and interest expense. Our results of operations, therefore, are particularly sensitive to fluctuations in revenue. We can offer no assurance that the results of any particular period are an indication of future performance in our business operations. Fluctuations in our results of operations could have a negative impact on our ability to raise additional capital and execute our business plan.

We may incur additional goodwill and other intangible asset impairment charges, restructuring charges or both.

The assumptions, inputs and judgments used in performing the valuation analysis and assessments of goodwill and other intangible assets are inherently subjective and reflect estimates based on known facts and circumstances at the time the valuation is performed. The use of different assumptions, inputs and judgments or changes in circumstances could materially affect the results of the valuation and assessments. Due to the inherent uncertainty involved in making these estimates, actual results could differ from our estimates.

When circumstances warrant, we may elect to exit certain business activities or change the manner in which we conduct ongoing operations. When we make such a change, we will estimate the costs to exit a business or restructure ongoing operations. The components of the estimates may include estimates and assumptions regarding the timing and costs of future events and activities that represent our best expectations based on known facts and circumstances at the time of estimation. Should circumstances warrant, we will adjust our previous estimates to reflect what we then believe to be a more accurate representation of expected future costs. Because our estimates and assumptions regarding impairment and restructuring charges include probabilities of future events, such as expected operating results, future economic conditions, the ability to find a sublease tenant within a reasonable period of time or the rate at which a sublease tenant will pay for the available space, such estimates are inherently vulnerable to changes due to unforeseen circumstances that could materially and adversely affect our results of operations. Adverse changes in any of these factors could result in an additional impairment and restructuring charges in the future.
 
- 14 -
 

 

 
Our stock price may be volatile.

The market for our equity securities has been extremely volatile. Our stock price could suffer in the future as a result of any failure to meet the expectations of public market analysts and investors about our results of operations from quarter to quarter. The following factors could cause the price of our common stock in the public market to fluctuate significantly:

 
actual or anticipated variations in our quarterly and annual results of operations;
 
changes in market valuations of companies in the industries in which we may compete;
 
changes in expectations of future financial performance or changes in estimates of securities analysts;
 
fluctuations in stock market prices and volumes;
 
future issuances of common stock or other securities;
 
the addition or departure of key personnel; and
 
announcements by us or our competitors of acquisitions, investments or strategic alliances.

Our stockholders may experience significant dilution, which could depress the market price of our common stock.

Holders of our stock options may exercise those options to purchase our common stock, which would increase the number of shares of our common stock that are outstanding in the future. As of December 31, 2014, options to purchase an aggregate of 5.9 million shares of our common stock at a weighted average exercise price of $7.07 were outstanding. Also, the vesting of 0.8 million outstanding shares of restricted stock will increase the weighted average number of shares used for calculating diluted net loss per share. Greater than expected capital requirements could require us to obtain additional financing through the issuance of securities, which could be in the form of common stock or preferred stock or other securities having greater rights than our common stock. The issuance of our common stock or other securities, whether upon the exercise of options, the future vesting and issuance of stock awards to our executives and employees, in financing transactions or otherwise, could depress the market price of our common stock by increasing the number of shares of common stock or other securities outstanding on an absolute basis or as a result of the timing of additional shares of common stock becoming available on the market.

Our existing credit agreement places certain limitations on us.

Our existing credit agreement requires us to meet certain financial covenants related to maximum total leverage ratio, minimum consolidated interest coverage ratio and limitation on capital expenditures, as well as negative and reporting covenants. In addition, these covenants create liens on a majority our assets. If we do not satisfy these covenants, we would be in default under the credit agreement. Any defaults, if not waived, could result in our lenders ceasing to make loans or extending credit to us, accelerating or declaring all or any obligations immediately due or taking possession of or liquidating collateral. If any of these events occur, we may not be able to borrow sufficient funds to refinance the credit agreement on terms that are acceptable to us, or at all, which could materially and adversely impact our business, consolidated financial condition, results of operations and cash flows. Finally, our ability to access the capital markets may be limited at a time when we would like or need to do so, which could have an impact on our flexibility to pursue expansion opportunities and maintain our desired level of revenue growth in the future.

Any failure to meet our debt obligations and other long-term commitments would damage our business.

As of December 31, 2014, our total debt, including capital leases, was $367.1 million. If we use more cash than we generate in the future, our level of indebtedness could adversely affect our future operations by increasing our vulnerability to adverse changes in general economic and industry conditions and by limiting or prohibiting our ability to obtain additional financing for future capital expenditures, acquisitions and general corporate and other purposes. In addition, if we are unable to make interest or principal payments when due, we would be in default under the terms of our long-term debt obligations, which would result in all principal and interest becoming due and payable which, in turn, would seriously harm our business.

We also have other long-term commitments for operating leases and service and purchase contracts totaling $130.5 million in the future with a minimum of $43.3 million payable in 2015. If we are unable to make payments when due, we would be in breach of contractual terms of the agreements, which may result in disruptions of our services which, in turn, would seriously harm our business.

Our ability to use U.S. net operating loss carryforwards might be limited.

As of December 31, 2014, we had net operating loss carryforwards of $208.8 million for U.S. federal tax purposes. These loss carryforwards expire between 2018 and 2034. To the extent these net operating loss carryforwards are available, we intend to use them to reduce the corporate income tax liability associated with our operations. Section 382 of the U.S. Internal Revenue Code generally imposes an annual limitation on the amount of net operating loss carryforwards that might be used to offset taxable income when a corporation has undergone significant changes in stock ownership. To the extent our use of net operating loss carryforwards is significantly limited, our income could be subject to corporate income tax earlier than it would if we were able to use net operating loss carryforwards, which could result in lower profits.
 
- 15 -
 

 

 
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, trademark, trade secret and other intellectual property law, nondisclosure agreements and other protective measures to protect our proprietary rights. We also utilize unpatented proprietary know-how and trade secrets and employ various methods to protect such intellectual property. We believe our intellectual property rights are significant and that the loss of all or a substantial portion of such rights could have a material adverse impact on our results of operations. We can offer no assurance that the steps we have taken to protect our intellectual property will be sufficient to prevent misappropriation of our technology, or that our trade secrets will not become known or be independently discovered by competitors. In addition, the laws of many foreign countries do not protect our intellectual property to the same extent as the laws of the U.S. From time-to-time, third parties have or may assert infringement claims against us or against our customers in connection with their use of our products or services.

In addition, we rely on the intellectual property of others. We may desire or be required to renew or to obtain licenses from these other parties to further develop and market commercially-viable products or services effectively. We can offer no assurance that any necessary licenses will be available on reasonable terms, or at all.

Changes to conform to new accounting principles and/or financial regulation may be costly and disrupt our current planning, analysis and reporting processes.

Accounting oversight bodies in the U.S. and internationally are actively contemplating and enacting a number of new accounting regulations. To comply with these changes, we may need to incur a significant amount of time and resources to adapt personnel, processes, reporting and systems. The newly issued guidance under generally accepted accounting principles in the U.S. (“GAAP”) provides a single model for revenue arising from contracts with customers and supersedes current revenue recognition guidance and, while still under our review, could significantly change our results of operations and related disclosures. Likewise, changes proposed to current lease accounting guidance under GAAP would require reclassification of most of our operating leases to capital lease treatment and would significantly change the nature of our balance sheet.

In addition, laws relating to public company governance practices, such as the Dodd-Frank Act Wall Street Reform and Consumer Protection Act which is being implemented over time, have modified existing corporate governance practices and potentially increase liability related to stockholder actions, whistleblower claims and governmental enforcement actions.

While we have implemented internal practices to proactively review, assess and adapt to constantly changing regulations, we cannot predict with certainty the impact, if any, that future regulation or regulatory changes may have on our business or the potential costs we may incur related to compliance with new laws and regulations.

We may face litigation and liability due to claims of infringement of third-party intellectual property rights and due to our customers’ use of our IT infrastructure services.

The IT infrastructure services industry is characterized by the existence of a large number of patents and frequent litigation based on allegations of patent infringement. From time-to-time, third parties may assert patent, copyright, trademark, trade secret and other intellectual property rights to technologies that are important to our business. Any claims that our IT infrastructure 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 impact our operating results. In addition, our customer agreements generally require us to indemnify our customers for expenses and liabilities resulting from claimed infringement of patents or copyrights of third parties, subject to certain limitations. If an infringement claim against us were to be successful, and we were not able to obtain a license to the relevant technology or a substitute technology on acceptable terms or redesign our services or products to avoid infringement, our ability to compete successfully in our market would be materially impaired.

In addition, our customers use our IT infrastructure services to operate and run certain aspects and functions of their businesses. From time-to-time, third parties may assert that our customers’ businesses, including the business aspects and functions for which they use our IT infrastructure services, infringe patent, copyright, trademark, trade secret or other intellectual property or legal rights. Our customers’ businesses may also be subject to regulatory oversight, governmental investigation, data breaches and lawsuits by their customers, competitors or other third parties based on a broad range of legal theories. Such third parties may seek to hold us liable on the basis of contributory or vicarious liability or other legal theories. Any such claims, 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 impact our operating results. If any such claim against us were to be successful, damages could be significant and our ability to compete successfully in our market would be materially impaired.

We do not expect to pay dividends on our common stock, and investors would only be able to receive cash in respect of the shares of common stock upon the sale of their shares.

We have no intention in the foreseeable future to pay any cash dividends on our common stock, and the covenants in our credit agreement limit our ability to pay dividends. Therefore, an investor in our common stock may obtain an economic benefit from the common stock only after an increase in its trading price and only by selling the common stock.
 
- 16 -
 

 

 
Provisions of our charter documents and Delaware law may have anti-takeover effects that could prevent a change in control even if the change in control would be beneficial to our stockholders.

