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Internap Network Services (NASDAQ:INAP)

Q1 2011 Earnings Call

April 28, 2011 5:00 pm ET

Executives

J. Cooney - Chief Executive Officer, President and Director

George Kilguss - Chief Financial Officer, Principal Accounting Officer and Vice President

Andrew McBath - Director of Investor Relations

Analysts

Colby Synesael - Cowen and Company, LLC

Gray Powell - Wells Fargo Securities, LLC

Donna Jaegers - D.A. Davidson & Co.

Mark Kelleher - Dougherty & Company LLC

Jonathan Atkin - RBC Capital Markets, LLC

Erik Suppiger - Signal Hill

Clayton Moran - The Benchmark Company, LLC

Operator

Good day, ladies and gentlemen, and welcome to the Internap Network Services First Quarter 2011 Earnings Conference Call. [Operator Instructions] Now I would like to turn the conference over to your host, Mr. Drew McBath.

Andrew McBath

Thanks, Matthew. Good afternoon, and thank you for listening in today. I'm joined by Eric Cooney, our President and Chief Executive Officer; and George Kilguss, our Chief Financial Officer. Following prepared remarks, we will open up the call for your questions.

We will reference slides in our conference call today. These slides are available in the presentation section of Internap's Investor Services website. Non-GAAP reconciliations in our supplemental data sheet, which includes additional operational and financial metrics, are available under the Financial Information Quarterly Results section of our Investor Services site.

Today's call contains forward-looking statements, including our expectations regarding future financial performance, including profitability and achievement of top line growth in both business segments, our expectations that first quarter 2011 is the last quarter in which we will be impacted by completed proactive churn program, industry growth rates, expected results from our strategy to invest in sales, marketing, engineering and operations staff, our business strategy including expected results from investing in company-controlled data centers which we expect to result in future growth, and our expectations regarding new markets, the timing for bringing new data centers online and our belief that we can accelerate selling into new company-controlled data center space.

Because these statements are not guarantees of future performance and involve risks and uncertainties, important factors could cause our actual results to differ materially from those in the forward-looking statements. We discussed 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 first quarter 2011 results, we will also discuss recent developments.

Now let me turn the call over to Eric Cooney.

J. Cooney

Thank you, Drew, and good afternoon, everyone. Thank you for joining us for our first quarter 2011 financial results presentation.

I'll start off with a summary of our first quarter results and then George will detail our quarterly financial results and operating metrics. I will then conclude with a high-level summary, and we will open the call for your questions.

We've summarized revenue and segment profitability results in the period on Slide 3. Revenue decreased $4 million year-over-year and $0.6 million compared with the fourth quarter of 2010. The year-over-year and sequential declines were primarily driven by our initiative to exit low-margin and negative-margin contracts in select partner data centers. As I will detail in a moment, this program was completed in the fourth quarter of 2010, and the final revenue impact was evident in first quarter results. We expect that first quarter 2011 is the last quarter in which revenue is impacted by the now successfully completed proactive data center churn program.

Our segment profit and segment margin continues to improve steadily. Segment profit improved $0.9 million sequentially and $1.1 million over the same quarter last year. The combination of higher absolute segment profit on a smaller revenue base has significantly benefited our segment margin over the past year. Segment margin improved 490 basis points year-over-year. Sequentially, segment margin increased 200 basis points. Beyond the immediate benefit of higher segment profitability, the implication for future sales of company services into this significantly higher segment profit margin bodes well for the company's long-term profitable growth.

On Slide 4, we've detailed the basis for the sequential decline in revenue. Of the $0.6 million quarter-over-quarter decrease, $0.4 million came from IP services. Based on bookings and churn trends, we continue to expect the IP segment to show sequential revenue growth in the second quarter of 2011. As we described last quarter, we completed our data center profitability program at the end of fourth quarter 2010. $0.8 million of the quarter-over-quarter revenue decline was attributable to this program and the associated exit of low-margin contracts.

While we exited the contracts during the fourth quarter, the full revenue impact was not evident until the first quarter of 2011. We do not expect this flow-through effect to impact our future sequential quarterly comparisons in the Data Center Services segment. Beyond this proactive data center churn impact, the remaining Data Center Services revenue increased $0.6 million compared with the fourth quarter.

We were particularly pleased with the first quarter revenue growth rates in both our company-controlled Data Center and Managed Hosting businesses. We feel these businesses are delivering revenue growth at or above market rates, which we believe are in the 15% to 20% range.

