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Executives

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

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

Andrew McBath - Director of Investor Relations

Analysts

Colby Synesael - Cowen and Company, LLC, Research Division

Christopher M. Larsen - Piper Jaffray Companies, Research Division

Michael Gary Nelson - Mizuho Securities USA Inc., Research Division

Clayton F. Moran - The Benchmark Company, LLC, Research Division

Jonathan Atkin - RBC Capital Markets, LLC, Research Division

Robert Dezego - SunTrust Robinson Humphrey, Inc., Research Division

Mark Kelleher - Dougherty & Company LLC, Research Division

Internap Network Services (INAP) Q3 2011 Earnings Call October 27, 2011 5:00 PM ET

Operator

Good day, ladies and gentlemen. Welcome to the Internap Third Quarter 2011 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to Drew McBath. You may begin.

Andrew McBath

Good afternoon, and thank you for joining us 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 expectations regarding our future financial performance and long-term profitable growth; our belief in our business strategy, including the value proposition of our IP services business; timing for bringing new data centers online and installing customers; expected levels of capital expenditures; belief in our ability to increase our leverage; and expected levels of future churn.

Because these statements are not guarantees of future performance and involve risk and uncertainties, important factors 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 third quarter 2011 results, we will also discuss recent developments.

Now let me turn the call over to Eric Cooney.

J. Eric Cooney

Thanks, Drew, and good afternoon, everyone. I'll start off by saying that we are pleased with our third quarter results, as we believe they provide further validation of the company's strategy, and also demonstrate our ability to execute this strategy. It becomes increasingly clear that the company's strategic shift to an IT infrastructure services provider was the right decision as our solid third-quarter financials are underpinned by success in the company-controlled data center and Managed Hosting businesses.

As you can see from the chart on Slide 3, we saw a sequential and year-over-year improvement in revenue, segment profit and segment margin in the third quarter.

Total revenue bolstered by strong data center services results increased sequentially at its fastest rate in 3 years. Our business unit profit margin also showed solid increases. Total segment profit was $31.2 million, the highest level in the history of the company and segment margin was 50.4%, an increase of 270 basis points year-over-year and 100 basis points sequentially.

Most of the segment profit improvement flowed directly through to adjusted EBITDA as shown on Slide 4. In fact, third-quarter adjusted EBITDA totaled $11.3 million, an increase of 23% year-over-year and 10% compared with the second quarter of 2011.

Adjusted EBITDA margin was 18.2%, up 300 basis points compared with the prior year's quarter and 120 basis points sequentially. Third quarter adjusted EBITDA and adjusted EBITDA margin both reached record highs. Revenue and segment margin trends in our 2 reporting units are detailed on Slide 5.

The third quarter of 2011 represented the second consecutive quarter of solid top line growth for the Data Center Services business. Revenue in this segment increased 8% over the third quarter of 2010 and 5% compared with the second quarter of 2011.

Data Center segment profit was up strongly from a year ago rising 22% year-over-year and 7% sequentially. The top line in segment profit results were driven by strength in colocation services sold in company-controlled facilities, as well as managed hosting services. IP services revenue was flat sequentially and down year-over-year, although the business unit continues to generate strong profitability and cash flow.

Segment profit in IP totaled $17.6 million, an increase of 3% sequentially and flat year-over-year. IP segment margin was 63.1%, an increase of 190 basis points compared with both the third quarter of 2010 and the second quarter of 2011. We persist in our efforts to negotiate contracts with our backbone service providers and have also instituted network efficiency programs all geared to drive our network cost down.

The performance and availability benefits derived from our IP services offering remains a key element of the company's competitive differentiation as an IT infrastructure services provider. Earlier this week, we announced the availability of our transmuxing solution for live and on-demand mobile content delivery. This technology dynamically repackages video content in transmission to meet the formatting requirements of myriad end-user devices, including the iPhone, iPad, and Android powered devices, as well as devices supporting Microsoft Silverlight.

Similar to our adapted bit rate deployment in 2010, recent media console upgrades and our integration of TCP Acceleration into the content delivery network last quarter, we are adding features that simplify and speed the publication and distribution of our customer's digital assets.

Whether purchased on a stand-alone basis or as part of our IT infrastructure services, we believe our high-performance connectivity services further differentiate us in the market. On Slide 6, I'd like to update you on the progress we are making in the data center builds we've announced over the past few quarters. In Dallas, we are tracking ahead of our originally planned opening date of the first quarter of 2012. We're finalizing site work and expect to install our first customer in December of this year.