Provisions of our Certificate of Incorporation and Bylaws, and provisions of Delaware law, could discourage, delay or prevent a merger, acquisition or other change in control of our company. These provisions are intended to protect stockholders’ interests by providing our board of directors a means to attempt to deny coercive takeover attempts or to negotiate with a potential acquirer in order to obtain more favorable terms. Such provisions include a board of directors that is classified so that only one-third of directors stand for election each year. These provisions could also discourage proxy contests and make it more difficult for stockholders to elect directors and take other corporate actions.

 
None.
 
 
Our principal executive offices are located in Atlanta, Georgia. Our Atlanta headquarters consists of 62,000 square feet under a lease, with renewal options, that expires in 2019.
 
Leased data center facilities in our top markets include Atlanta, Boston, Dallas, Houston, Los Angeles, Montreal, New York metro area, Northern California and Seattle. We believe our existing facilities 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.
 
 
We are subject to legal proceedings, claims and litigation arising in the ordinary course of business. Although the outcome of these matters is currently not determinable, we do not expect that the ultimate costs to resolve these matters will have a material adverse impact on our financial condition, results of operations or cash flows.
 
 
Not applicable.
 
 
 
Our common stock is listed on the NASDAQ Global Market under the symbol “INAP.” The following table presents, for the periods indicated, the range of high and low per share sales prices of our common stock, as reported on the NASDAQ Global Market. Our fiscal year ends on December 31.
               
Year Ended December 31, 2014:
   
High
 
Low
 
Fourth Quarter
 
$
8.35
 
$
6.52
 
Third Quarter
   
7.39
   
6.27
 
Second Quarter
   
7.68
   
6.35
 
First Quarter
   
8.50
   
6.89
 
               
Year Ended December 31, 2013:
   
High
 
Low
 
Fourth Quarter
 
$
7.75
 
$
6.51
 
Third Quarter
   
9.10
   
6.66
 
Second Quarter
   
9.47
   
7.82
 
First Quarter
   
9.60
   
6.80
 

As of February 2, 2015, we had approximately 600 stockholders of record of our common stock.
 
We have never declared or paid any cash dividends on our capital stock, and we do not anticipate paying cash dividends in the foreseeable future. We are prohibited from paying cash dividends under covenants contained in our credit agreement. We currently intend to retain our earnings, if any, for future growth. Future dividends on our common stock, if any, will be at the discretion of our board of directors and will depend on, among other things, our operations, capital requirements and surplus, general financial condition, contractual restrictions and such other factors as our board of directors may deem relevant.
 
- 17 -
 

 

The following table provides information regarding our current equity compensation plans as of December 31, 2014 (shares in thousands):
 
Equity Compensation Plan Information
 
Plan category
  Number of
securities
to be issued upon
exercise of
outstanding
options,
warrants and
rights
(a)
    Weighted-average
exercise price of
outstanding options,
warrants and rights
(b)
    Number of
securities

remaining
available
for future issuance
under equity
compensation
plans (excluding
securities reflected
in column (a))
(c)
 
Equity compensation plans approved by security holders(1)
    5,928     $ 7.07       4,232  
Equity compensation plans not approved by security holders
                 
Total
    5,928     $ 7.07       4,232  
 

(1)
Employees Consists of: 4,435,420 shares under the 2014 Stock Incentive Plan; 5,566,945 shares under the 2005 Incentive Stock Plan as amended; 35,389 shares under the 2000 Non-Officer Equity Incentive Plan and 122,080 shares under the 1999 Non-Employee Directors’ Stock Option Plan. We may only issue equity under the 2014 Stock Incentive Plan. Each plan listed above contains customary anti-dilution provisions that are applicable in the event of a stock split or certain other changes in our capitalization.

We have no publicly announced plans or programs for the repurchase of securities.

On May 31, 2014, we issued 80,580 shares of common stock to our non-employee directors under the 2014 Stock Incentive Plan. We relied on the exemption set forth under Section 4(a)(2) of the Securities Act. 
 
ISSUER PURCHASES OF EQUITY SECURITIES
 
The following table sets forth information regarding our repurchases of securities for each calendar month in the quarter ended December 31, 2014:
 
Period
    Total Number of
Shares

Purchased(1)
      Average Price
Paid

per Share
   
Total Number of
Shares
Purchased as
Part
of Publicly
Announced Plans
or Programs
      Maximum Number
(or Approximate
Dollar Value) of
Shares that
May Yet Be
Purchased Under
the
Plans or Programs
 
October 1 to 31, 2014
    2,010     $ 6.91              
November 1 to 30, 2014
    967       8.04              
December 1 to 31, 2014
    57,139       7.75              
Total
    60,116     $ 7.73              
 

(1)
Employees surrendered these shares to us as payment of statutory minimum payroll taxes due in connection with the vesting of restricted stock.
 
- 18 -
 

 

 
ITEM 6. SELECTED FINANCIAL DATA
 
We have derived the selected financial data shown below from our audited consolidated financial statements. You should read the following in conjunction with the accompanying consolidated financial statements and related notes contained and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in this Annual Report on Form 10-K.
                               
   
Year Ended December 31,
 
   
2014
   
2013(1)
   
2012
   
2011(2)
   
2010
 
(in thousands, except per share data)
                             
Consolidated Statements of Operations and Comprehensive Loss Data:
                             
Revenues
  $ 334,959     $ 283,342     $ 273,592     $ 244,628     $ 244,164  
Operating costs and expenses:
                                       
Direct costs of network, sales and services, exclusive of depreciation and amortization, shown below
    144,946       132,012       130,954       120,310       127,423  
Direct costs of customer support
    36,804       29,687       26,664       21,278       19,861  
Direct costs of amortization of acquired and developed technologies
    5,918       4,967       4,718       3,500       3,811  
Sales and marketing
    37,845       31,800       31,343       29,715       29,232  
General and administrative
    43,902       42,759       38,635       33,952       33,048  
Depreciation and amortization
    75,251       48,181       36,147       36,926       30,158  
Loss (gain) on disposals of property and equipment, net
    112       9       (55 )     37       116  
Exit activities, restructuring and impairments
    4,520       1,414       1,422       2,833       1,411  
Total operating costs and expenses
    349,298       290,829       269,828       248,551       245,060  
(Loss) income from operations
    (14,339 )     (7,487 )     3,764       (3,923 )     (896 )
Non-operating expenses
    26,775       12,841       7,849       3,866       2,170  
Loss before income taxes and equity in (earnings) of equity-method investment
    (41,114 )     (20,328 )     (4,085 )     (7,789 )     (3,066 )
(Benefit) provision for income taxes
    (1,361 )     (285 )     453       (5,612 )     952  
Equity in (earnings) of equity-method investment, net of taxes
    (259 )     (213 )     (220 )     (475 )     (396 )
Net loss
  $ (39,494 )   $ (19,830 )   $ (4,318 )   $ (1,702 )   $ (3,622 )
                                         
Net loss per share:
                                       
Basic and diluted
  $ (0.77 )   $ (0.39 )   $ (0.09 )   $ (0.03 )   $ (0.07 )

    December 31,  
   
2014
   
2013(1)
   
2012
   
2011(2)
   
2010
 
Consolidated Balance Sheets Data:
                             
Cash and cash equivalents
  $ 20,084     $ 35,018     $ 28,553     $ 29,772     $ 59,582  
Total assets
    591,784       614,241       400,712       356,710       293,142  
Credit facilities, due after one year, and capital lease obligations, less current portion
    356,686       346,800       136,555       94,673       37,889  
Total stockholders’ equity
    150,336       182,210       195,605       192,170       188,611  

    Year Ended December 31,  
   
2014
   
2013
   
2012
   
2011
   
2010
 
Other Financial Data:
                             
Capital expenditures, net of equipment sale-leaseback transactions
  $ 77,408     $ 62,798     $ 74,947     $ 68,542     $ 62,184  
Net cash flows provided by operating activities
    53,248       33,683       43,742       28,630       39,602  
Net cash flows used in investing activities
    (75,727 )     (208,086 )     (79,697 )     (96,265 )     (55,184 )
Net cash flows provided by financing activities
    7,924       180,810       34,571       37,901       1,224  


 (1)
On November 26, 2013, we completed our acquisition of iWeb. We allocated the purchase price to iWeb’s net tangible and intangible assets based on their estimated fair values as of November 26, 2013. We recorded the excess purchase price over the value of the net tangible and identifiable intangible assets as goodwill.
(2)
On December 30, 2011, we completed our acquisition of Voxel Holdings, Inc. (“Voxel”). We allocated the purchase price to Voxel’s net tangible and intangible assets based on their estimated fair values as of December 30, 2011. We recorded the excess purchase price over the value of the net tangible and identifiable intangible assets as goodwill. In addition, as a result of our purchase price accounting, our net loss was reduced by a $6.1 million deferred tax benefit that offset our existing income tax expense of $0.5 million.
 
- 19 -
 

 

 
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
The following discussion should be read in conjunction with the accompanying consolidated financial statements and notes provided under Part II, Item 8 of this Annual Report on Form 10-K.
 
2014 Financial Highlights and Outlook
 

Business Performance

 

We continued to focus on profitable growth in 2014 through three primary initiatives: enhancing margin through new product offerings and product mix shift; expanding capacity to support growth; and extending our routes to market via online, e-commerce channels.

 

Enhancing Margin

 

We continued our efforts to shift our product mix to the more profitable parts of our business, specifically core data center services, which includes company-controlled colocation, hosting and cloud services, including revenues attributable to iWeb, as well as increasing the average revenue per customer through new product offerings, including hybridized solutions. Shifting our product mix to higher margin core data center services allows us to more efficiently utilize our company-controlled data center space and increase the revenue per square foot of occupied space. Additionally, we believe our ability to increase average revenue per customer is indicative of not only the trend toward companies outsourcing their IT services, but also reflective of our ability to capture a larger proportion of the enterprise customers spend for high performance IT infrastructure services.