Moving on to Slide 5. We generated $9.2 million in adjusted EBITDA in the quarter. Adjusted EBITDA decreased $0.7 million year-over-year and $1.1 million, sequentially. Improvements in segment profit were offset by higher operating costs in the quarter relative to both comparable quarters. Sequentially, operating costs increased by $2 million as we added more than 20 new staff in sales, marketing, engineering and operations while also incurring costs associated with our annual sales kickoff meeting and certain targeted marketing initiatives. We believe these investments are appropriate and are expected to support future top line growth.

I'll cover segment results on Slide 6. In Data Center Services, our results were similar to last quarter. A strong quarter-over-quarter profitability increase on essentially flat sequential revenue as we sold through the final remnants of the proactive data center churn program, Data Center Services revenue declined $2.2 million year-over-year and $0.2 million compared with the fourth quarter of 2010. Segment profit in Data Center Services improved $2.3 million compared with the first quarter of 2010 and $0.8 million sequentially, representing 22% and 7% increases, respectively. Data Center segment margin has also shown a strong improvement, rising 960 basis points over the first quarter of 2010, and 280 basis points compared with the fourth quarter of 2010 to 41.3%.

In IP Services, revenue decline continued to slow. Compared with the first quarter of 2010, IP revenue decreased 6%. Sequentially, the decline was 1% or $0.4 million. IP segment profit, while down year-over-year due to the decrease in revenue, increased sequentially for the first time since the fourth quarter of 2009. Segment margin in this business remained strong. First quarter IP segment margin increased 120 basis points quarter-over-quarter to 62.3%. Compared with the prior year's quarters, segment margin declined 50 basis points.

As mentioned earlier, we expect IP Services revenue to grow sequentially in the second quarter of 2011. Our IP business unit product offering, including both IP Transit and CDN Services, continues to provide a key element for the competitive differentiation of our Data Center Services offerings.

Our colocation and managed hosting customers continue to remind us that our IP products are a key factor in their purchase decision. The company's intelligent IT infrastructure solutions differentiated by best-in-class performance availability and support are a compelling offer for the enterprise IT customer.

Moving on to Slide 7. We announced today that we will construct a new data center in Los Angeles, marking our third new North American market and seventh expansion announcement since the fourth quarter of 2009. Our Los Angeles facility will total 55,000 net sellable square feet, likely opened in 5 phases. The first of which we expect to bring online in the second quarter of 2012 with approximately 15,000 net sellable square feet.

Clearly, our data centers provide the platform from which we expect to deliver profitable growth across the complete portfolio of IT infrastructure services, including connectivity, colocation, managed hosting and cloud. Over the past year, we've added 34,000 net sellable square feet to our company-controlled inventory.

Since the first quarter of 2008, we've increased our company-controlled footprint by 58,000 net sellable square feet. With 41% of our company-controlled data center footprint deployed within the past 3 years, we regularly see a competitive benefit derived from our use of the latest innovations in data center design, including scalable power and cooling densities, environmental efficiencies, and state-of-the-art high reliability architectural designs.

On Slide 8, we've broken out occupancy figures to give you a sense for the progress we are making in selling into the company-controlled capacity we are deploying. We expect we can accelerate this trend with an expanded focused sales force and new capacity in the Dallas and Los Angeles markets coming online over the next several quarters.

In the first quarter, company-controlled occupied square footage increased 16% year-over-year. Sequentially, occupancy increased 5%. Utilization on both partner and company-controlled data center footprint was 68% in the quarter as we brought online an incremental 7,000 square feet in Boston. Total data center revenue per square foot increased 4% year-over-year. Churn of customers at lower price points and partner data centers, combined with stable pricing in company-controlled data centers, helped increase this year-over-year per unit metric.

On Slide 9, we provide some visibility to a few recent key enterprise customer wins, which provide a sense of where we are winning and why. In the first quarter, we sold a complex managed hosting and connectivity solution to a large digital media publisher that required a highly skilled provisioning and support staff and flexible data center infrastructure. A medical device manufacturer looked to us to provide premium colocation and optimized connectivity. Our data center design and availability standards as well as our support capabilities proved pivotal in winning this deal. This is increasingly common feedback from customers that have selected our colocation services.

We also recently closed on an agreement to provide content delivery services to a digital media distribution company. A scalable and reliable network combined with a robust service level agreement and strong support staff helps drive this win.

In total, these deals represented approximately $2.2 million in annual contract value and reflect the type of enterprise customers who are increasingly drawn to intelligent IT infrastructure solutions. Now let me turn the presentation over to George to take you through some additional financial and operational results.

George Kilguss

Thank you, Eric, and good afternoon, everyone.

