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InterNAP Network Services (NASDAQ:INAP)

Q2 2013 Earnings Call

July 25, 2013 5:00 pm ET

Executives

Michael Nelson

J. Eric Cooney - Chief Executive Officer, President and Director

Kevin Mark Dotts - Chief Financial Officer, Principal Accounting Officer and Senior Vice President

Analysts

Andrew J. Nowinski - Piper Jaffray Companies, Research Division

Barry M. Sine - Drexel Hamilton, LLC, Research Division

Daniel L. Kurnos - The Benchmark Company, LLC, Research Division

Gray Powell - Wells Fargo Securities, LLC, Research Division

Colby Synesael - Cowen and Company, LLC, Research Division

Operator

Good day, ladies and gentlemen, and welcome to the Internap's Second Quarter 2013 Earnings Conference Call. [Operator Instructions] As a reminder, this call may be recorded. I would now like to introduce your host for today's conference, Michael Nelson, Senior Director of Investor Relations. You may begin.

Michael Nelson

Good afternoon, and thank you for joining us today. I'm joined by Eric Cooney, our Chief Executive Officer; and Kevin Dotts, our Chief Financial Officer. Following prepared remarks, we will open up the call for your questions. The slides we reference in the call are available on our website in the Presentation section on the Investor Relations page.

Non-GAAP reconciliations and our supplemental data sheet, which includes additional operational and financial metrics, are available under the Financial Information Quarterly Results section of our Investor Relations page.

Today's call contains forward-looking statements, including expectations regarding future performance and the drivers for long-term profitable growth; belief in our business strategy, including the benefits from investing in company-controlled colocation, hosting and cloud services and its impact on revenue per occupied square foot; timing for bringing new and expanded data centers online, and expectations regarding consolidation of our New York metro data center footprint; expectations regarding margins, churn, cash flow, returns on capital and capital expenditures. Because these statements are not guarantees of future performance and involve risks and uncertainties, there are important factors that could cause our actual results to differ materially from those in the forward-looking statements. We discuss these factors in our filings with the Securities and Exchange Commission. We undertake no obligation to amend, update or clarify these statements. In addition to reviewing the second quarter 2013 results, we will also discuss recent developments.

Now let me turn the call over to Eric Cooney.

J. Eric Cooney

Thank you, Michael, and good afternoon, everyone. We are pleased you could join us for our second quarter 2013 earnings presentation. I will start the discussion with a summary of our results and then turn the call over to Kevin Dotts, our Chief Financial Officer, to take you through our detailed financial results. From there, I will briefly wrap up our prepared remarks before we open up the call to take your questions.

Beginning on Slide 3, you will see we delivered total revenue in the second quarter of 2013 of $70 million, representing an increase of 2% year-over-year, and up slightly quarter-over-quarter. Consistent with our strategic plan, we continue to deliver growth from our core data center services business, including company-controlled colocation, hosting and cloud services. On a sequential basis, the growth in data center services revenue was largely offset by a decline in IP services revenue.

Despite minimal sequential revenue growth, segment profit and segment margin increased due to the favorable product mix shift. Segment profit totaled $37.3 million, an increase of 4% year-over-year and 1% quarter-over-quarter. Segment margin was 53.3%, an increase of 80 basis points year-over-year and 50 basis points sequentially. The primary driver for this increase in segment profit and segment margin was the solid growth in the data center services revenue and a larger proportion of higher-margin, company-controlled colocation, hosting and cloud services.

On Slide 4, we identified the sources of the change in revenue from the first quarter to the second quarter of 2013. Our core data center services remain the engine for top line company growth and contributed $1.2 million of incremental revenue in the quarter. Our core data center revenue represented over 70% of total data center revenue for the quarter. The growth in data center services revenue was partially offset by the continued decline in IP services revenue of $0.9 million.

Turning to Slide 5, I'll cover segment results. Data center services revenue totaled $45.6 million in the quarter, an increase of 10% year-over-year and 3% quarter-over-quarter. The revenue mix shift associated with the move away from partner data centers and into company-controlled data centers as well as hosting and cloud services revenue also helped deliver strong profitability growth.

Data center segment profit was up strongly, increasing 22% year-over-year and 5% quarter-over-quarter. Data center segment margin expanded 490 basis points year-over-year and 130 basis point sequentially to a company record level of 50.3%. This improvement in segment margin was achieved despite the negative impact of seasonal power cost increases tied to unusually high temperatures already experienced in many parts of the country during the second quarter.