 

Total revenue increased 18% to $335.0 million for the year ended December 31, 2014, compared to $283.3 million for the same period in 2013. Core data center services revenue increased 46% to $195.4 million for the year ended December 31, 2014, compared to $134.0 million for the same period in 2013. Core data center services revenue represents 81% of data center services segment revenue and 58% of total revenue for the year ended December 31, 2014, compared to 72% and 47%, respectively, for the same period in 2013. 

 

Adjusted earnings before interest, taxes, depreciation and amortization (“EBITDA”) margin, a non-GAAP performance measure, increased 300 basis points to 23.5% for the year ended December 31, 2014, compared to 20.5% for the same period in 2013. We calculate adjusted EBITDA margin as adjusted EBITDA, defined below in “—Non-GAAP Financial Measure,” as a percentage of revenues. We will continue to focus on enhancing margin in 2015 through product mix shift, hybridized product offerings and other efficiency initiatives.

 

Expanding Capacity

 

Our services are dependent on premium data center space with sufficient power. We will continue our focus on efficiently utilizing our existing space and power and investing in additional company-controlled space and power to support our growth. During 2014, we spent $77.4 million on capital expenditures to upgrade existing space and power, procure new space and power, procure hardware and software and make other investments to grow our business.

 

At December 31, 2014, we had approximately 284,000 net sellable square feet of data center space with a utilization rate of 60%, compared to approximately 292,000 net sellable square feet of data center space with a utilization rate of 60% at December 31, 2013. At December 31, 2014 and 2013, 80% and 79%, respectively, of our total net sellable square feet were in company-controlled data centers versus 20% and 21%, respectively, in partner sites.

 

Our services also depend on procurement of bandwidth from our underlying network service providers to meet our current and future needs. During 2014, overall bandwidth traffic increased approximately 55% compared to 2013, calculated based on an average over the number of months in the respective periods.

 

Extending our Routes to Market

 

Our strategy is to leverage the benefits of multiple routes to market, including online e-commerce, direct sales and channel sales programs. Historically, we have relied largely on a direct enterprise sales route to market. More recently, we have augmented our direct enterprise sales route to market with investment in our channel sales program selling into the same target enterprise customer base. Additionally, as we see our target customers become increasingly comfortable procuring IT infrastructure services online, we are leveraging our product portfolio through an expansion of our online e-commerce route to market. During 2014, we expanded our online e-commerce route to market and increased sales delivered through this route to roughly 25% of sales from roughly 5% in 2013, primarily through our acquisition of iWeb in December 2013. This route-to-market capability includes extensive inbound/outbound digital marketing, multi-lingual sales, campaign management and customer support skill sets. We believe there is a significant opportunity to leverage our online e-commerce route to market capabilities to sell IT infrastructure services across our global footprint to an increasingly international customer base. We seek to leverage diverse routes to market across a common platform of IT infrastructure services and maximize the opportunity for profitable growth while simultaneously minimizing the risk of incremental capital investment.


Non-GAAP Financial Measures
 
We report our consolidated financial statements in accordance with GAAP. We present the non-GAAP performance measures of adjusted EBITDA and adjusted EBITDA margin, discussed above in “—2014 Financial Highlights and Outlook,” to assist us in explaining underlying performance trends in our business, which we believe will enhance investors’ ability to analyze trends in our business and evaluate our performance relative to other companies. We define adjusted EBITDA as (loss) income from operations plus depreciation and amortization, loss (gain) on disposals of property and equipment, exit activities, restructuring and impairments, stock-based compensation and acquisition costs.

As a non-GAAP financial measure, adjusted EBITDA should not be considered in isolation of, or as a substitute for, net loss or other GAAP measures as an indicator of operating performance. In addition, adjusted EBITDA should not be considered as an alternative to income from operations or net loss as a measure of operating performance. Our calculation of adjusted EBITDA may differ from others in our industry and is not necessarily comparable with similar titles used by other companies.
 
The following table reconciles adjusted EBITDA to (loss) income from operations as presented in our consolidated statements of operations and comprehensive loss:
                   
   
Year Ended December 31,
 
   
2014
   
2013
   
2012
 
(Loss) income from operations
  $ (14,339 )   $ (7,487 )   $ 3,764  
Depreciation and amortization, including amortization of acquired and developed technologies
    81,169       53,148       40,865  
Loss (gain) on disposals of property and equipment, net
    112       9       (55 )
Exit activities, restructuring and impairments
    4,520       1,414       1,422  
Stock-based compensation
    7,182       6,743       5,858  
Acquisition costs
    85       4,210        
Adjusted EBITDA
  $ 78,729     $ 58,037     $ 51,854  
 
- 20 -
 

 

 
Critical Accounting Policies and Estimates
 
This discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which we have prepared in accordance with GAAP. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expense and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those summarized below. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances; the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ materially from these estimates.
 
In addition to our significant accounting policies summarized in note 2 to our accompanying consolidated financial statements, we believe the following policies are the most sensitive to judgments and estimates in the preparation of our consolidated financial statements.
 
Revenue Recognition
 
We generate revenues primarily from the sale of data center services, including colocation, hosting and cloud, and IP services. Our revenues typically consist of monthly recurring revenues from contracts with terms of one year or more and we typically recognize the monthly minimum as revenue each month. We record installation fees as deferred revenue and recognize the revenue ratably over the estimated customer life, which was approximately six years for 2014 and 2013 and five years for 2012.
 
For multiple-deliverable revenue arrangements we allocate arrangement consideration at the inception of an arrangement to all deliverables using the relative selling price method. The hierarchy for determining the selling price of a deliverable includes (a) vendor-specific objective evidence, if available, (b) third-party evidence, if vendor-specific objective evidence is not available and (c) best estimated selling price, if neither vendor-specific nor third-party evidence is available.
 
We determine third-party evidence based on the prices charged by our competitors for a similar deliverable when sold separately. Our determination of best estimated selling price involves a weighting of several factors including, but not limited to, pricing practices and market conditions. We analyze the selling prices used in our allocation of arrangement consideration on an annual basis at a minimum.
 
We account for each deliverable within a multiple-deliverable revenue arrangement as a separate unit of accounting if both of the following criteria are met: (a) the delivered item or items have value to the customer on a standalone basis and (b) for an arrangement that includes a general right of return relative to the delivered item(s), we consider delivery or performance of the undelivered item(s) probable and substantially in our control. We consider a deliverable to have standalone value if we sell this item separately or if the item is sold by another vendor or could be resold by the customer. Further, our revenue arrangements generally do not include a right of return for delivered services. We combine deliverables not meeting the criteria for being a separate unit of accounting with a deliverable that does meet that criterion. We then determine the appropriate allocation of arrangement consideration and recognition of revenue for the combined unit of accounting.
 
We routinely review the collectability of our accounts receivable and payment status of our customers. If we determine that collection of revenue is uncertain, we do not recognize revenue until collection is reasonably assured. Additionally, we maintain an allowance for doubtful accounts resulting from the inability of our customers to make required payments on accounts receivable. We base the allowance for doubtful accounts upon general customer information, which primarily includes our historical cash collection experience and the aging of our accounts receivable. We assess the payment status of customers by reference to the terms under which we provide services or goods, with any payments not made on or before their due date considered past-due. Once we have exhausted all collection efforts, we write the uncollectible balance off against the allowance for doubtful accounts. In addition, we record a reserve amount for potential credits to be issued under our SLAs and other sales adjustments.

Goodwill and Other Intangible and Long-lived Assets
 
Our annual assessment of goodwill for impairment, performed each year on August 1 absent any impairment indicators or other changes that may cause more frequent analysis, includes comparing the fair value of each reporting unit to the carrying value, referred to as “step one.” We estimate fair value using a combination of discounted cash flow models and market approaches. If the fair value of a reporting unit exceeds its carrying value, goodwill is not impaired and no further testing is necessary. If the carrying value of a reporting unit exceeds its fair value, we perform a second test, referred to as “step two,” to measure the amount of impairment to goodwill, if any. To measure the amount of any impairment, we determine the implied fair value of goodwill in the same manner as if we were acquiring the affected reporting unit in a business combination. Specifically, we allocate the fair value of the affected reporting unit to all of the assets and liabilities of that unit, including any unrecognized intangible assets, in a hypothetical calculation that would yield the implied fair value of goodwill. If the implied fair value of goodwill is less than the goodwill recorded on our consolidated balance sheet, we record an impairment charge for the difference.
 
We base the impairment analysis of goodwill on estimated fair values. Our assumptions, inputs and judgments used in performing the valuation analysis are inherently subjective and reflect estimates based on known facts and circumstances at the time we perform the valuation. These estimates and assumptions primarily include, but are not limited to, discount rates; terminal growth rates; projected revenues and costs; projected EBITDA for expected cash flows; market comparables and capital expenditures forecasts. The use of different assumptions, inputs and judgments, or changes in circumstances, could materially affect the results of the valuation. Due to the inherent uncertainty involved in making these estimates, actual results could differ from our estimates and could result in additional non-cash impairment charges in the future.
 
- 21 -
 

 

 
Other intangible assets have finite lives and we record these assets at cost less accumulated amortization. We record amortization of acquired technologies using the greater of (a) the ratio of current revenues to total and anticipated future revenues for the applicable technology or (b) the straight-line method over the remaining estimated economic life. We amortize the cost of the acquired technologies over their useful lives of five to eight years and 10 to 30 years for customer relationships and trade names. We assess other intangible assets and long-lived assets on a quarterly basis whenever any events have occurred or circumstances have changed that would indicate impairment could exist. Our assessment is based on estimated future cash flows directly associated with the asset or asset group. If we determine that the carrying value is not recoverable, we may record an impairment charge, reduce the estimated remaining useful life or both.
 
During 2014, 2013 and 2012, we concluded that an impairment indicator existed to cause us to reassess certain property and equipment. Following the reassessment, further described in note 5 to our accompanying consolidated financial statements, we recorded an impairment charge of $0.5 million, $0.5 million and $0.4 million, respectively, which we include in “Exit activities, restructuring and impairments” on the accompanying consolidated statements of operations and comprehensive loss.
 