Beginning on Slide 10. Total revenue in the period declined by $600,000 compared with the fourth quarter of 2010 and $4 million compared with the first quarter last year. Both the year-over-year and the sequential decline was primarily driven by our data center proactive churn program, which we completed in the fourth quarter of 2010. Net of the forced churn program in Q4, total revenue increased modestly quarter-over-quarter.

Total segment profits improved $1.1 million year-over-year and $900,000 sequentially. This profitability increase reflects the impact of our churn initiative and our refocus on the development, deployment and the sale of higher-margin Internap-owned services. With the increased operating leverage we are building, particularly in our Data Center Services business, improvements in our revenue trajectory should help drive more profit for every incremental dollar of revenue that we generate.

Cash operating expense was $21.2 million in the first quarter, increasing $1.8 million year-over-year and $2 million sequentially. The primary contributor to this OpEx increase was the addition of 21 employees quarter-to-quarter in sales, marketing, operations and engineering, which increased our cash compensation cost. These investments are directed toward revenue-generating activities in an effort to enable top line growth which we believe will begin to emerge in the second quarter. In addition, approximately $600,000 of the sequential increase was due to executive severance cost that will not reoccur in the second quarter.

Adjusted EBITDA in the first quarter totaled $9.2 million and decreased $700,000 compared with the first quarter a year ago and $1.1 million compared with the fourth quarter of 2010. Increased cash operating expense more than offset the increased segment profit in both comparable periods.

Adjusted EBITDA margin was 15.5% compared with 15.6% in the first quarter of 2010 and 17.1% in the fourth quarter of last year. Our GAAP net loss was $1.5 million in the quarter, a decrease compared with the first quarter of 2010 and sequentially.

Normalized net loss, which excludes the impact of stock-based compensation and a $200,000 non-cash charge to restructuring expense, totaled $400,000 or $0.01 per share.

Turning to a summary of our cash flow and balance sheet on Slide 11. Capital expenditures outpaced adjusted EBITDA for the quarter by $3.5 million. First quarter capital expenditures totaled $12.7 million. Three quarters of this amount was spent in our Data Center Services business segment and was primarily attributable to our data center expansions in Boston and Dallas. We believe these investments are fundamental to our strategy of providing a full portfolio of high-performing IT infrastructure services and generate strong returns on capital in the coming years.

At March 31, 2011, cash and cash equivalents totaled more than $46 million. Funded debt totaled $19 million and remained flat compared with the prior quarter. Capital leases increased $9 million over December 31, 2010, to $29 million as we entered into a new lease agreement for our new company-controlled data center in Dallas.

A continuing strength for the company is our solid financial position. At the end of the first quarter, we maintained a liability-to-equity ratio of 56%, a figure well below the peer group. Days sales outstanding improved slightly to 25 days in the first quarter compared to 26 days last quarter.

Moving on to Slide 12. I'd like to cover our segment results in more detail. Data Center Services revenue totaled $31.5 million in the quarter, down from $2.2 million year-over-year and $200,000 sequentially. While our proactive churn program was completed at the end of the fourth quarter, we had a headwind of approximately 800,000 of low-margin partner revenue that was included in the fourth quarter revenue but was not present in our first quarter revenue as it was churned out late in the fourth quarter. This impact more than offset the quarter-over-quarter revenue growth of approximately $600,000 in Data Center Services.

Our data center profitability program continues to drive measurable increases in Data Center Services segment profit and margin. Absolute segment profit improved 22% year-over-year and 7% sequentially, despite decreases in revenue over the same periods. Data Center segment margin has also shown strong improvement, rising 960 basis points compared with the first quarter of 2010 and 280 basis points over the fourth quarter of 2010. Data Center revenue churn in the first quarter was 1.1% compared with 2.1%, both in the first and in the fourth quarters of 2010.

In our IP Services segment, revenue totaled $27.9 million, down from $29.6 million a year ago and $28.2 million compared with the prior quarter. Lower network costs and moderating revenue declines, however, allowed the IP segment profit and IP segment margin to improve sequentially in the first quarter.

IP churn totaled 1.4% in Q1 and remained in check, trending up only modestly versus historically low fourth quarter. As Eric mentioned in his remarks earlier, all of the products we sell within the IP Services segment helped differentiate our complete portfolio of IT infrastructure services. In addition to a flexible data center platform where customers can select colocation, managed hosting and ultimately, cloud, we have connectivity technologies like performance IP, zip application acceleration, and content delivery that provide superior performance and availability all the way to the end user.