When fully deployed, this facility will add 55,000 net-sellable square feet to our company-controlled footprint, with Phase I adding 15,000 net-sellable square feet. Our existing footprint in Dallas made up of 3 partner data centers is approaching capacity. Our Dallas facility will remove these capacity constraints and further leverage a strong regional sales team, and good brand recognition.

Like Dallas, our Los Angeles site will be a stand-alone data center, with the first phase adding 15,000 net-sellable square feet out of a total net-sellable footprint of 55,000 square feet. We've completed design and demolition, and continued to be on schedule for our second quarter 2012 opening of this facility. Los Angeles is another market where our partner data center supply is severely limited, providing strong motivation for us to move ahead swiftly and deploy our company-controlled data center assets in this market.

We are currently in the design phase of the expansion of our existing Atlanta data center, which we expect to bring online in the third quarter of 2012. Phase 1 will add 12,000 net-sellable square feet, with another 19,000 available for future phases. As with Dallas and Los Angeles, we are at or rapidly approaching capacity in our Atlanta facilities.

In keeping with our commitment to provide superior performance and availability, we are building all of these sites to N+1 redundancy standards for power, cooling and connectivity to accommodate power densities of up to 200 watts per square foot, and to adhere to SAS 70 Type II audit procedures. As we pointed out in the past, our data centers form the foundation for all of these services we sell. One that we are very excited to add to our facilities is Internap's enterprise cloud service, which we've just recently launched.

As outlined on Slide 7, we've designed our enterprise cloud service with the flexibility to address a range of customization, control and cost requirements. Our dedicated private cloud on the far left of the diagram provides the highest level of control and customization. This service uses fully dedicated infrastructure to ensure complete data isolation.

Our virtual private cloud allows customers to reserve compute memory and storage resources, while still gaining some of the cost efficiencies of a shared infrastructure. Custom public cloud is a pure multi-tenant architecture that provides complete on-demand usage with utility-based billing. On-demand provisioning and granular pricing allow customers to address fluctuating compute requirements cost-effectively.

On the far right is our open public cloud. Unlike the dedicated private, virtual private and custom public options, which are all built using VMware, our open public cloud is based on the OpenStack platform. This service delivers a lower cost, open source management tools and open APIs to avoid vendor lock-in. This offering is particularly relevant as an indication of our commitment to technology leadership. In that, we believe we are the first service provider to launch production availability of public cloud compute services based on the OpenStack platform.

Not only can our customers easily interchange our cloud services depending on their use case, hybrid options that pair cloud services with colocation and/or manage hosting can also be seamlessly delivered. Turning to Slide 8, it should be evident that we've consciously build flexibility into our cloud to match our flexible data center platform.

In order for enterprises to truly future proof their IT infrastructure needs, they require a full portfolio of platform options including colocation, managed hosting, and cloud services delivered with high-performance connectivity. We believe this message is resonating with our customers and prospects and it's one reason we're confident in our ability to drive long-term profitable growth.

We've spent a good deal of time in the past describing the importance of our customer support to Internap's overall value proposition. On Slide 9, I'd like to provide some evidence we feel supports our claim of best-in-class customer support. This information came from a technology services industry association benchmarking study performed in the second quarter of 2011 comparing our key support metrics to industry peers.

Hold times for inbound support calls averaged 2.5 minutes across the universe of 44 telecom and networking companies. By comparison, Internap's average hold time was 10 seconds. Average industry response time for inbound support e-mails was 2 hours and 15 minutes, while Internap responded to similar requests within 15 minutes on average.

The percentage of service issues resolved within 1 business day was 54% for the industry and 75% for Internap. We continue to invest in all aspects of our customer support organization, in particular, the highly trained certified engineering staff that ultimately makes the difference for our world-class support organization.

Now let me turn the call over to George, so he can take you through a more detailed discussion of the financial and operating metrics.

George E. Kilguss

Thanks, Eric. I'll start my comments on Slide 10, which covers our income statement comparisons. Third quarter 2011 revenue increased $1.7 million compared with the same period last year, representing a year-over-year growth of almost 3%. Compared with the second quarter of 2011, total revenue rose by $1.6 million, also increasing by 3%. This quarter-over-quarter growth represents the largest sequential improvement in 3 years both in absolute dollars and in percentage terms.