Property and Equipment
 
We carry property and equipment at original acquisition cost less accumulated depreciation and amortization. We calculate depreciation and amortization on a straight-line basis over the estimated useful lives of the assets. Estimated useful lives used for network equipment are generally five years; furniture, equipment and software are three to seven years; and leasehold improvements are 10 to 25 years or over the lease term, depending on the nature of the improvement. We capitalize additions and improvements that increase the value or extend the life of an asset. We expense maintenance and repairs as incurred. We charge gains or losses from disposals of property and equipment to operations.
 
Exit Activities and Restructuring
 
When circumstances warrant, we may elect to exit certain business activities or change the manner in which we conduct ongoing operations. If we make such a change, we will estimate the costs to exit a business or restructure ongoing operations. The components of the estimates may include estimates and assumptions regarding the timing and costs of future events and activities that represent our best expectations based on known facts and circumstances at the time of estimation. If circumstances warrant, we will adjust our previous estimates to reflect what we then believe to be a more accurate representation of expected future costs. Because our estimates and assumptions regarding exit activities and restructuring charges include probabilities of future events, such as our ability to find a sublease tenant within a reasonable period of time or the rate at which a sublease tenant will pay for the available space, such estimates are inherently vulnerable to changes due to unforeseen circumstances that could materially and adversely affect our results of operations. If the amount of time that we expect it to take to find sublease tenants in all of the vacant space already in restructuring were to increase by three months and assuming no other changes to the properties in restructuring, we would record less than $0.1 million in additional restructuring charges in the consolidated statements of operations and comprehensive loss during the period in which the change in estimate occurred. We monitor market conditions at each period end reporting date and will continue to assess our key assumptions and estimates used in the calculation of our exit activities and restructuring accrual.

Income Taxes
 
We recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. We measure the tax benefits recognized in our accompanying consolidated financial statements from such a position based on the largest benefit that has a greater than 50% likelihood of being realized upon settlement. We recognize interest and penalties related to uncertain tax positions as part of the provision for income taxes and we accrue such items beginning in the period that such interest and penalties would be applicable under relevant tax law until such time that we recognize the related tax benefits.
 
We maintain a valuation allowance to reduce our deferred tax assets to their estimated realizable value. Although we consider the potential for future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance, if we determine we would be able to realize our deferred tax assets in the future in excess of our net recorded amount, an adjustment to reduce the valuation allowance would increase net income in the period we made such determination. We may recognize deferred tax assets in future periods if and when we estimate them to be realizable and supported by historical trends of profitability and expectations of future profits within each tax jurisdiction.
 
Based on an analysis of our historic and projected future U.S. pre-tax income, we do not have sufficient positive evidence to expect a release of our valuation allowance against our U.S. deferred tax assets currently or within the next 12 months. We reached the same conclusion regarding our foreign jurisdictions, other than the United Kingdom (“U.K.”) and Canada. Accordingly, we continue to maintain the full valuation allowance in the U.S. and all foreign jurisdictions, other than the U.K. and Canada.
 
- 22 -
 

 

 
Stock-Based Compensation
 
We measure stock-based compensation cost at the grant date based on the calculated fair value of the award. We recognize the expense over the employee’s requisite service period, generally the vesting period of the award. The fair value of restricted stock is the market value on the date of grant. The fair value of stock options is estimated at the grant date using the Black-Scholes option pricing model with weighted average assumptions for the activity under our stock plans. Option pricing model input assumptions, such as expected term, expected volatility and risk-free interest rate, impact the fair value estimate. Further, the forfeiture rate impacts the amount of aggregate compensation. These assumptions are subjective and generally require significant analysis and judgment to develop.
 
The expected term represents the weighted average period of time that we expect granted options to be outstanding, considering the vesting schedules and our historical exercise patterns. Because our options are not publicly traded, we assume volatility based on the historical volatility of our stock. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant for periods corresponding to the expected option term. We have also used historical data to estimate option exercises, employee termination and stock option forfeiture rates. Changes in any of these assumptions could materially impact our results of operations in the period the change is made.
 
Capitalized Software Costs
 
We capitalize software development costs incurred during the application development stage. Amortization begins once the software is ready for its intended use and is computed based on the straight-line method over the economic life. Judgment is required in determining which software projects are capitalized and the resulting economic life.
 
Recent Accounting Pronouncements
 
Recent accounting pronouncements are summarized in note 2 to the accompanying consolidated financial statements.
 
Results of Operations
 
Revenues
 
We generate revenues primarily from the sale of data center services and IP services.

Direct Costs of Network, Sales and Services

Direct costs of network, sales and services are comprised primarily of:

 
costs for connecting to and accessing ISPs and competitive local exchange providers;
 
facility and occupancy costs, including power and utilities, for hosting and operating our equipment and hosting our customers’ equipment;
 
costs incurred for providing additional third party services to our customers; and
 
royalties and costs of license fees for operating systems software.
 
If a network access point is not colocated with the respective ISP, we may incur additional local loop charges on a recurring basis. Connectivity costs vary depending on customer demands and pricing variables while P-NAP facility costs are generally fixed. Direct costs of network, sales and services do not include compensation, depreciation or amortization.
 
Direct Costs of Customer Support
 
Direct costs of customer support consist primarily of compensation and other personnel costs for employees engaged in connecting customers to our network, installing customer equipment into P-NAP facilities and servicing customers through our NOCs. In addition, direct costs of customer support include facilities costs associated with the NOCs, including costs related to servicing our data center customers.
 
Direct Costs of Amortization of Acquired and Developed Technologies
 
Direct costs of amortization of acquired and developed technologies are for technologies that are an integral part of the services we sell, which were acquired through business combinations or developed internally. We record amortization using the greater of (a) the ratio of current revenues to total and anticipated future revenues for the applicable technology or (b) the straight-line method over the remaining estimated economic life. We amortize the cost over their useful lives of five to eight years. At December 31, 2014, the carrying value of the acquired and developed technologies was $11.8 million and the weighted average remaining life was approximately four years.
 
- 23 -
 

 

 
Sales and Marketing

Sales and marketing costs consist of compensation, commissions, bonuses and other costs for personnel engaged in marketing, sales and field service support functions, and advertising, online marketing, tradeshows, direct response programs, facility open houses, management of our external website and other promotional costs.

General and Administrative

General and administrative costs consist primarily of compensation and other expense for executive, finance, product development, human resources and administrative personnel, professional fees and other general corporate costs. General and administrative costs also include consultant fees and non-capitalized prototype costs related to the design, development and testing of our proprietary technology, enhancement of our network management software and development of internal systems. We capitalize costs associated with internal-use software when the software enters the application development stage until the software is ready for its intended use. We expense all other product development costs as incurred.

Results of Operations
 
The following table sets forth selected consolidated statements of operations and comprehensive loss data during the periods presented, including comparative information between the periods (dollars in thousands):
                                           
   
Year Ended December 31,
   
Increase
(decrease)
from 2013 to
2014
   
Increase
(decrease)
from 2012 to
2013
 
   
2014
   
2013
   
2012
   
Amount
   
Percent
   
Amount
   
Percent
 
Revenues:
                                         
Data center services:
                                         
  Core
  $ 195,373     $ 133,970     $ 113,399     $ 61,403       46 %   $ 20,571       18 %
  Partner
    47,250       51,177       53,887       (3,927 )     (8 )     (2,710 )     (5 )
  Total data center services
    242,623       185,147       167,286       57,476       31       17,861       11  
IP services
    92,336       98,195       106,306       (5,859 )     (6 )     (8,111 )     (8 )
Total revenues
    334,959       283,342       273,592       51,617       18       9,750       4  
                                                         
Operating costs and expenses:
                                                       
Direct costs of network, sales and services, exclusive of depreciation and amortization, shown below:
                                                       
Data center services:
                                                       
  Core
    70,998       55,270       51,081       15,728       28       4,189       8  
  Partner
    35,161       37,294       39,523       (2,133 )     (6 )     (2,229 )     (6 )
  Total data center services
    106,159       92,564       90,604       13,595       15       1,960       2  
IP services
    38,787       39,448       40,350       (661 )     (2 )     (902 )     (2 )
Direct costs of customer support
    36,804       29,687       26,664       7,117       24       3,023       11  
Direct costs of amortization of acquired and developed technologies
    5,918       4,967       4,718       951       19       249       5  
Sales and marketing
    37,845       31,800       31,343       6,045       19       457       1  
General and administrative
    43,902       42,759       38,635       1,143       3       4,124       11  
Depreciation and amortization
    75,251       48,181       36,147       27,070       56       12,034       33  
Loss (gain) on disposal of property and equipment, net
    112       9       (55 )     103             64       116  
Exit activities, restructuring and impairments
    4,520       1,414       1,422       3,106       220       (8 )     (1 )
Total operating costs and expenses
    349,298       290,829       269,828       58,469       20       21,001       8  
(Loss) income from operations
  $ (14,339 )   $ (7,487 )   $ 3,764     $ (6,852 )     (92 )   $ (11,251 )     (299 )
                                                         
Interest expense
  $ 26,742     $ 11,346     $ 7,566     $ 15,396       136     $ 3,780       50  
(Benefit) provision for income taxes
  $ (1,361 )   $ (285 )   $ 453     $ (1,076 )     (378 )%   $ (738 )     (163 )%
 
- 24 -
 

 


Segment Information
 
We operate in two business segments: data center services and IP services. Segment results for each of the three years ended December 31, 2014 are summarized as follows (in thousands):
                   
   
Year Ended December 31,
 
   
2014
   
2013
   
2012
 
Revenues:
                 
Data center services
  $ 242,623     $ 185,147     $ 167,286  
IP services
    92,336       98,195       106,306  
Total revenues
    334,959       283,342       273,592  
                         