I'll close on Slide 13. I'd like to point out that we've seen across-the-board section of our operating metrics improve over the past several quarters. Revenue churn, exclusive of our proactive churn program, has steadily trended down over the past 2 years, while bookings have continued to trend upward. Our quarterly net customer losses have moderated substantially since the fourth quarter of 2009, and our net promoter score, a measure that gauges the percentage of our customers likely to recommend us to others, has improved more than 20 points over the past 12 months. We believe the actions we have taken to improve operations, expand our set of higher-margin services and the refocusing of our sales and marketing teams are having positive effects.

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

J. Cooney

Thanks, George. I'll sum up on Slide 14.

With the return to revenue growth expected in the second quarter, we are continuing our investments in sales and marketing activities as well as engineering and operations to enable us to sustain and accelerate long-term profitable growth. In our Data Center Services segment, we are successfully executing on a number of fronts. We are actively filling existing company-controlled capacity and deploying additional company-controlled capacity in key markets to lay the foundation for future growth while simultaneously delivering substantial improvements to segment profitability. In IP Services, segment profit has stabilized, and we are executing the strategy to support revenue growth based, in part, on an expanded and enhanced product offering for both IP transit and content delivery services.

Looking ahead, we expect sequential revenue growth in both business units in the second quarter on a more profitable margin base. Our company-controlled data center investments in Boston, Seattle, Santa Clara, Dallas and now Los Angeles, along with ongoing product development initiatives, will help support this return to top line growth and provide the platform for sustained long-term profitable growth of the business.

Now we'd be happy to take your questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Erik Suppiger from Signal Hill.

Erik Suppiger - Signal Hill

A few questions here. First off, why did you choose to hire -- you stepped up your hiring pretty aggressively this quarter. Why did you choose to do that this quarter?

J. Cooney

Well, we actually made the decision in terms of staffing for 2011 back in early Q4 time frame, so the timing wasn't a January decision per se. But the reasons behind the incremental staffing are primarily focused on adding extra sales folks and adding extra engineering development staff, both of which we think are necessary to support and accelerate the long-term growth of the company.

Erik Suppiger - Signal Hill

Do you expect to continue a relatively aggressive hiring or is this kind of an anomaly?

J. Cooney

I would say, no. We don't expect aggressive continuing of hiring of staff. We finished the quarter with just over 430 staff and while we have some marginal incremental headcount expansions through the remainder of the year, I would not expect "aggressive additions" from this point forward.

Erik Suppiger - Signal Hill

If you look at your -- I think it was the G&A that popped up this quarter. Do you expect that to stay at these levels or continue growing from these levels?

J. Cooney

We're not providing explicit guidance, but I'll suggest to you that the OpEx level we achieved in Q1 is probably a reasonable number for the company for the foreseeable future.

Erik Suppiger - Signal Hill

What kind of growth did you see in your managed services? The acceleration and the Managed Security and the like, how was that progressing during the quarter?

J. Cooney

We specifically commented, very happy with the growth we're seeing, actually in both company controlled and the Managed Hosting business. Managed Hosting, albeit growing from a smaller base, but certainly delivering, we believe, well above market growth rates in the managed services business.

Erik Suppiger - Signal Hill

Any sense when we might get that broken out?

J. Cooney

Probably the best way to describe that is at the point it becomes a large meaningful proportion of our Data Center Services business unit revenue, then it probably makes sense for us to start breaking it out. Right now, it's a relatively small proportion of our Data Center Services business.

Erik Suppiger - Signal Hill

Just to understand the churn. This quarter came down to 1.1%, but you still had the decline in the revenues. Is this 1.1% churn in the data center space, is that probably a normalized level? Would we expect it to stay in that range? Or where do you think that would fall out?

J. Cooney

So again, Eric, we're not providing guidance, but we were pleased with the 1.1% churn in the Data Center business. Total churn was about 1.25% across all businesses, but I think that the 1.1% is a metric that we're trying to continue to maintain and continue to achieve.

Erik Suppiger - Signal Hill

And then lastly, pricing in the colo space was reasonably stable? Or any thoughts on pricing there?

J. Cooney

Yes, reasonably stable. And a general comment about the competitive landscape. From our perspective, we've not seen a change. It's certainly a competitive market, but we've not seen a change or an intensifying of the competitive landscape.

Erik Suppiger - Signal Hill

Do you think there's any risk that the combination of CenturyLink with Savvis would have any effect in that market?

J. Cooney

Certainly not in terms of the competitive landscape. I think as with any acquisition, there's always some disruption, both on the buy side and the sell side. So to the extent this acquisition is like those, there's perhaps opportunity for other players in the space to benefit from that "disruption." But in the long-term, I don't see the competitive dynamics changing as a result of that acquisition.