Total segment profit grew 9% year-over-year, and 5% sequentially to $31.2 million, a record high for the company. Total segment margins was up 270 basis points year-over-year and showed a solid sequential increase of 100 basis points despite higher seasonal power costs in our Data Center business. Total cash operating expense increased 2% year-over-year and quarter-over-quarter. We held cash OpEx at 32% of revenue, in line with comparable periods.

Adjusted EBITDA improved 23% compared with the third quarter of 2010, and 10% sequentially to $11.3 million. Increased segment profit more than offset increased cash operating expense. Adjusted EBITDA margin was 18.2% compared with 15.2% in the third quarter of 2010 and 17% in the second quarter of this year.

GAAP net loss was $1.8 million in the quarter, a decrease compared with the third quarter of 2010 and an improvement over the second quarter of 2011, which included a $1.3 million noncash restructuring charge.

Normalized net loss, which excluded the impact of stock-based compensation and certain items management considers as nonrecurring, totaled $600,000 or $0.01 per share.

Turning to a summary of our cash flow in the balance sheet on Slide 11. CapEx outpaced adjusted EBITDA in the quarter by $16.5 million, as we continued to invest in growing our company-controlled data center footprint. Our capital expenditures in the third quarter totaled $27.8 million, a large increase year-over-year and sequentially, as our investments in our new data center in Dallas accelerated.

Earlier this year, we outlined our capital expenditures expectations for 2011, estimating that we would spend between $75 million and $85 million in total capital for the year. Because we will incur a portion of the capital spend for our Los Angeles and Atlanta facilities in 2012 rather than in 2011 as previously expected, we now estimate that the CapEx will be between $65 million and $75 million for the full-year 2011.

As I'll outline in a moment, only a small portion of the total capital that we are currently deploying is required to support our existing customer base and ongoing operations. At the end of the third quarter, cash and cash equivalents totaled more than $34 million. Funded debt totaled $19 million, remaining flat compared with the balance at June 30, 2011.

Capital leases increased $8 million over the quarter and due to the addition of the lease of our new company-controlled data center in Los Angeles, California. Third quarter total debt to last quarter annualized EBITDA was 1.2x, well below the average for our data center peers. Our announced expansion data center expansions are fully funded with our current debt facilities, cash generation and cash on hand. We also believe we have the ability to increase our leverage should we decide to add incremental capacity in key new markets.

Day sales outstanding remained at 27 days in the third quarter, reflecting continued discipline in our collection procedure and prescreening credit policies. On Slide 12, I'll cover our segment results in more detail. Data center services revenue totaled $34.1 million in the quarter, an increase of $2.6 million year-over-year and $1.6 million sequentially. Core company-controlled colocation and managed hosting services revenue in the quarter made up approximately 60% of total data center revenue. Revenue growth in core data center services accelerated in the period driving the 8.1% year-over-year and 5% quarter-over-quarter improvements.

The changing mix from revenue generated at lower margin partner data centers to higher value company-controlled facilities and managed hosting also helped drive the strong profitability growth. Absolute segment profit in data center services improved 22% year-over-year and 7% sequentially.

Data Center segment margin increased 470 basis points compared to third quarter of 2010, and 80 basis points over the second quarter of 2011 despite an increase in seasonal power cost. In our IP Services segment, revenue totaled $27.9 million, down from $28.8 million a year ago, and flat compared with the prior quarter.

Lower network cost and moderating revenue declines however, allowed both the IP segment profit and IP segment margin to improve sequentially in the third quarter.

Data center revenue churn in the third quarter was 0.8% compared with 1.9% in the third quarter of 2010, and 1% in the second quarter. IP churn came in at 1.3%, at the low end of its historical range. Total churn across both Data Center services and IP services was 1%, reaching its lowest point in several years.

While total revenue churn has trended lower this year, we expect total churn to increase to approximately 2% in the fourth quarter of 2011 as we have had several large customer contracts coming up for renewal.

On Slide 13, you can see the occupied square footage and revenue per square foot trends in our company-controlled and partner data centers. Since the same period last year, we've added 13,000 square feet or more than 500 cabinets of customer occupancy in our 9 company-controlled facilities. Conversely, as part of our profitability improvement strategy, customer occupancy in our partner data centers has declined by 5,000 square feet. Total average monthly revenue per square foot over the same timeframe has been solid, rising 3% year-over-year.

We have also provided updated and additional historical break out of our occupied and net-sellable square feet statistics for both partner and company-controlled facilities in our supplemental data sheets located on our website.