Direct costs of network, sales and services, exclusive of depreciation and amortization:
                       
Data center services
    106,159       92,564       90,604  
IP services
    38,787       39,448       40,350  
Total direct costs of network, sales and services, exclusive of depreciation and amortization
    144,946       132,012       130,954  
                         
Segment profit:
                       
Data center services
    136,464       92,583       76,682  
IP services
    53,549       58,747       65,956  
Total segment profit
    190,013       151,330       142,638  
                         
Exit activities, restructuring and impairments
    4,520       1,414       1,422  
Other operating expenses, including direct costs of customer support, depreciation and amortization
    199,832       157,403       137,452  
(Loss) income from operations
    (14,339 )     (7,487 )     3,764  
Non-operating expense
    26,775       12,841       7,849  
Loss before income taxes and equity in (earnings) of equity-method investment
  $ (41,114 )   $ (20,328 )   $ (4,085 )
 
Segment profit is calculated as segment revenues less direct costs of network, sales and services, exclusive of depreciation and amortization for the segment and does not include direct costs of customer support, direct costs of amortization of acquired technologies or any other depreciation or amortization associated with direct costs. We view direct costs of network, sales and services as generally less-controllable, external costs and we regularly monitor the margin of revenues in excess of these direct costs. We also view the costs of customer support to be an important component of costs of revenues, but believe that the costs of customer support are more within our control and, to some degree, discretionary in that we can adjust those costs by managing personnel needs. We also have excluded depreciation and amortization from segment profit because it is based on estimated useful lives of tangible and intangible assets. Further, we base depreciation and amortization on historical costs incurred to build out our deployed network and the historical costs of these assets may not be indicative of current or future capital expenditures. Although we believe, for the foregoing reasons, that our presentation of segment profit non-GAAP financial presentation provides useful supplemental information to investors regarding our results of operations, our non-GAAP financial measures should only be considered in addition to, and not as a substitute for, or superior to, any measure of financial performance prepared in accordance with GAAP.
 
Years Ended December 31, 2014 and 2013
 
Data Center Services
 
Revenues for data center services increased 31% to $242.6 million for the year ended December 31, 2014, compared to $185.1 million for the same period in 2013. The increase was primarily due to net revenue growth in our core data center services, which includes company-controlled colocation, hosting and cloud services, and $43.2 million of revenue attributable to iWeb. Revenue growth has benefited from higher average revenue per customer and the capturing of a larger proportion of the enterprise customer spend for high performance services with our hybrid platform of colocation, hosting and cloud services. In addition, the benefit of our hybrid strategy is also reflected in an increase in the revenue per square foot generated from our company- controlled data centers.
 
Direct costs of data center services, exclusive of depreciation and amortization, increased 15% to $106.2 million for the year ended December 31, 2014, compared to $92.6 million for the same period in 2013. The increase in direct costs was primarily due to revenue growth, with an increasing proportion of higher margin core data center services, and $7.8 million of direct costs attributable to iWeb, offset by cost reduction efforts.
 
- 25 -
 

 

 
Direct costs of data center services, exclusive of depreciation and amortization, have substantial fixed cost components, primarily rent for operating leases, but also significant demand-based pricing variables, such as utilities attributable to seasonal costs and customers’ changing power requirements. Direct costs of data center services as a percentage of revenues vary with the mix of usage between company-controlled data centers and partner sites and the utilization of total available space. Since we recognize some of the initial operating costs of company-controlled data centers in advance of revenues or in advance of sites being fully utilized, these sites are less profitable in the early years of operation compared to partner sites and we expect them to be more profitable as occupancy increases. Conversely, costs in partner sites are more demand-based and therefore are more closely associated with the level of utilization.

We will continue to focus on increasing revenues from company-controlled facilities as compared to partner sites. We also expect direct costs of data center services as a percentage of corresponding revenues to decrease as our new and recently-expanded company-controlled data centers continue to contribute to revenue and become more fully occupied. This is evidenced by the improvement in direct costs of data center services as a percentage of corresponding revenues of 44% during the year ended December 31, 2014, compared to 50% during the same period in 2013.
 
IP Services
 
Revenues for IP services decreased 6% to $92.3 million for the year ended December 31, 2014, compared to $98.2 million for the same period in 2013. The decrease continues to be driven by a decline in IP pricing for new and renewing customers and the loss of legacy contracts, partially offset by an increase in overall traffic. IP traffic increased approximately 11% for the year ended December 31, 2014, compared to the same period in 2013, calculated based on an average over the number of months in the respective periods.
 
Direct costs of IP services, exclusive of depreciation and amortization, decreased 2% to $38.8 million for the year ended December 31, 2014, compared to $39.4 million for the same period in 2013. This decrease was primarily due to renegotiation of vendor contracts and cost reduction efforts.
 
There have been ongoing industry-wide pricing declines over the last several years and this trend continued during 2014. Technological improvements and excess capacity have been the primary drivers for lower pricing of IP services. The increase in IP traffic resulted from both new and existing customers.
 
Other Operating Costs and Expenses
 
Compensation. Total compensation and benefits, including stock-based compensation, were $81.0 million and $71.1 million for the years ended December 31, 2014 and 2013, respectively. The increase was primarily due to $12.0 million of expenses attributable to iWeb, partially offset by a $1.3 million decrease in cash-based compensation and a $0.9 million decrease in stock-based compensation.
 
Stock-based compensation, net of amount capitalized, increased to $7.2 million during the year ended December 31, 2014 from $6.7 million during the same period in 2013. The increase was primarily due to $1.3 million of expense for grants to certain iWeb employees after the acquisition, offset by a $0.9 million decrease in stock-based compensation unrelated to iWeb. The following table summarizes the amount of stock-based compensation, net of estimated forfeitures, included in the accompanying consolidated statements of operations and comprehensive loss (in thousands):
             
   
2014
   
2013
 
Direct costs of customer support
  $ 1,448     $ 1,108  
Sales and marketing
    1,147       1,110  
General and administrative
    4,587       4,525  
    $ 7,182     $ 6,743  
 
Direct Costs of Customer Support. Direct costs of customer support increased 24% to $36.8 million during the year ended December 31, 2014 from $29.7 million during the same period in 2013. The increase was primarily due to $6.6 million of expenses attributable to iWeb.
 
Direct Costs of Amortization of Acquired and Developed Technologies. Direct costs of amortization of acquired and developed technologies increased 19% to $5.9 million during the year ended December 31, 2014 from $5.0 million during the same period in 2013. The increase was primarily due to amortization of acquired intangibles from the iWeb acquisition.
 
Sales and Marketing. Sales and marketing costs increased 19% to $37.8 million during the year ended December 31, 2014 from $31.8 million during the same period in 2013. The increase was primarily due to $5.9 million of expenses related to iWeb and a $0.5 million increase in agent fees.
 
General and Administrative. General and administrative costs increased 3% to $43.9 million during the year ended December 31, 2014 from $42.8 million during the same period in 2013. The increase was primarily due to $8.1 million of expenses attributable to iWeb, partially offset by a $3.3 million decrease in outside professional services, a $1.1 million decrease in bad debt expense, a $0.9 million decrease in stock-based compensation unrelated to iWeb, a $0.7 million decrease in cash-based compensation and a $0.5 million decrease in net taxes as a result of passing additional taxes through to our customers.
 
Depreciation and Amortization. Depreciation and amortization increased 56% to $75.3 million during the year ended December 31, 2014 from $48.2 million during the same period in 2013. The increase was primarily due to the effects of expanding our company-controlled data centers, including increased power capacity and servers, network infrastructure and capitalized software, and $11.6 million of expense attributable to iWeb related to the amortization for the acquired assets at purchase price accounting values.
 
- 26 -
 

 


Exit Activities, Restructuring and Impairments. Exit activities and impairments increased 220% to $4.5 million during the year ended December 31, 2014 from $1.4 million during the same period in 2013. The increase was primarily due to initial exit activity charges related to ceasing use of certain data center space of $3.5 million, as well as plan adjustments in sublease income assumptions for certain properties included in our previously-disclosed plans of $1.1 million.
 
Interest Expense. Interest expense increased 136% to $26.7 million during the year ended December 31, 2014 from $11.3 million during the same period in 2013. The increase was due to increased borrowings and interest rate under our credit agreement.
 
Benefit for Income Taxes. The benefit for income taxes increased 378% to $1.4 million during the year ended December 31, 2014 from $0.3 million during the same period in 2013. The variance was primarily due to an income tax benefit created by the activity of iWeb and the reduction of a prior year uncertain tax position reserve.
 
Our effective income tax rate, as a percentage of pre-tax income, for the years ended December 31, 2014 and 2013, was (3%) and (1%), respectively. The fluctuation in the effective income tax rate was primarily due to a reduction of the prior year uncertain tax position reserve and an income tax benefit created by iWeb for a full 12-month period.
 
Years Ended December 31, 2013 and 2012
 
Data Center Services
 
Revenues for data center services increased 11% to $185.1 million for the year ended December 31, 2013, compared to $167.3 million for the same period in 2012. The increase was primarily due to net revenue growth in company-controlled colocation, hosting and cloud services and $3.6 million of revenue attributable to iWeb.
 
Direct costs of data center services, exclusive of depreciation and amortization, increased 2% to $92.6 million for the year ended December 31, 2013, compared to $90.6 million for the same period in 2012. The increase in direct costs was primarily due to revenue growth and $1.0 million of direct costs attributable to iWeb, offset by cost reduction efforts.
 
IP Services
 
Revenues for IP services decreased 8% to $98.2 million for the year ended December 31, 2013, compared to $106.3 million for the same period in 2012. The decrease was driven by a decline in IP pricing for new and renewing customers and the loss of legacy contracts, partially offset by an increase in overall traffic. IP traffic increased approximately 16% for the year ended December 31, 2013, compared to the same period in 2012, calculated based on an average over the number of months in the respective periods.
 