Operator

Our next question comes from Jonathan Atkin of RBC Capital Markets.

Jonathan Atkin - RBC Capital Markets, LLC

So on data center revenues, if you X out the 800,000 of churn, it implies sequential growth of, I guess, 600,000. And is that a reasonable sequential growth pace going forward to think about through the year? Secondly, I was curious about further markets where you might think about adding capacity. You mentioned LA in this particular presentation and then there's been other expansions that have been talked about in the past. So any of the markets that you're reaching a point of in terms of demand or supply where you might need to grow? And then third, relating to that, you've invested incrementally and I'm wondering on the M&A side, are there any assets out there or operations out there that would make sense for you to actually purchase that would fit in well within their product portfolio?

J. Cooney

Sure. Thanks, Jonathan. So in terms of your first question, the data center and growth rates. The most I'd like to say there is, we're targeting ourselves relative to industry benchmark or industry market growth rates and from our perspective, it looks like the data center colocation market is growing between 15% and 20% on an annualized basis. And certainly, our expectations, our challenge for ourselves, is to ensure that we grow at or above market growth rates for our company-controlled data center revenue. For your question about market expansion, future markets, we have a, I would say, quite expensive approach to evaluating markets, geographic markets, which could make sense for the company to expand. And we look at a whole range of factors, including things like, of course, the supply and demand characteristics in the market, the cost of power in the market, the types of enterprises operating in the market. In other words, are they enterprises which we could expect to benefit from Internap's performance availability and support value proposition? We look at things like, do we have local market knowledge? For example, do I have an existing local sales presence as we do in Los Angeles? They've just historically been quite successful selling somebody else's data center. Now we'd obviously like to leverage them to sell Internap data center. So we look at all of those things with a very clear focus for Internap today on the North American market and essentially then use that framework to go into the market and then explore either existing data center facilities, which might be available for sale, or properties in which we could re-purpose to data center. So the long way to answer your question, it's an ongoing process and we are actively evaluating other locations around the North American market. And then your final question about M&A. I think I'll answer that one very shortly by saying our focus and clearly, our priority is all about returning the company to profitable growth. Growth, meaning not only profitability, but revenue growth. So it's fair to say that the management team is entirely focused and committed to achieving that, as opposed to spending cycles exploring a lot of M&A activity.

Operator

Our next question is from Gray Powell of Wells Fargo.

Gray Powell - Wells Fargo Securities, LLC

I just have a few. Can you discuss the demand trends for the fill rates for the facilities in Houston, Seattle and Santa Clara that you opened in Q3 of 2010?

J. Cooney

Short answer is, no. We're not breaking out individual facility demand rates. But I'll try to give you some color. You mentioned specifically Houston, Santa Clara and Seattle, I believe. And I guess, let's phrase it this way, we would be much less comfortable making incremental investments in further data center expansions even if they were in different markets, like we have in Dallas and Los Angeles, if we weren't deriving some comfort from our track record of success with the investments that we've previously made in data center expansions. So without getting too explicit, we're pleased with what we've done in the past, we like what we're seeing in terms of revenue and cash flow and profitability generation from those previous expansions, and with that level of comfort, we're making investments in new markets and expansions within existing markets.

Gray Powell - Wells Fargo Securities, LLC

Got it. And then, I mean, just over the last year, I need to check the schedules, but I think you guys have roughly expanded the company-controlled footprint by around 30%. Is there any reason why company controlled revenue should not grow in excess of sort of the 15% to 20% data center industry average?

J. Cooney

Well, we're, as I mentioned, we're certainly targeting ourselves against that 15% to 20% market growth rate with an expectation that we grow at or above that level.

Gray Powell - Wells Fargo Securities, LLC

Okay, great. And then, I guess, just last question. Is the $0.6 million in data center revenue growth, is that entirely in the company-controlled footprint? Or did the third-party facilities have further declines, which means that the company-controlled growth is actually a little bit higher?

J. Cooney

It's actually a net figure inclusive of both partner- and company-controlled.

Gray Powell - Wells Fargo Securities, LLC

Okay. But, yes, I mean, I think like kind of the way I was looking at it just looking at company-controlled year-over-year, I had about maybe like sort of a mid- to high-teens kind of year-over-year growth rate. I just wanted to see if that kind of made sense with the way you see it since you actually have the numbers.

J. Cooney

Sure. Again, the focus for the sales organization is of course, on our company-controlled facilities. That being said, we do consider literally on a case-by-case basis, sale of partner colocation, but only to the extent that there's a significant component of other Internap services associated with that third party product. So again, there is some partner. But clearly, the lion share is attributable to company-controlled revenue.