Along with most other operating metrics this quarter, net customer additions and the average revenue per customer improved relative to comparable prior periods. A historical view and of these measures, along with average revenue per customer, is shown in the chart on Slide 14.

We've done a good job over the past 2.5 years of driving ARPU higher. Some of these increase is a function of churning out smaller, less profitable customers, particularly in the IP business. But we have also consciously expanded our portfolio of IT infrastructure services tailored for the enterprise. This approach had helped grow our presence among key existing accounts and increase the size of deals sold to new logos.

Since the first quarter of 2009, our average revenue per user per month has increased more than 15%. We were particularly pleased to see this growth per customer coupled with absolute gross in the customer base in the third quarter. Given the level of capital we're deploying in 2011, it's worthwhile to describe how the components of this spend affect our ability to generate incremental revenue and cash flow versus just maintaining our current level of business.

As shown in the bar chart on Slide 15, a full 85% of the midpoint of our 2011 capital plan is either capital deployed for future growth, or success-based capital tied to customer installation request. If we experience a dramatic weakening of demand for our data center services like colocation, managed hosting, and cloud, we could scale back capital deployment to levels well below where we are today.

This flexibility helps strengthen the business model by allowing it to adapt to changes in macro and industry trends. Now, let me turn the call back to Eric for his closing remarks before we take your questions.

J. Eric Cooney

Thanks, George. Now I'll summarize our discussion today on Slide 16. We believe our third quarter results affirm both a strategic direction we have chosen for the company, as well as demonstrates solid execution across the business. Underpinned by revenue growth at or above market rates in company-controlled, colocation and manage hosting, we were able to deliver the larger sequential revenue increase since 2008.

More importantly, we delivered strong profitability with $11.3 million in adjusted EBITDA, the highest in the history of the company, and a 23% increase over the last year. Finally, we completed the launch of a truly differentiated enterprise cloud offering and deployed a significant feature upgrade for our CEN platform.

Looking ahead, we are focused on continued execution, with the upcoming opening of 42,000 net-sellable square feet of data center capacity in Dallas, Los Angeles and Atlanta over the next several quarters, and the roll out of a compelling enterprise cloud offering, we're optimistic that we will continue to build momentum and deliver long-term profitable growth for our stockholders.

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

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is from Chris Larsen of Piper Jaffray.

Christopher M. Larsen - Piper Jaffray Companies, Research Division

A couple of questions on the cloud. I think it's good to see you moving into the cloud, but maybe how we start to think about this flowing through in both the income statement, and the cash flows, and balance sheet. First maybe if you could touch on just how the cost of may ramp as you get into the cloud, and then how quickly you can scale so that let's say a positive margin contribution service. And then how far in advance do you need to have servers, does that change dramatically? George, you gave a great summary on Slide 15 going through what you can cut, and not cut. Maybe you can update that slide or think about how we should think about that slide in the context of the cloud.

J. Eric Cooney

Sure. Maybe I'll try and address your first question about cost ramping and how the cloud is expected to impact primarily our P&L. From our standpoint, I think the first point to make is the cloud services are both for customer terms and in financial terms, an extension of our data center services offering. So all of the financials will flow through our data center services business unit. In terms of how to think about the ramping of those costs, I think the main point there is to distinguish capital expenditures tied to data center expansion versus capital expenditure for cloud services. And perhaps exactly as you'd expect, the capital expenditures for data centers significantly lead the revenues associated with those data centers. Obviously, we need to build the data centers and then gradually fill them with customers before we generate significant revenues. Cloud services in contrast, the CapEx is much closer to the actual revenue that will be derived from those investments. In many cases, we're talking weeks as opposed to months or years for data center builds. George?

George E. Kilguss

Yes, Chris, we will give our 2012 CapEx guidance on our fourth quarter call, so next quarter. But as Eric said, by housing this cloud pods in our existing data center, we take advantage of our existing infrastructure, employees and networks to deliver it. So the incremental CapEx as revenue ramps up will be very closely tied to revenue and really will be resulting as a result of the increased server capacity that we need to deploy during those times of growth.

Operator

Our next question is from Robert Dezego of SunTrust Robinson.

Robert Dezego - SunTrust Robinson Humphrey, Inc., Research Division

Just quick questions, can you tell us the revenue from the company controlled versus the partner sites? And then a follow-up would be, could you help us maybe think about some of the incremental operating capital costs that are going to come in over the next couple of quarters as you get the new sites up and running? And could you maybe tell us how much you think you're going to spend to get Dallas and Atlanta Phase I completed?