Direct costs of IP services, exclusive of depreciation and amortization, decreased 2% to $39.4 million for the year ended December 31, 2013, compared to $40.4 million for the same period in 2012. This decrease was primarily due to renegotiation of vendor contracts and cost reduction efforts.
 
Other Operating Costs and Expenses
 
Compensation. Total compensation and benefits, including stock-based compensation, were $71.1 million and $67.5 million for the years ended December 31, 2013 and 2012, respectively. The variance was primarily due to a $2.5 million increase related to a higher employee headcount and increased salary levels, a $0.9 million increase in stock-based compensation and $1.3 million of expenses attributable to iWeb, partially offset by a $0.9 million decrease in commissions.
 
Stock-based compensation, net of amount capitalized, increased to $6.7 million during the year ended December 31, 2013 from $5.9 million during the same period in 2012. The increase was primarily due to the expense associated with option grants valued higher than in previous years. The following table summarizes the amount of stock-based compensation, net of estimated forfeitures, included in the accompanying consolidated statements of operations and comprehensive loss (in thousands):
             
   
2013
   
2012
 
Direct costs of customer support
  $ 1,108     $ 936  
Sales and marketing
    1,110       929  
General and administrative
    4,525       3,993  
    $ 6,743     $ 5,858  
 
Direct Costs of Customer Support. Direct costs of customer support increased 11% to $29.7 million during the year ended December 31, 2013 from $26.7 million during the same period in 2012. The increase was primarily due to a $2.4 million increase in cash-based compensation and payroll taxes and $0.7 million of expenses attributable to iWeb.
 
Direct Costs of Amortization of Acquired and Developed Technologies. Direct costs of amortization of acquired and developed technologies were $5.0 million and $4.7 million during the years ended December 31, 2013 and 2012, respectively.
 
Sales and Marketing. Sales and marketing costs increased 1% to $31.8 million during the year ended December 31, 2013 from $31.3 million during the same period in 2012. The increase was primarily due to $0.7 million of expenses related to iWeb.
 
- 27 -
 

 

 
General and Administrative. General and administrative costs increased 11% to $42.8 million during the year ended December 31, 2013 from $38.6 million during the same period in 2012. The increase was primarily due to a $2.2 million increase in outside professional services, a $0.9 million increase in bad debt expense, a $0.4 million increase in cash-based compensation costs and payroll taxes, a $0.4 million increase in stock-based compensation and $0.5 million of expenses attributable to iWeb, partially offset by a $0.4 million decrease in bonus compensation accrual and severance.
 
Depreciation and Amortization. Depreciation and amortization was $48.2 million and $36.1 million during the years ended December 31, 2013 and 2012, respectively. The increase was primarily due to the effects of expanding our company-controlled data centers, P-NAP infrastructure and capitalized software and $1.0 million of expense attributable to iWeb.

Exit Activities, Restructuring and Impairments. For the years ended December 31, 2013 and December 31, 2012, exit activities, restructuring and impairments were $1.4 million.
 
Interest Expense. Interest expense increased to $11.3 million during the year ended December 31, 2013, compared to $7.6 million during the same period in 2012. The increase in interest expense was primarily due to new capital lease obligations related to expanding our company-controlled data centers and the increase in our borrowings under our term loan and revolving credit facility.
 
(Benefit) Provision for Income Taxes. The (benefit) provision for income taxes was ($0.3 million) and $0.5 million during the years ended December 31, 2013 and 2012, respectively. The variance was primarily due to income tax benefits created by reducing the prior years’ uncertain tax position reserve and the activity of iWeb.
 
Our effective income tax rate, as a percentage of pre-tax income, for the years ended December 31, 2013 and 2012, was (1%) and 11%, respectively. The fluctuation in the effective income tax rate was attributable to a change in valuation allowance, reduction of uncertain tax position reserve and the income tax benefit created by iWeb for the applicable short period.

Liquidity and Capital Resources
 
Liquidity

As of December 31, 2014, we had a deficit in working capital, which represented an excess of current liabilities over current assets due to our strategy to minimize interest costs by not accessing additional borrowing capacity under our revolving credit facility. We believe that cash flows from operations, together with our cash and cash equivalents and borrowing capacity under our revolving credit facility, will be sufficient to meet our cash requirements for the next 12 months and for the foreseeable future. If our cash requirements vary materially from what we expect or if we fail to generate sufficient cash flows from selling our services, we may require additional financing sooner than anticipated. We can offer no assurance that we will be able to obtain additional financing on commercially favorable terms, or at all, and provisions in our credit agreement limit our ability to incur additional indebtedness. Our anticipated uses of cash include capital expenditures of $70.0 to $80.0 million in 2015, working capital needs and required payments on our credit agreement and other commitments.
 
We have a history of quarterly and annual period net losses. During the year ended December 31, 2014, we had a net loss of $39.5 million. As of December 31, 2014, our accumulated deficit was $1.1 billion. We continue to analyze our business to control our costs, principally through making process enhancements and renegotiating network contracts for more favorable pricing and terms. We may not be able to sustain or increase profitability on a quarterly basis, and our failure to do so may adversely affect our business, including our ability to raise additional funds.
 
We monitor and review our performance and operations in light of global economic conditions, which could impact the ability of our customers to meet their obligations to us, which could delay collection of accounts receivable and increase our provision for doubtful accounts.
 
Capital Resources
 
Credit Agreement. During 2013, we entered into a $350.0 million credit agreement, which provides for a $300.0 million term loan and a $50.0 million revolving credit facility, due November 26, 2018. We summarize the credit agreement in note 11 to the accompanying consolidated financial statements. Concurrently with the effective date and funding of the term loan, we acquired iWeb and paid off our previous credit facility.
 
As of December 31, 2014, the revolving credit facility had an outstanding balance of $10.0 million and we issued $6.3 million in letters of credit, resulting in $33.7 million in borrowing capacity. As of December 31, 2014, the term loan had an outstanding principal amount of $297.0 million, which we repay in $750,000 quarterly installments on the last day of each fiscal quarter, with the remaining unpaid balance due November 26, 2019. As of December 31, 2014, the interest rate on the revolving credit facility was 4.7% and term loan was 6.0%.
 
The credit agreement includes customary representations, warranties, negative and affirmative covenants, including certain financial covenants relating to maximum total leverage ratio, minimum consolidated interest coverage ratio and limitation on capital expenditures. As of December 31 2014, we were in compliance with these covenants.
 
- 28 -
 

 

 
Capital Leases. During 2014, we completed sale-leaseback transactions with third-parties for equipment and a building for cash proceeds of $3.1 million and $1.6 million, respectively.  As a result of these transactions, we recorded capital lease obligations of $3.4 million.
 
Also during 2014, we exercised a renewal option of an existing operating lease for company-controlled data center space in Montreal. The lease extension, for accounting purposes, triggered a new lease which expires in 2032, with the new terms resulting in capital lease treatment. We recorded property of $6.0 million, net of the deferred rent balance on the previous operating lease, and a capital lease obligation of $7.4 million.
 
Our future minimum lease payments on all remaining capital lease obligations at December 31, 2014 were $60.1 million. We summarize our existing capital lease obligations in note 11 to the accompanying consolidated financial statements.
 
Commitments and Other Obligations. We have commitments and other obligations that are contractual in nature and will represent a use of cash in the future unless the agreements are modified. Service and purchase commitments primarily relate to IP, telecommunications and data center services. Our ability to improve cash provided by operations in the future would be negatively impacted if we do not grow our business at a rate that would allow us to offset the purchase and service commitments with corresponding revenue growth.
 
The following table summarizes our commitments and other obligations as of December 31, 2014 (in thousands):
                               
   
Payments Due by Period
 
   
Total
   
Less than
1 year
   
1-3
Years
   
3-5
Years
   
More
than 5
years
 
                               
Term loan, including interest
  $ 383,519     $ 20,999     $ 41,450     $ 321,070     $  
Revolving credit facility, including interest
    11,825       466       932       10,427        
Interest rate swap
    813       765       48              
Capital lease obligations, including interest
    91,610       12,488       22,156       19,414       37,552  
Exit activities and restructuring
    6,529       2,581       3,095       853        
Asset retirement obligation
    4,863             1,479             3,384  
Operating lease commitments
    103,354       24,831       44,445       21,726       12,352  
Service and purchase commitments
    27,102       18,420       8,216       433       33  
    $ 629,615     $ 80,550     $ 121,821     $ 373,923     $ 53,321  

Cash Flows
 
Operating Activities
 
Year Ended December 31, 2014. Net cash provided by operating activities during the year ended December 31, 2014 was $53.2 million. We generated cash from operations of $52.6 million, while changes in operating assets and liabilities generated cash from operations of $0.6 million. We expect to use cash flows from operating activities to fund a portion of our capital expenditures and other requirements and to meet our other commitments and obligations, including outstanding debt.
 
Year Ended December 31, 2013. Net cash provided by operating activities during the year ended December 31, 2013 was $33.7 million. Our net loss, after adjustments for non-cash items, generated cash from operations of $43.1 million, while changes in operating assets and liabilities used cash from operations of $9.4 million.
 
Year Ended December 31, 2012. Net cash provided by operating activities during the year ended December 31, 2012 was $43.7 million. Our net loss, after adjustments for non-cash items, generated cash from operations of $44.4 million, while changes in operating assets and liabilities used cash from operations of $0.7 million.
 
Investing Activities
 
Year Ended December 31, 2014. Net cash used in investing activities during the year ended December 31, 2014 was $75.7 million, primarily due to capital expenditures of $77.4 million, net of  equipment sale-leaseback proceeds. Capital expenditures related to the continued expansion and upgrade of our company-controlled data centers and network infrastructure.
 
Year Ended December 31, 2013. Net cash used in investing activities during the year ended December 31, 2013 was $208.1 million, primarily due to the iWeb acquisition, net of cash received, of $144.5 million and capital expenditures of $62.8 million. Capital expenditures related to the continued expansion and upgrade of our company-controlled data centers and network infrastructure.
 