In our IP services segment, revenue decreased year-over-year and sequentially to $24.4 million. IP segment margin decreased 60 basis points sequentially to 59% due to lower IP transit revenue and the lost legacy contracts. Given that our IP costs are largely fixed in the short term, we see the impact to IP segment margin. However, we would expect this margin impact to mitigate as we both replace the lost customer traffic and negotiate contract renewals at contract expiration with our backbone service providers, thereby lowering our underlying network costs.

Despite the revenue headwinds created by the declining IP services revenue, the segment continues to deliver solid segment profitability and cash flow, which we leveraged to invest in the more capital-intensive data center services segment. This allows us to maintain low financial leverage relative to many of our peers while also providing a key element of competitive differentiation for our data center services business.

In the second quarter, churn in our data center segment decreased 20 basis points year-over-year and 80 basis points sequentially to 0.8%. Churn in our IP segment increased 20 basis points year-over-year and 50 basis points sequentially to 1.9%. Total company churn remained flat year-over-year and decreased 30 basis points sequentially to 1.2%.

Looking into the second half of 2013, we may experience a modest increase in churn, driven largely by internal consolidation, as several of our customers rationalize their data center footprint.

Moving on to Slide 6, you can see we delivered a solid quarter of adjusted EBITDA and adjusted EBITDA margin. Second quarter adjusted EBITDA was $14.1 million, an increase of 15% year-over-year and a decline of 1% quarter-over-quarter. Adjusted EBITDA margin increased 240 basis points over the second quarter of 2012 and declined 20 basis points sequentially.

The year-over-year improvement in adjusted EBITDA and the associated margin expansion was predominantly the result of revenue and segment profit growth in data center services and positive operating leverage in our business model.

Cash operating expenses increased $0.6 million sequentially, largely due to annual employee merit raises and increased marketing expenses during the quarter.

On Slide 7, we thought it would be useful to provide further insight into some positive revenue trends within our data center services segment, which we feel are a result of the successful design and execution of our company's strategy.

First, you can see the historical trend and the solid 12% year-over-year and 4% sequential increase in data center services' ARPU we delivered in the second quarter. We feel this is indicative of not only the trend towards enterprises outsourcing their IT services, but also reflective of Internap's ability to capture a larger proportion of the enterprise customer spend with our platform of colocation, hosting and cloud services.

Further, we can also see the benefit of our platform's strategy reflected in the steady increase in the revenue per square foot generated from our company-controlled data centers.

As we seek to maximize the return on capital from our data center capital investments, we are pleased to fill our capacity with a mix of hybridized IT infrastructure services. As we continue to sell hosting and cloud services into the data center, the revenue per occupied square foot would be expected to increase.

To put this into perspective, managed hosting services can generate 10x and cloud services can generate 100x the revenue per square foot of traditional colocation services.

Moving on to Slide 8. We are providing an update on our data center expansion efforts. Expansion of our data center in Santa Clara is currently under way, and we have already brought online roughly half of the planned 5,000 net sellable square feet in response to customer demand. Likewise, we are on track for a third quarter 2013 expansion of approximately 5,000 net sellable square feet in our existing data center in Boston. Construction of our new premium company-controlled data center in Secaucus, New Jersey is under way. The first phase of this expansion project will include approximately 13,000 net sellable square feet, which is on track to come online in the fourth quarter of 2013. This new facility will be our 12th company-controlled facility across 8 North American markets and reflects continued strong demand for our core data center services solutions in the New York metro market.

As we complete the construction of this new facility, we intend to consolidate our data center footprint in the New York metro market. Prior to the lease expiration at the end of 2014 for our data center at 111 8th Avenue, we will migrate our colocation and hosting infrastructure into our new data center in Secaucus. This new state-of-the-art data center will again allow us to offer our customers the complete platform of hybridized IT services and to do so in the important New York metro market.

Finally, we think it's useful to review the positive results of our corporate strategy as seen in the data center segment profit and segment margin over the past 4 years. With a 30% compound annual growth rate in data center segment profit and a 2,520-basis point increase in segment margin over this period, it seems clear that we're on the right track and executing well.

Moving to Slide 9, we show how Internap is leveraging our best-in-class performance, platform flexibility and geographically distributed footprint to support companies with cloud-based applications.