J. Eric Cooney

So lots of questions there. I guess the first question, breakout of partner versus company-controlled revenue. We don't explicitly break that out, but we've made some general comments and the general comment we'll make now is that our data center services revenue is approximately 60% company controlled as opposed to partner. In your second question was about the operating and capital cost projections. I think as George mentioned, we don't -- we're not yet providing guidance for 2012 CapEx. We'll provide that explicitly on next earnings call when we release our fourth quarter results.

George E. Kilguss

You also though asked, Robert, about Dallas, and as Eric pointed out in his comments, we do plan to install our first customer in the month of December. So all of Dallas expenses will be in the fiscal year 2011. And we have out a significant amount of those expenses in the third quarter as you can surmise.

Robert Dezego - SunTrust Robinson Humphrey, Inc., Research Division

Can we talk about the total cost to get Dallas up and running, as that's...

J. Eric Cooney

Rough figures to use, we're pretty close to $1,500 per net-sellable square foot. And if you want to use 15,000 net-sellable square feet you can do some pretty good napkin math from there.

Robert Dezego - SunTrust Robinson Humphrey, Inc., Research Division

And if I could follow with one more question, can you maybe just give us a little bit color on some of the take rates you're seeing for these IT infrastructure products that you're talking about versus the colo and the IP? Are you seeing an attach rate to these IT services i.e. with colo and IT? And if you can maybe just talk about how well those products are starting to sell now versus maybe 6 months ago.

J. Eric Cooney

I would say what we're seeing is increasing importance for customers to seek suppliers who can offer a range of IT infrastructure services. And by range, I'm primarily referring to colocation as well as managed hosting, as well as enterprise cloud. So it's increasingly important for customers to find suppliers who can offer that platform flexibility as we describe it. In terms of, let's say success to date, we are advertising that today. We have something over 100 cloud customers operating on our platform. Obviously, it's relatively new but nonetheless, we do have real revenue-generating customers successfully using that platform.

Operator

Our next question is from Michael Nelson of Mizuho Securities.

Michael Gary Nelson - Mizuho Securities USA Inc., Research Division

I'm wondering, what's your outlook for the pricing trends within the data center and IP services segment? And I'm wondering what kind of pricing power you have within that data center segment and you think you still are at a point where demand's still far outstrips supply or are we getting to the point where supply is catching up?

J. Eric Cooney

Pricing trends on IP services first. I'll suggest we're seeing a similar trend to what we've experienced over the past 2 to 3 years, namely about a 20% annual price erosion in IP services. On the data center services side, yes, we do still see "demand" outstripping supply for the data center services subject to specific local market variations. But in general, yes, we're seeing demand outstripping supply. In terms of the price trend in data center services, we do generally see increasing year-over-year prices both in terms of the power prices, as well as the square footage elements of the data center services.

Michael Gary Nelson - Mizuho Securities USA Inc., Research Division

Let me ask you a follow-up on that, in terms of the, I guess, supply and demand. How should we think about the potential for additional data center expansions beyond what you've already announced? And I'm wondering, do you have other markets where utilization is running close to 100%, will you possibly expand them or are you looking at potentially expanding into new markets?

J. Eric Cooney

The answer to that question is both. As our capacity in existing markets as you say approaches 100%, I would probably say as it gets closer to 85% to 90%, it's effectively full. At that stage in that market, we ask ourselves the question, what are our future projections for demand in that market and if it looks like demand is going to continue to outstrip supply, then it's likely we'll look favorably at an incremental CapEx expansion in parallel with existing markets, we're obviously also aggressively evaluating new markets for the company. Clearly, Santa Clara, Dallas, Los Angeles in recent history all represent new markets for the company and we would expect to continue that literally on a global basis.

Operator

Our next question comes from Colby Synesael of Cowen.

Colby Synesael - Cowen and Company, LLC, Research Division

I was hoping you could talk about your cloud distribution strategy, and maybe tie that back into the recent hire of a new head of global sales. I think with the cloud you're focusing on the enterprise versus SME or at least SMB, which I would think will be a little more difficult and not necessarily just an online sale. And then my next question is I just was hoping that you can give us a little bit more color on the 2% churn that you noted that you're expecting in the fourth quarter. Is that a customer who's staying who's simply reducing their services or are you giving them a price cut, a little bit color on that. And also, just can you remind us how much visibility you typically have on your churn?