Year Ended December 31, 2012. Net cash used in investing activities during the year ended December 31, 2012 was $79.7 million, primarily due to capital expenditures of $74.9 million. Capital expenditures related to the continued expansion and upgrade of our company-controlled data centers and network infrastructure. In addition, we paid $4.8 million in accrued contingent consideration for technology deliverables related to the Voxel acquisition.
 
- 29 -
 

 

 
Financing Activities
 
Year Ended December 31, 2014. Net cash provided by financing activities during the year ended December 31, 2014 was $7.9 million, primarily due to $10.0 million of proceeds received from the revolving credit facility and a return of deposit collateral of $6.5 million, partially offset by principal payments of $8.9 million on our credit agreement and capital lease obligations.
 
Year Ended December 31, 2013. Net cash provided by financing activities during the year ended December 31, 2013 was $180.8 million, primarily due to $320.0 million proceeds received on the credit agreement, partially offset by principal payments of $120.7 million on our prior credit agreement and capital lease obligations and the payment of debt issuance costs of $12.4 million.
 
Year Ended December 31, 2012. Net cash provided by financing activities during the year ended December 31, 2012 was $34.6 million, primarily due to $40.4 million proceeds received on our prior credit agreement, partially offset by principal payments of $3.3 million each on the credit agreement and capital lease obligations.
 
Off-Balance Sheet Arrangements
 
As of December 31, 2014, 2013 and 2012, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. Other than our operating leases, we do not engage in off-balance sheet financial arrangements.

 
Other Investments
 
Prior to 2013, we invested $4.1 million in Internap Japan Co. We account for this investment using the equity method and we have recognized $1.5 million in equity-method losses over the life of the investment, representing our proportionate share of the aggregate joint venture losses and income. The joint venture investment is subject to foreign currency exchange rate risk.
 
Interest Rate Risk
 
Our objective in managing interest rate risk is to maintain favorable long-term fixed rate or a balance of fixed and variable rate debt within reasonable risk parameters. At December 31, 2014, we had an interest rate swap with a notional amount starting at $150.0 million through December 30, 2016 with an interest rate of 1.5%. We summarize our interest rate swap activity in note 10 to the accompanying consolidated financial statements.
 
As of December 31, 2014, our long-term debt consisted of $297.0 million borrowed under our term loan and $10.0 million borrowed under our revolving credit facility. At December 31, 2014, the interest rate on the term loan and revolving credit facility was 6.0% and 4.7%, respectively. We summarize the credit agreement in “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Capital Resources—Credit Agreement” and in note 11 to the accompanying consolidated financial statements.
 
We are required to pay a commitment fee at a rate of 0.50% per annum on the average daily unused portion of the revolving credit facility, payable quarterly in arrears. In addition, we are required to pay certain participation fees and fronting fees in connection with standby letters of credit issued under the revolving credit facility.
 
We estimate that a change in the interest rate of 100 basis points would change our interest expense and payments by $3.1 million per year, assuming we do not increase our amount outstanding.
 
Foreign Currency Risk
 
As of December 31, 2014, the majority of our revenue was in U.S. dollars. However, our results of operations and cash flows are subject to fluctuations in foreign currency exchange rates. We also have exposure to foreign currency transaction gains and losses as the result of certain receivables due from our foreign subsidiaries. During the year ended December 30, 2014, we realized foreign currency gains of less than $0.1 million, which we included as non-operating income in “Other, net,” and we recorded unrealized foreign currency translation losses of $0.4 million, which we included in “Other comprehensive (loss) income,” both in the accompanying consolidated statement of operations and comprehensive loss. As we grow our international operations, our exposure to foreign currency risk could become more significant.
 
- 30 -
 

 

 
 
Our accompanying consolidated financial statements, financial statement schedule and the report of our independent registered public accounting firm appear in Part IV of this Annual Report on Form 10-K. Our report on internal control over financial reporting appears in Item 9A of this Form 10-K.
 
 
None.
 
 
Evaluation of Disclosure Controls and Procedures
 
Based on our management’s evaluation (with the participation of our Chief Executive Officer and Chief Financial Officer), as of the end of the period covered by this report, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) are effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

Report of Management on Internal Control Over Financial Reporting
 
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in “Internal Control—Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission, or COSO, issued in 2013.
 
Based on our evaluation under the framework in “Internal Control—Integrated Framework” issued by COSO, our management concluded that our internal control over financial reporting was effective as of December 31, 2014. Our independent registered public accounting firm, PricewaterhouseCoopers LLP, audited our consolidated financial statements included in this Annual Report on Form 10-K and issued an attestation report on our internal control over financial reporting as of December 31, 2014, which is included in the report included under Item 15 of this Annual Report on Form 10-K.
 
Changes in Internal Control over Financial Reporting
 
There was no change in our internal control over financial reporting that occurred during the quarter ended December 31, 2014 that has materially affected, or that is reasonably likely to materially affect, our internal control over financial reporting.
 
 
None.
 
 
 
We will include information regarding our directors and executive officers in our definitive proxy statement for our annual meeting of stockholders to be held in 2015, which we will file within 120 days after the end of the fiscal year covered by this Annual Report on Form 10-K. This information is incorporated herein by reference.
 
Code of Conduct
 
We have adopted a code of conduct that applies to all of our directors, officers and employees. A copy of the code of conduct is available on our website at www.internap.com by clicking on the “Investor Relations—Corporate Governance—Code of Conduct” links. We will furnish copies without charge upon request at the following address: Internap Corporation, Attn: SVP, Legal Services, One Ravinia Drive, Suite 1300, Atlanta, Georgia 30346.
 
If we make any amendments to the code of conduct other than technical, administrative or other non-substantive amendments, or grant any waivers, including implicit waivers, from the code of conduct, we will disclose the nature of the amendment or waiver, its effective date and to whom it applies on our website or in a Current Report on Form 8-K filed with the SEC.
 
- 31 -
 

 

 
 
We will include information regarding executive compensation in our definitive proxy statement for our annual meeting of stockholders to be held in 2015, which we will file within 120 days after the end of the fiscal year covered by this Annual Report on Form 10-K. This information is incorporated herein by reference.
 
 
We will include information regarding security ownership of certain beneficial owners and management and related stockholder matters in our definitive proxy statement for our annual meeting of stockholders to be held in 2015, which we will file within 120 days after the end of the fiscal year covered by this Annual Report on Form 10-K. This information is incorporated herein by reference.
 
The information under the heading “Equity Compensation Plan Information” in Item 5 of this Annual Report on Form 10-K is incorporated herein by reference.
 
 
We will include information regarding certain relationships, related transactions and director independence in our definitive proxy statement for our annual meeting of stockholders to be held in 2015, which we will file within 120 days after the end of the fiscal year covered by this Annual Report on Form 10-K. This information is incorporated herein by reference.
 
 
We will include information regarding principal accountant fees and services in our definitive proxy statement for our annual meeting of stockholders to be held in 2015, which we will file within 120 days after the end of the fiscal year covered by this Annual Report on Form 10-K. This information is incorporated herein by reference.
 
 
 
Item 15(a)(1). Financial Statements. The following consolidated financial statements are filed herewith:
     
   
Page
Report of Independent Registered Public Accounting Firm
 
F-1
Consolidated Statements of Operations and Comprehensive Loss
 
F-2
Consolidated Balance Sheets
 
F-3
Consolidated Statements of Stockholders’ Equity
 
F-4
Consolidated Statements of Cash Flows
 
F-5
Notes to Consolidated Financial Statements
 
F-6
     
Item 15(a)(2). Financial Statement Schedules. The following financial statement schedule is filed herewith:
   
     
   
Page
Schedule II - Valuation and Qualifying Accounts and Reserves
 
S-1
 
- 32 -
 

 

 
Item 15(a)(3). Exhibits. The following exhibits are filed as part of this report:
       
Exhibit
Number
 
Description
 
     
2.1
 
Share Purchase Agreement made as of October 30, 2013 between iWeb Group Inc., its stockholders and stockholders’ representative and 8672377 Canada Inc. and Internap Network Services Corporation (incorporated herein by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K, filed October 31, 2013).†
     
3.1
 
Certificate of Elimination of the Series B Preferred Stock (incorporated herein by reference to Exhibit 3.1 to the Company’s Annual Report on Form 10-K, filed March 2, 2010).
     
3.2
 
Restated Certificate of Incorporation of the Company (incorporated herein by reference to Exhibit 3.2 to the Company’s Annual Report on Form 10-K, filed March 2, 2010).
     
3.3
 
Certificate of Amendment of Restated Certificate of Incorporation of the Company (incorporated herein by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K, filed June 21, 2010).
     
3.4
 
Certificate of Amendment to the Restated Certificate of Incorporation of the Company (incorporated herein by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K, filed November 25, 2014).
     
3.5
 
Amended and Restated Bylaws of the Company (incorporated herein by reference to Exhibit 3.2 to the Company’s Current Report on Form 8-K, filed November 25, 2014).
     