TalentWise is a technology company that has built a single online platform that automates the hiring process and delivers the solution to their customers via Software-as-a-Service platform. Given this SaaS model, it's easy to appreciate why TalentWise required a low-latency, scalable and secure infrastructure that would allow the company to shift IT resources towards developing their own application and selecting an IT services partner to meet their critical IT infrastructure requirements.

TalentWise selected Internap to deploy a customed hosting platform for their primary site in Dallas, a disaster recovery site in Santa Clara and an additional development site in Seattle. Our ability to provide better performance and support in a multi-site environment has helped us earn this customer's business and established Internap as a partner for TalentWise's long-term IT infrastructure needs.

Now I will pass the call over to Kevin Dotts, our Chief Financial Officer, who will give us a more detailed review of our financial results. Kevin?

Kevin Mark Dotts

Thanks, Eric. I'll start my comments on Slide 10, which covers our income statement comparisons. Second quarter 2013 revenue totaled $70 million, a $1.3 million increase compared to the same period last year, representing 2% year-over-year growth. Compared to the first quarter of 2013, total revenue increased $0.3 million. The year-over-year and sequential increase were the result of higher core data center services revenue, offset by lower IP services revenue.

Total segment profit was $37.3 million, an increase of 4% year-over-year and 1% quarter-over-quarter. Segment margin expanded 80 basis points year-over-year and 50 basis points sequentially to 53.3%. Segment profit and segment margin were positively affected by solid growth in the data center services revenue and a large mix of higher-margin company-controlled colocation, hosting and cloud services.

Total cash operating expense of $23.3 million declined 3% year-over-year and increased 3% quarter-over-quarter. The year-over-year decrease was the result of benefits from the several internal programs implemented previously to increase efficiency and improve our cost structure. This sequential increase was largely driven by annual employee merit increases and benefits that went into effect on April 1, as well as modest increase in marketing expenses during the quarter. We remain focused on cost containment to help drive operational performance.

Cash operating expense to revenue was 32.2%, down from the same period a year ago, and up slightly sequentially. Adjusted EBITDA totaled $14.1 million, an increase of 15% year-over-year and a decrease of 1% quarter-over-quarter. Adjusted EBITDA was 20.1%, an expansion of 240 basis points year-over-year and a decline of 20 basis points sequentially. The solid year-over-year performance was driven by a favorable shift to higher-margin core data center services and the positive operating leverage we are building into the business.

GAAP net loss in the second quarter of 2013 was $3.7 million or $0.07 per share loss, an increase year-over-year and sequentially, primarily as a result of higher interest expense, depreciation and amortization expense attributable to our capital investments.

Normalized net income, which excludes the impact of stock-based compensation and certain items management considers nonrecurring, totaled a negative $1.3 million or negative $0.03 per share.

Cash flow and balance sheet summaries are shown on Slide 11. Capital expenditures exceeded adjusted EBITDA in the second quarter by $0.8 million, as we continue to invest in our company-controlled data center footprint. We expect our capital expenditures to ramp during the second half of 2013 as we build out our new data center in the New York metro market, as well as expand in our existing data centers in Santa Clara and Boston. We continue to expect to spend between $60 million to $65 million of CapEx in 2013.

At the end of the second quarter, cash and cash equivalents totaled $26.7 million. Funded debt totaled $103.7 million, roughly unchanged from prior quarter. As of June 30, 2013, our debt consisted of $63.2 million borrowed under our term loan and $40.5 million borrowed under our revolving credit facility. We also had $55.9 million in capital leases.

Our announced data center expansions are fully funded with our current debt facilities, cash generation and cash on hand. Day sales outstanding were 28 days in the second quarter and in line with our expectations.

On Slide 12, we highlight our capital flexibility and healthy balance sheet, with financial leverage that is below the average of our data center peers. Our net debt to last quarter annualized adjusted EBITDA was 2.4x compared to the average of 2.6x for the peer group. Likewise, we maintain a debt to capital of 45% versus 66% for our data center peers.

We retained substantial cash generation capability as evidenced by our discretionary cash flow defined as adjusted EBITDA less maintenance CapEx. Annualizing our second quarter adjusted EBITDA and subtracting for our full year 2013 maintenance CapEx guidance implies an annualized discretionary cash flow of roughly $41 million. We have a very disciplined approach to capital allocation, and we believe we have significant opportunity to invest in the business and generate returns well in excess of our cost to capital.

Now let me turn the call back to Eric for his closing remarks before we take your questions.