Operator

Our next question is from Clay Moran of Benchmark Company.

Clayton Moran - The Benchmark Company, LLC

Two questions. Can you just give us a sense of how the pipeline looks relative to recent quarters and how the bookings and pipeline are in terms of the mix between colocation and managed, and has that mix changed meaningfully in the past few quarters? I guess those 2 would be the first question. The second question is how you -- if we're talking about all the M&A that's occurring in the data center space, I'm just wondering how might your IP business be viewed by potential telecom, cable or network-neutral buyers?

J. Cooney

Sure. So first question with regard to pipeline. I'll say that we're pleased with the upward trend we've seen in recent months as it relates to our sales funnel or sales opportunity pipeline. Your second question was about the mix colocation versus managed hosting as it relates to pipeline and if I'm understanding your question correctly, it was about relative changes, colocation versus managed-hosting pipeline. And I think the short answer is our managed hosting pipeline is growing at a rate above what our company-controlled pipeline is growing. And the third question was about M&A in the data center space with regard to possible acquisitions of Internap by telecom providers and what would they think about our IP Services business. I think probably best to ask them, but our interpretation would be to first of all remind folks that Internap isn't actually an owner of fiber or telecom assets, as such. We are effectively a reseller of IP services. We buy IP transit from other network service providers, we add our route optimization TCP acceleration technologies and turn around those IP services with a better performance availability and support value proposition. And that's how we add value and deliver our IP services to our customers. So in the sense of a carrier-neutral data center, which you mentioned, we actually articulate that our data centers are in fact carrier-neutral in the sense that we are providing connectivity ultimately to multiple network service providers in the same way that another carrier-neutral data center provider offers that "carrier neutrality." We just go one step further and actually dynamically enhance the performance we're providing our customers across those multiple carriers. So I guess the bottom line is I don't think our IP Services business or valued proposition changes adversely the concept of a carrier-neutral data center, if that's the asset that a potential acquirer was interested in Internap.

Clayton Moran - The Benchmark Company, LLC

Okay. And a follow up on each of those, if I could. In terms of the mixed colocation and managed hosting, is there any change in for the relative mix there? I'm not surprised that managed hosting is growing faster. Has that accelerated relative to the co-lo or has that been sort of steady over the past few quarters? And then in terms of going back to the IP business and consolidation in the industry, how might, again, a cable company view that IP business? I know it's hypothetical, but just curious about your thoughts.

J. Cooney

With regard to the co-lo managed hosting rates, I don't actually have the exact numbers in front of me, so I'll hedge a little bit, but I will say that yes, our perception is that the managed hosting rate of pipeline growth is growing faster than company-controlled and that represents a change for Internap over recent history. And primarily, we think that's because as a business, we've been investing more heavily in managed hosting over recent quarters than we did previously. So we have more people, more products, more focus. We've trained the sales organization on managed hosting. So we're, simply put, getting results of those investments and as a result, seeing more pipeline activity. How would a cable operator view our IP Services business? Cable or telco, I think the opportunity for them or the interest would be really boil down to their perception of our value differentiations, specifically the route optimization, and the TCP acceleration technology. Would that telecom or cable operator derive a benefit from that? The obvious question or point to keep in mind is our technology works because we leverage access to multiple network providers and in realtime, shift traffic across alternative network providers. It's not immediately obvious to me how that would benefit a single network provider who's likely interest is in pushing all traffic across their network and not opportunistically based on performance, routing customers' traffic to somebody else's network. Does that answer your question?

Clayton Moran - The Benchmark Company, LLC

Yes.

Operator

Next question is from Colby Synesael from Cowen And Company.

Colby Synesael - Cowen and Company, LLC

I have 3 different questions. The first one has to do with the due diligence that you do when you're looking at doing an expansion. I was wondering if you can just talk to us about what gives you confidence when you go into a market like L.A. I noticed you mentioned that you look at your strong track record as a good point of confidence in terms of having success, but just wondering if you do any type of survey work or if you have to have an anchor tenant when you go into these markets considering you are spending a significant amount of CapEx now to make the data centers a bigger part of your strategy. My other question has to actually do with growth. You keep on referencing 15% to 20% growth in your data center space for company-controlled facilities. Can you actually break out what percentage of the revenues of data centers is the company-controlled revenue at this point? And then my third question will have to do with the cloud. It seems like when I compare you guys to the 3 companies that were recently acquired, Navasite, Savvis and Telmark, the one thing that was highlighted in each of those transactions is that they have on-demand cloud offerings where there's an ability for a customer to go and spin up a server whether it's Linux based or Windows based and call in a five, 10 minute time period and all of a sudden have the ability to be utilizing those solutions. To my knowledge, you don't offer that type of service. I'm wondering if that's on your road map, and if you could talk a little bit about that.