10.1
 
Internap Network Services Corporation 1999 Non-Employee Directors’ Stock Option Plan (incorporated herein by reference to Exhibit 10.2 to the Company’s Annual Report on Form 10-K, filed March 13, 2009).+
     
10.2
 
First Amendment to the Internap Network Services Corporation 1999 Non-Employee Directors’ Stock Option Plan (incorporated herein by reference to Exhibit 10.3 to the Company’s Annual Report on Form 10-K, filed March 13, 2009).+
     
10.3
 
Internap Network Services Corporation 2000 Non-Officer Equity Incentive Plan (incorporated herein by reference to Exhibit 99.1 to the Company’s Registration Statement on Form S-8, File No. 333-37400 dated May 19, 2000).+
     
10.4
 
2005 Incentive Stock Plan, as amended (incorporated herein by reference to Exhibit 10.9 to the Company’s Annual Report on Form 10-K, filed February 20, 2014).+
     
10.5
 
Form of Stock Grant Certificate under the Amended and Restated Internap Network Services Corporation 2005 Incentive Stock Plan (incorporated herein by reference to Exhibit 10.14 to the Company’s Annual Report on Form 10-K, filed March 2, 2010).+
     
10.6
 
Form of Stock Option Certificate under the Amended and Restated Internap Network Services Corporation 2005 Incentive Stock Plan (incorporated herein by reference to Exhibit 10.15 to the Company’s Annual Report on Form 10-K, filed March 2, 2010).+
     
10.7
  2014 Stock Incentive Plan (incorporated herein by reference to Exhibit 10.1 to the Company’s Registration Statement on Form S-8, filed June 16, 2014).+
     
10.8*
 
Form of Stock Grant Certificate under the 2014 Stock Incentive Plan.+
     
10.9*
 
Form of Stock Option Certificate under the 2014 Stock Incentive Plan.+
     
10.10*
  Form of Stock Grant Certificate (Canada) under the 2014 Stock Incentive Plan.+
     
10.11*
 
Form of Stock Option Certificate (Canada) under the 2014 Stock Incentive Plan.+
     
10.12
 
Employment Security Plan dated November 14, 2007 (incorporated herein by reference to Exhibit 10.13 to the Company’s Annual Report on Form 10-K, filed February 21, 2013).+
     
10.13
 
Form of Indemnity Agreement for directors and officers of the Company (incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K, filed May 29, 2009).+
     
10.14
 
Commitment Letter dated October 30, 2013 (incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K, filed October 31, 2013).
     
10.15
 
Credit Agreement dated as of November 26, 2013 among Internap Network Services Corporation, as Borrower; the Guarantors party thereto, as Guarantors; the Lenders party thereto; Jefferies Finance, LLC, as Administrative Agent and Collateral Agent; Jefferies Finance LLC and PNC Capital Markets LLC, as Joint Lead Arrangers and Joint Book Managers; PNC Bank National Association, as Syndication Agent; and Jefferies Finance LLC, as Issuing Bank and Swingline Lender (incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K, filed November 26, 2013).†
 
- 33 -
 

 

 
     
10.16
 
Security Agreement dated as of November 26, 2013 among Internap Network Services Corporation; the Guarantors party thereto; and Jefferies Finance LLC, as Collateral Agent ((incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K, filed November 26, 2013).†
     
10.17
 
Lease Agreement by and between Cousins Properties Incorporated and CO Space Services, LLC, originally dated January 10, 2000 and as amended through February 26, 2007 (incorporated herein by reference to Exhibit 10.20 to the Company’s Annual Report on Form 10-K, filed February 24, 2011).†§
     
10.18
 
Joinder Agreement to the Employment Security Plan executed by Steven A. Orchard (incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K, filed May 6, 2010).+
     
10.19
 
Offer Letter between the Company and Eric Cooney, dated January 16, 2009 (incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K, filed February 2, 2009).+
     
10.20
 
Joinder Agreement to the Employment Security Plan executed by Eric Cooney (incorporated herein by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K, filed February 2, 2009).+
     
10.21
 
Employment Security Agreement executed by Kevin M. Dotts (incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K, filed July 26, 2012).+
     
10.22
 
2014 Short Term Incentive Plan (incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K, filed February 21, 2014).+
     
21.1*
 
List of Subsidiaries.
     
23.1*
 
Consent of PricewaterhouseCoopers LLP, Independent Registered Public Accounting Firm.
     
31.1*
 
Rule 13a-14(a)/15d-14(a) Certification, executed by J. Eric Cooney, President and Chief Executive Officer of the Company.
     
31.2*
 
Rule 13a-14(a)/15d-14(a) Certification, executed by Kevin M. Dotts, Chief Financial Officer of the Company.
     
32.1*
 
Section 1350 Certification, executed by J. Eric Cooney, President and Chief Executive Officer of the Company.
     
32.2*
 
Section 1350 Certification, executed by Kevin M. Dotts, Chief Financial Officer of the Company.
     
101*
 
Interactive Data File.
 

*
Documents filed herewith.
+
Management contract and compensatory plan and arrangement.
Schedules and exhibits have been omitted pursuant to Item 601(b)(2) of Regulation S-K. The Company hereby undertakes to furnish supplementally copies of any of the omitted schedules and exhibits upon request by the Securities and Exchange Commission.
§
Confidential treatment has been requested for this exhibit. The copy filed as an exhibit omits the information subject to the request for confidential treatment.
 
- 34 -
 

 

 
SIGNATURES
 
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
 
INTERNAP CORPORATION
Date: February 19, 2015
   
 
By:
/s/ Kevin M. Dotts
 
   
Kevin M. Dotts
   
Chief Financial Officer
   
(Principal Accounting Officer)
 
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following persons on behalf of the Company and in the capacities and on the dates indicated:
 
Signature
 
Title
 
Date
 
 
 
 
 
/s/ J. Eric Cooney
 
 
 
 
J. Eric Cooney
 
President, Chief Executive Officer and Director
 
February 19, 2015
 
 
(Principal Executive Officer)
 
 
 
 
 
 
 
/s/ Kevin M. Dotts
 
 
 
 
Kevin M. Dotts
 
Chief Financial Officer
 
February 19, 2015
 
 
(Principal Accounting Officer)
 
 
 
 
 
 
 
/s/ Daniel C. Stanzione
 
 
 
 
Daniel C. Stanzione
 
Non-Executive Chairman and Director
 
February 19, 2015
 
 
 
 
 
/s/ Charles B. Coe
 
 
 
 
Charles B. Coe
 
Director
 
February 19, 2015
 
 
 
 
 
/s/ Patricia L. Higgins
 
 
 
 
Patricia L. Higgins
 
Director
 
February 19, 2015
 
 
 
 
 
/s/ Gary M. Pfeiffer
 
 
 
 
Gary M. Pfeiffer
 
Director
 
February 19, 2015
 
 
 
 
 
/s/ Michael A. Ruffolo
 
 
 
 
Michael A. Ruffolo
 
Director
 
February 19, 2015
 
 
 
 
 
/s/ Debora J. Wilson
 
 
 
 
Debora J. Wilson
 
Director
 
February 19, 2015
 
- 35 -
 

 

 
Internap Corporation
Index to Consolidated Financial Statements
 
 
i
 

 

 
 
To the Board of Directors and Stockholders of Internap Corporation:
 

In our opinion, the consolidated financial statements listed in the index appearing under Item 15(a)(1) present fairly, in all material respects, the financial position of Internap Corporation and its subsidiaries at December 31, 2014 and December 31, 2013, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2014 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule appearing under Item 15(a)(2) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control - Integrated Framework 2013 issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the Report of Management on Internal Control Over Financial Reporting appearing under item 9A. Our responsibility is to express opinions on these financial statements, on the financial statement schedule, and on the Company's internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included 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. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

 

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

 /s/ PricewaterhouseCoopers LLP
Atlanta, GA
February 19, 2015
 

 

F-1
 

 

 
INTERNAP CORPORATION AND SUBSIDIARIES
(In thousands, except per share amounts)
                   
   
Year Ended December 31,
 
   
2014
   
2013
   
2012
 
Revenues:
                 
Data center services
  $ 242,623     $ 185,147     $ 167,286  
Internet protocol (IP) services
    92,336       98,195       106,306  
Total revenues
    334,959       283,342       273,592  
                         
Operating costs and expenses:
                       
Direct costs of network, sales and services, exclusive of depreciation and amortization, shown below:
                       
   Data center services
    106,159       92,564       90,604  
   IP services
    38,787       39,448       40,350  
Direct costs of customer support
    36,804       29,687       26,664  
Direct costs of amortization of acquired and developed technologies
    5,918       4,967       4,718  
Sales and marketing
    37,845       31,800       31,343  
General and administrative
    43,902       42,759       38,635  
Depreciation and amortization
    75,251       48,181       36,147  
Loss (gain) on disposal of property and equipment, net
    112       9       (55 )
Exit activities, restructuring and impairments
    4,520       1,414       1,422  
   Total operating costs and expenses
    349,298       290,829       269,828  
(Loss) income from operations
    (14,339 )     (7,487 )     3,764  
                         
Non-operating expenses:
                       
Interest expense
    26,742       11,346       7,566  
Loss on extinguishment of debt
          881        
Other, net
    33       614       283  
   Total non-operating expenses
    26,775       12,841       7,849  
                         
Loss before income taxes and equity in (earnings) of equity-method investment
    (41,114 )     (20,328 )     (4,085 )
(Benefit) provision for income taxes
    (1,361 )     (285 )     453  
Equity in (earnings) of equity-method investment, net of taxes
    (259 )     (213 )     (220 )
                         
Net loss
    (39,494 )     (19,830 )     (4,318 )
                         
Other comprehensive (loss) income:
                       
Foreign currency translation adjustment, net of taxes
    (431 )     (464 )     84  
Unrealized loss on interest rate swap
    (36 )     (777 )      
Total other comprehensive (loss) income
    (467 )     (1,241 )     84  
                         
Comprehensive loss
  $ (39,961 )   $ (21,071 )   $ (4,234 )
                         
Basic and diluted net loss per share
  $ (0.77 )   $ (0.39 )   $ (0.09 )
                         
Weighted average shares outstanding used in computing basic and diluted net loss per share
    51,237       51,135       50,761  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
F-2
 

 

 
INTERNAP CORPORATION AND SUBSIDIARIES
(In thousands, except par value amounts)
       
   
December 31,
 
   
2014
   
2013
 
ASSETS
           
Current assets:
           
Cash and cash equivalents
  $ 20,084     $ 35,018  
Accounts receivable, net of allowance for doubtful accounts of $2,121 and $1,995, respectively
    19,606