J. Eric Cooney

Thanks, Kevin. Now I'll briefly summarize on Slide 13. We believe our second quarter results affirm both the strategic direction we have chosen for the company, as well as demonstrate focused execution across the business. We continue to balance the favorable growth we are experiencing in our core data center services with the decline in our IP services business, while remaining confident in the strategic importance of our full suite of IT infrastructure services. The data center services segment delivered the highest levels of segment profits and segment margin in the history of the company, with segment profit up 22% and segment margin up 490 basis points year-over-year. Over the same period, adjusted EBITDA increased 15% and adjusted EBITDA margin increased 240 basis points, highlighting the successful execution of our data center services strategy and the solid operating leverage we are building into our business model.

Looking forward, we remain focused on executing the strategy we've put in place. We will continue to leverage our company-controlled data center capacity and look to fill this capacity with our full portfolio of hybridized IT infrastructure services, including colocation, hosting and cloud offerings. We remain on track to expand our footprint in 2013 in the New York metro market, as well as in Santa Clara and Boston markets in response to customer demand. Further, we continue to focus on operational excellence in support of long-term profitable growth for our shareholders.

Now we'd like to open up the call for your questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is from Andrew Nowinski of Piper Jaffray.

Andrew J. Nowinski - Piper Jaffray Companies, Research Division

I guess I'd like to get an understanding of your margin expansion opportunities. Your data center services margin expanded nicely, more than offsetting the decline in IP services. And I realized you had higher sales and marketing costs this quarter, but could you just provide some color on the pathways to expanding EBITDA margins longer term, and then the primary drivers there, given that this is the second consecutive quarter adjusted EBITDA has declined sequentially?

J. Eric Cooney

Long term, the expectation is that we can continue to drive an increase in EBITDA margin. And the fundamental premise behind that is the continued product mix shift of our business. Or said more specifically, as the revenue derived from core company-owned colocation, custom-hosting cloud offerings increases in proportion relative to the other revenue in the business, we would expect our EBITDA margins to increase. That is the strategy we've put in place several years ago and continue to execute.

Andrew J. Nowinski - Piper Jaffray Companies, Research Division

Have you given any sort of parameters in terms of what it could get to, do you think, over the next 2 years?

J. Eric Cooney

Well, internally, we hold ourselves up against, perhaps, what you might consider best-in-class peer group comparables. So as it relates to colocation, we're, of course, looking at companies like Equinix. And as it relates to hosting and cloud services, the closest publicly traded comparable is Rackspace. So those are the companies we internally focus on when we're setting our targets and budget expectations.

Andrew J. Nowinski - Piper Jaffray Companies, Research Division

Okay. Then just last question from me. I want to talk about the utilization rates, particularly at your company-controlled data centers. It looks like it was up 58% this quarter. And so as you bring on new capacity in Boston, Santa Clara and Secaucus, I guess, normally, we should expect that to go down initially, but I would guess that those markets are relatively stronger than some of your other locations. So you think we could see perhaps a quicker uptake at those sites?

J. Eric Cooney

For Boston and Santa Clara, it's absolutely the case that we are expanding in those markets in response to continued customer demand for data center services in those markets. So yes, we would expect to continue our success in filling net sellable square feet in those markets. Yes, you are correct. Mathematically, the first day we "opened up" incremental data center capacity, of course, the utilization percentage dropped. But yes, we expect to fill that up quite quickly.

Operator

Our next question is from Barry Sine of Drexel Hamilton.

Barry M. Sine - Drexel Hamilton, LLC, Research Division

First question, I guess, for Eric. Last conference call, you talked a little bit about product roadmap and you talked about perhaps some new products and features coming out in the second half of this year. We've seen what you've announced on the Cloudy Colo product offering. Could you get a little more explicit in terms of what you're looking at in terms of second half product roadmap? And is there anything do you expect might really move the needle in terms of revenue and/or revenue per customer?

J. Eric Cooney

I'd prefer not to be specific in terms of, call it, near-term product features and functions other than to say we're primarily focused on our hosting and cloud offerings. So the majority of our incremental feature function releases here in the second half will be as part of our hosting cloud offerings. And in terms of the impact on revenue growth, it's a recurring revenue model, obviously, so short-term impact to revenue on new product releases tends to be pretty modest. But clearly, the expectation is long term where we're driving sustainable competitive differentiation, and that's where we expect the value to come into play.