J. Cooney

Sure. In terms of due diligence, it sounded like -- due diligence for our data center market expansions. One of your questions there was, do we have any anchor tenants at the point we execute or sign for the property? And typically, the answer is, no. We don't typically have anchor tenants at the point we commit to a data center expansion. Certainly, would like to do that, but just, frankly, based on the lead times and at least our typical customer profile to-date, we're of course, a retail colocation service provider as opposed to wholesale. So most of our target customers have much shorter lead times and aren't making buying decisions 6 to 12 months in advance, which is essentially the lead to bring our data centers to market. That being said, we do, at least from our perspective, rather extensive market due diligence before executing on a particular property. In surveying, if by that you mean looking at things, as I mentioned earlier in the call, but additionally, things like connectivity for a specific facility, talking to the power companies, talking to the local governmental agencies, exploring things like tax benefits or tax credits et cetera, et cetera. So we do a, again, from our perspective, quite extensive due diligence before we're making these very nontrivial capital investments. Your second question about breaking out company controlled data center. We haven't done that yet, but I will say it's an active topic of discussion, particularly as we've now effectively moved through this proactive data center churn program. We're considering all of the external representations we give to our financials. One of the other analysts asked about managed hosting, would we be breaking that out? So short answer to your question, we've not yet broken it out yet, but we are actively considering things like company-controlled managed hosting partner and how we might better give the market visibility to the underlying revenues and associated growth rates.

Colby Synesael - Cowen and Company, LLC

If I could just pushback on that a little bit and I appreciate you guys considering doing that. When you look at your 3 different business segments, you have the IT business which you've talked about how to grow in the low single digits over the long term. Correct me if I'm wrong there. And on the partner data center facility, I'm assuming that that's also expected to be roughly flat. So the real growth component for the company, which gets you from roughly 2% growth based off for where the street had for 2011 today, to hopefully double digits is obviously this company-controlled space and if we don't know exactly what that number is, I think it's very difficult for us as the investment community to really give you that -- or reward you with that, if we don't know exactly what that number is.

J. Cooney

Sure and I understand that. I think, based on the information we've previously provided, you've obviously know what the IP business unit is and you've got a pretty good idea what our partner revenue is, both based on figures we provided at the time we were commencing the proactive churn program. As I recall, we indicated proactively churning from about $17 million of quarterly revenue down to about $12 million of quarterly revenue. We also gave some figures last quarter in terms of the percentage breakout of both square footage and revenue. Again, across company-controlled and partner. So while we've not -- you're absolutely correct, we've not broken it out into explicit detail. We have definitely given enough so that the street has a very good sense for what that company-controlled revenue element looks like. And we are actively considering being even more explicit. We just need to decide what we want to do with the managed hosting in terms of external reporting.

Colby Synesael - Cowen and Company, LLC

Excellent. And I guess, just on the last question regarding the cloud.

J. Cooney

And you probably recall, we announced a little earlier this year, a storage a beta launch of a storage cloud product and while we've not yet announced a further cloud offering, I think your question was is that on the roadmap? It definitely is on the roadmap. From our perspective, cloud IT infrastructure services is a very natural extension of our existing colocation managed hosting business. Can we simply look at it as another means to monetize these investments in company controlled data centers serving those enterprise customers needs whether they be a need for colocation or managed services or cloud IT infrastructure? Internap's intention is to support all of the above.

Colby Synesael - Cowen and Company, LLC

And the way you would do that, I guess, is organically or will you look to do acquisitions and it seems like the market opportunity is clearly now, and everyday that goes by that you don't have that may be a missed opportunity. Just trying to understand what your sense of timeliness is.

J. Cooney

Time is definitely of the essence. Let's put it that way. And you could appropriately infer the launch of the cloud storage product earlier this year, was the first step. We did that development "organically" and the expectation is that we'll bring the final stage, the computer offering, later in 2011. And likewise, we are on track to do that organically. That's, to put a point on it, that's of course, a big part of the reason we've been investing over the past year in significant expansions to our engineering development organization.

Operator

The next question comes from Mark Kelleher of Dougherty & Company.

Mark Kelleher - Dougherty & Company LLC

Just continuing on with the previous question. I assume you're referring to open stock? And could you give us an update on how the beta is going with that and when we might expect that to rollout?