Barry M. Sine - Drexel Hamilton, LLC, Research Division

Okay. And my other question, I guess, is for Kevin. On Slide 12, on the top, where you talked about the potential cash flow from the company, $41 million, if we could discuss a little bit what you're thinking is longer term on CapEx, and I guess the way I want to address that is when you talk about some of the data centers you're not building and expanding this year, is there anything -- any other data centers that's getting near capacity where you're going to have to spend a significant more capital, let's say, in 2014, 2015, or do we start to really ramp down CapEx and get close to that discretionary cash flow number you talked about?

Kevin Mark Dotts

I think at this point, right, we are anticipating that will begin to see some leverage going forward. The -- I would say as the business has looked at its capital expenditure spend over the past several years, Barry, I don't think we're going to be running it, let's say, necessarily at the rates that we saw last year. Obviously, by the guidance that we gave this year at 60, 65, we're beginning to see that rate. I don't know if that is exactly a linear trend downwards, from 75 down to the 60, 65. I do think that it kind of attenuates as a curve at this point. Naturally, it's all going to be driven by take rates, and geographically, where those take rates are and available capacity. And we continue to think about that investment. As we said in past is basically are we delivering the right return on investment. If we can continue to spend capital and build out capacity and assure ourselves that we're continuing to get those types of returns that we believe we're getting, then we'll continue to deploy that CapEx.

J. Eric Cooney

I would just add 2 -- maybe 2 comments to Kevin's remark. One is just reminding everybody, as one of the previous callers highlighted, our utilization today in company-controlled data centers is below 60%. So without a doubt, our priority is to take advantage of that opportunity and fill that capacity. Whether we do that with colocation, hosting or cloud services, we're equally happy in terms of return on capital. The other thing that I would mention is -- and it wouldn't be immediately obvious from our recent expansions, is particularly with regard to the Atlanta and Santa Clara markets, we have seen strength in sales in those markets. And even though we've relatively recently expanded, we will, in the future, be driven by local market capacity constraints. So to the extent that we continue successful selling into markets like Atlanta and Santa Clara, it's possible that we may need incremental expansions in those markets even as early as 2014. But if we do, reasonable to assume that's a good problem to have because it's indicative of successfully selling up the capacity we have already brought online in those markets.

Operator

Our next question comes from Dan Kurnos of The Benchmark.

Daniel L. Kurnos - The Benchmark Company, LLC, Research Division

I just want to ask you a couple of high-level questions first. We've kind of seen an evolution of the space recently where we see this mix shift from colo to cloud, and there's been a lot of talk of cloud replacing colo. I think everybody understands that long term, that's not really a viable solution. In your results this quarter, it might seem to indicate that maybe cloud outperformed a little bit, and colo maybe slightly underperformed. We also saw that with Equinix. Could you sort of talk to the evolving landscape on how you guys are positioning yourselves?

J. Eric Cooney

Sure. So I guess I'll reiterate your inference in that. We don't see and haven't developed a strategy with an expectation that cloud replaces colocation. Our expectation is that there will, for a long period of time, be clear and significant customer demand for colocation as a product. That being said, one of Internap's key elements of competitive differentiation and foundation for our strategy is a belief that we can optimally serve the market and maximize our returns on capital by going to market with a platform of integrated data center services, including colocation, hosting and cloud. So that's a key tenet of our underlying basis for competitive differentiation. The other thing that I would mention or highlight is there are definitely differences in both the market growth rates and certainly Internap's growth rates across, if we say, those 3 different products: Colocation, hosting and cloud services. And in general terms, the hosting and cloud growth rates exceed both in terms of expected market growth rate, as well as reflected in Internap's internal growth rate. In general, hosting and cloud exceed the colocation growth rates.

Daniel L. Kurnos - The Benchmark Company, LLC, Research Division

And then turning to Equinix again, just for a second, they did mention in their remarks that they did see longer sales cycles in the enterprise segment, along with the reduction in average deal size. Given the changing ecosystem, you guys seem to actually perform well, at least in your prepared remarks, in the enterprise segment. Do you think that maybe you guys were able to take share on an incremental basis from them? Is it a platform differential? Or are you seeing different dynamics than they are in the market?

J. Eric Cooney

Well, I'll keep my remarks to Internap's experiences. And all I can say is, from our perspective, I would not suggest we've seen an increase in the sales cycle and our, if you will, average deal size tends to be and has been trending up. So I'll leave it to Equinix to provide further clarity on their remarks, but not something we've seen from Internap's standpoint.

Daniel L. Kurnos - The Benchmark Company, LLC, Research Division

Great. And maybe just one more high level one and I guess I'll jump back in the queue. I don't think that this has a major impact in your business, but since Google has entered the cloud space, and we've seen both Microsoft and AWS get more aggressive in response, have you seen any trickle-down effect from that so far?

J. Eric Cooney

We've not, specifically. Having said that, we're obviously mindful that in relative terms, I mean Internap is a small company as compared to the likes of AWS and Google. That being said, the impact for us is that we work very hard from a strategic standpoint to understand what is going to be Internap's basis for long-term competitive differentiation in a market with players like that. And you can conclude safely that we spend a lot of time thinking about that and think we've put in place a strategy that will carve out a healthy niche of market for Internap, and in so doing, allow us to deliver a very healthy return on the capital we're investing in these platforms.

Operator

Our next question is from Gray Powell of Wells Fargo.

Gray Powell - Wells Fargo Securities, LLC, Research Division

Maybe I can just start with sort of a high level one. What vertical does your hybrid cloud and colocation message resonating with us today? And the use case you've shown in the slide deck was helpful. Can you just talk about the -- like just general use cases and applications where it makes the most sense for customers to deploy a hybrid architecture versus a pure colo cloud.

J. Eric Cooney

Sure. So I'll start by saying the majority of customers requirements and the majority of application workloads that are being deployed today are not in fact utilizing a hybrid IT infrastructure, hybrid in the sense meaning a combination of colo and hosting or colo and cloud infrastructure. So again, the majority of workloads and customer decisions today are not deploying that -- leveraging that hybrid infrastructure. That being said, increasing frequency and quantity of customer-buying decisions, in our opinion, are being heavily influenced by the service provider, Internap, in this case, service provider's ability to offer a hybrid IT infrastructure solution because customers expect that in the future, they will need to or want to leverage that hybrid infrastructure to get the best combination of cost, performance, benefit. So today, it's a basis for competitive differentiation in many of the discussions we're in and I think a significant reason why when customers choose Internap, they are choosing us. To be specific about verticals, I think the best way to answer that is to reflect some of our remarks and maybe some of our slides from previous presentations, where you'll see that we've highlighted verticals including gaming, health care, Software-as-a-Service, big data or, if you will, online advertising has likewise been and remains a key segment for us. Across all of those verticals, my comments about hybrid infrastructure would consistently apply.

Gray Powell - Wells Fargo Securities, LLC, Research Division

Got it. That's helpful. And then maybe more of, I guess, a modeling question, if I may. So obviously, you saw a good improvement in sequential data center revenue growth in Q2 from Q1. Specifically, if I just look at total data center revenue, you grew about 2.7% quarter-over-quarter versus 1.6% last quarter. However, if I can just dissect it a little bit and roughly speaking, if I hold the third-party colocation flat, I get closer to a 4% sequential growth rate and sort of the core company-owned data center business, which was pretty good. So I guess I was just asking, is my math in the ballpark? And how should I think about that core data center revenue growth trending longer term?

J. Eric Cooney

Your math sounds a little high to me, but I guess we can take that offline and understand what -- how you're breaking down company-controlled versus partner data center. What I might suggest is we do continue to sell, on an exception basis, small amounts of partner data center. Clearly, not a primary driver for our business, but there is some of that in there. That being said, macro level, company-controlled colocation, you probably seen some of the same market reports I have, which suggest that the industry is growing. I've seen some reports that suggest low double-digits, I've seen others that perhaps suggest about a 15% growth rate. So we're internally challenging ourselves to grow at or above market with our company-controlled colocation profit line.

Gray Powell - Wells Fargo Securities, LLC, Research Division

Got it. And then just last one, can you talk about the pricing environment? There's been some discussion of wholesale players getting more aggressive, I guess, maybe doing smaller deals. Do you see any evidence of that at all in your markets?

J. Eric Cooney

I would say that probably starting 2 years ago, maybe slightly more, I think it's fair to say that we saw an increase in frequency of larger wholesale providers coming, let's say, downsize in terms of the types of footprint or quantity of power that they would pursue. That being said, I've not seen any recent change in the competitive dynamic as it relates to the competition between wholesale and retail data center providers.

Operator

Our next question comes from Colby Synesael of Cowen and Company.