J. Cooney

I prefer not to make product launches or product launch announcements on this call. I will say that yes, OpenStack is the technology that we used as the, let's say, underpinning platform for our cloud storage launch. And it's, of course, a reasonable assumption that we'll be using OpenStack as a platform for our future cloud compute launches. But I'd really rather not say a lot until we actually launch or announce the products.

Mark Kelleher - Dougherty & Company LLC

Okay. And second question, just on the IP services side. Can you just give us some idea what gives you the confidence that, that's returning to growth? Is that a pipeline building? What gives you the visibility that, that's finally turning around?

J. Cooney

;

I mean, it is a range of factors. Pipeline is certainly part of it, but also we're looking at bookings, trends. We're looking at customer churn. Those are probably the most, clearest indicators.

Mark Kelleher - Dougherty & Company LLC

And the pricing on that side of the business? The cost on that side, are those still under -- are there's going to be normalized, are those still going to have any changes to them?

J. Cooney

Well, if by normalized you mean something along the lines of 20% annual sell price erosion, that's essentially what we've seen, probably a little bit more than that over the past 18 months or so. We've not seen that rate of price erosion change. So if that's what you mean by normalized, yes, we expect that 20-plus percent range to be consistent and that certainly what's built into our models. So clearly, your traffic growth needs to exceed that in order, ultimately, for us to drive top line growth in the business.

Mark Kelleher - Dougherty & Company LLC

Okay, great.

Operator

[Operator Instructions] The next question is from Donna Jaegers of Data Vision.

Donna Jaegers - D.A. Davidson & Co.

I'm with D.A. Davidson. I just have 2 questions. On your IP Performance business. Given the mergers in the industry with Level 3 Bio Global Crossing and now Savvis and the Quest Network getting together under Century. I know it's sort of early days, but do you worry or do you think any changes will happen with pricing in the long-haul space? Maybe pray is a better word.

J. Cooney

Certainly, there's -- I would like to believe that there will be a further stabilization. Let's say a reduction in the rate of decline of pricing. We've certainly not built that the expectation into any of our models and I think we'll take a I'll believe it when I see it approach and be pleasantly surprised. But certainly, that's a possibility and there are folks in the space that are making that sort of projection.

Donna Jaegers - D.A. Davidson & Co.

Folks that you respect or -- there's lots of loose cannons that have been talking about price stabilization for a long time.

J. Cooney

Sure. So I'll speak only on behalf of Internap and say that from our perspective, we are not projecting a change in the rate of price decline in the IP Transit business.

Donna Jaegers - D.A. Davidson & Co.

Okay. And typically your terms on the contracts that you're buying capacity at are one year or less?

J. Cooney

We typically buy, so our costs are typically on one-year contracts. We typically sell to our customers at about 2-year contract length.

Donna Jaegers - D.A. Davidson & Co.

Okay. And then just one other quick question. On the increases that you made to your sales force, what kind -- where are you hiring salespeople from? Are they experienced in the industry and what sort of percentage increase, I guess, you guys call that what, 21 people that you hired? Probably not all those were in the sales force. So what sort of percentage increase did you do in just sales?

J. Cooney

So the percent sales increase was about 10%, maybe slightly more in terms of incremental heads. In terms of where we're finding or what type of sales executives, the vast majority of sales professionals we hire are, in fact, very seasoned sales professionals. Account executives, senior account executives, national account manager, tend to be the job titles that come with these individuals. And for the most part, we are hiring them from within the industry. So either competitors or related companies tend to be the background that these sales professionals have. Having said that, we also have some, what I would call more junior sales professionals, that we specifically bring on board. They tend to be a little younger, a little more junior in terms of their experience. And we're bringing these folks on. We also tend to focus them on a narrower set of our product offering. The idea being that we're essentially, over the long-term, growing our own senior account executives, national account managers. So bring the young, hungry, let's say college grads on board, get them trained with a smaller product set within the Internap portfolio, and then as they gain experience and confidence, expand their offering and as I said, grow our own senior account executives.

Donna Jaegers - D.A. Davidson & Co.

Great. And the expected ramp time for the more seasoned people that you're hiring, 6 months?

J. Cooney

There's pretty high degree of variability in terms of ramp time, but on average, I would say 6 to 12 months is a reasonable time to get fully ramped up and productive, depending on what their starting point was.

Operator

Since there are no more questions in queue, we will turn the call back to Drew.

Andrew McBath

Okay. Thanks, everyone, for joining us today. We look forward to hearing from you and we look forward to talking to you again for the second quarter call in a few months.

Operator

Ladies and gentlemen, thank you for your participation on today's conference. This does conclude the program and you may now disconnect.

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