Colby Synesael - Cowen and Company, LLC, Research Division

Two questions if I may. The first one, just want to get a little bit more color on the consolidation in New York that you talked about. You may have mentioned it, but I didn't hear it, as it relates to the timing on that, and what the potential of the cost savings from that move could actually end up being. And then just kind of thinking more broadly about consolidation of your portfolio of facilities, you obviously still have a decent amount of second-party or reseller facilities. What's the level of importance in terms of potentially getting out of some of those sooner rather than later, maybe shifting some of those customers to your actual controlled facilities where you can and trying to capture that cost savings. It seems like that's still a big opportunity if you guys chose to focus on that more.

J. Eric Cooney

So with regard to the 111 8th New York data center, that is currently one of Internap's company-controlled data centers. So in terms of the financials, segment margins and EBITDA margins, we have already pretty healthy margins in that 111 8th data center. As that lease in the, what is better known as the Google building in New York, comes to an end at the end of 2014, we, for various reasons, have concluded that the best option for Internap is to migrate our infrastructure out of that 111 8th building and into our brand-new Secaucus data center. So again, to be clear though, in terms of the cost savings from a pure colo in 111 8th to colo in Secaucus data center, there's probably a modest improvement, but not a massive improvement, because 111 8th isn't a "partner data center" for us.

Colby Synesael - Cowen and Company, LLC, Research Division

But what about from a rent perspective, though?

J. Eric Cooney

Certainly, rents are cheaper in Secaucus, but recognize that our 111 8th rent was derived from well over 10 years ago in terms of the market pricing in New York. So clearly, current rates are significantly higher than they were at the time we negotiated that deal. So again, we'll still see modest costs or margin benefit, but probably not as dramatic as you might expect going from a partner facility into a company-owned facility.

Gray Powell - Wells Fargo Securities, LLC, Research Division

And I guess on the other consolidation opportunities, partner facilities?

J. Eric Cooney

So sure, we have, as you know, a number of other partner facilities. And I guess what I would say is, we look at each of those, both when the underlying customer contracts come up for renewal, so in many cases, our partner facility contract terms are directly linked to our underlying customer contract terms. So we'll look at those on a case-by-case basis as the customer contract comes up for renewal. In a handful of cases, we have partner contract lease terms that aren't specifically lined up with individual customer contracts. So in those cases, when the bigger footprint for the partner lease comes up for renewal, we have a, let's say, a more significant decision to make in terms of whether we renew that lease and keep those partner facilities intact. We've not, thus far, made a financial decision to exit any significant partner facilities. We, of course, reserve the right to do that on a go-forward basis. But the decision to do that is cash flow and profitability driven and is ultimately down to a combination of the sale prices we've derived in the underlying customer contracts and the combination of the -- our ability to negotiate new rental rates with the partner data center provider. So I can't give you any explicit guidance on future partner moves, but other than to tell you that we do look at every single one of those on a case-by-case basis when they come up and just simply seek to drive profitable growth for Internap as a result of the negotiations.

Colby Synesael - Cowen and Company, LLC, Research Division

Have you maybe not prioritized that higher on the list of things to do because there's simply been so much -- other things going on in part, in terms of how you've been using your balance sheet to fund the CapEx spending? And maybe with that coming down a little bit, you'd have more financial flexibility to focus on these things, as well as time. Or is it simply that it's just too difficult or it's too tedious in terms of moving each of these customers on a case-by-case basis that's just not necessarily an obvious area for savings?

J. Eric Cooney

Well, the -- I'll tell you the priority is maximizing profitability. So to the extent there's a significant upside in terms of cash or profitability that we can bring to the business by "churning" a partner or migrating a partner office facility, we'll absolutely pursue that. But you can presume that at least over the past 18 to 24 months since we stopped our proactive or finished our proactive churn program, that in all the cases that have come up in that time, that profitability metric has adjusted. We were acceptable to keep those customers in the -- keep the revenue and profitability in those partner facilities.

Operator

Thank you. I'm not showing any further questions in the queue. I'd like to turn the call back over to Michael for any further remarks.

Michael Nelson

Thank you. That concludes our second quarter 2013 earnings call.

Operator

Ladies and gentlemen, thanks for participating in today's conference. This concludes today's program. You may all disconnect. Everyone, have a great day.

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Source: InterNAP Network Services (INAP) Management Discusses Q2 2013 Results - Earnings Call Transcript

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