J. Eric Cooney

So I'll take your first question about our cloud distribution strategy. And you're correct. Our strategy, not only for cloud, but actually across the entire portfolio is in fact, an enterprise targeted customer base, and more specifically a direct sales force and channel partner enterprise targeted customer base. I'm specifically drawing the distinction between a direct enterprise pursuit versus an online marketing perhaps online portal sign-up model. So the implication of that is well it manifest itself in several ways in terms of the complexity of the sale, the length of the sales cycle, the typical deal size, the typical monthly IT customer spend. All of these things tend towards larger deals, more complex sales and yes, your statement about or your question about our new Head of Sales, clearly -- Rich Shank has joined the company here several weeks ago, has taken over our global sales organization, and clearly we expect Rich can lead organization in that pursuit of let's say larger, more strategic account selling activities.

Colby Synesael - Cowen and Company, LLC, Research Division

Is it fair to say that distribution system that you just described is currently being built and is not yet in place or would you argue it's already in place and you're selling into it?

J. Eric Cooney

No, I would argue the latter that it's already in place and we're selling into it and perhaps one of the best indicators of that is our customer ARPU is steadily trending upwards. I think the addition of Rich is just, let's say, a natural augment to that existing sales distribution platform.

Colby Synesael - Cowen and Company, LLC, Research Division

And then I guess in the churn?

George E. Kilguss

Sure. Colby, this is George. So with regard to churn, as I'm sure you're aware, we count churn as the amount of revenue lost to customers that are either leaving or writing down contracts at renewal. I can tell you that, while we've had churn of 1% on average for the third quarter, we do expect it to go to 2% in the fourth quarter. It specifically relates to customers whose contracts are coming up for renewal, and we don't expect them to leave us completely, but we do expect that on the IP side, we have some contracts that we probably will price to market, and we have some other customers that have had some changes in their business plans and they've talked to us about it and their contracts are coming up near the end of the year, and so they're going to be reducing some of their spend with us in some other areas. But again, all of those customers will be staying with us. That's clearly our expectation, but it's really just a portion of the contract that we'll be downgrading in the fourth quarter.

Colby Synesael - Cowen and Company, LLC, Research Division

And can you remind us what the visibility typical has on these bigger churn events like the one that you're going to have on the fourth quarter?

J. Eric Cooney

So we have pretty decent visibility as you can expect on IP services. They tend to be multi-year contracts and to the extent there's not a change in the price erosion that 20% I mentioned previously, we can fairly accurately predict that most of our customers stay with us, but we'll experience a revenue write-down at the point of contract renewal. On the data center services side, we also tend to have a pretty reasonable visibility, meaning several months ahead of contract renewal, and the decision is not so much the question, it's is not so much of revenue write-down because pricing tends to increase on colocation contracts, but more a discussion about, "Hey! Have the customers IT services needs changed for any reason such that they're no longer going to require our colocation services." So obviously, that's a much rarer circumstance but those are the 2 elements of visibility to customer churn that we have.

Colby Synesael - Cowen and Company, LLC, Research Division

Okay and if I could just sneak one more in there, on the IP side of things, you noted that you took cost out of the business in the third quarter. It sounds like you just renegotiated some of your IP transit contracts with your vendors. How much more can you take out of the business, is that something where even if that doesn't gear out, we go up again in the fourth quarter, we can actually still see profitability go up or should we think of this what happened in the third quarter as more of a onetime benefit? And obviously it'll continue going forward but we aren't going to see it continue to improve?

J. Eric Cooney

I think there were 2 elements of the cost reduction for our IP services. One, you named correctly, the negotiation with our service providers and the reduction in our transit cost. The other element though was more tied to our IP network infrastructure. So, for example, as we upgrade the hardware, the network infrastructure as an example, we've reduced the footprint that we require for our IP points of presence more than servers and storage. Therefore, less footprint, therefore, less power, less base cost, et cetera, et cetera. Those while not onetime they're on an ongoing basis but they're definitely not as, let's say, common or frequent as contract renewals with our IP transit providers.

Operator

Our next question is from Clay Moran of Benchmark.

Clayton F. Moran - The Benchmark Company, LLC, Research Division

I have 2 questions. George had talked about the flexibility around CapEx spending in case of a macro slowdown. So I'm just wondering are you seeing anything that would indicate a macro slowdown, any change in demand trends or elongation of the sales cycle or anything along those lines? And then secondly could you talk about a little bit more about the 3 data centers that are about to launch. Maybe just any indication you can give us on the pipeline. Do you have customers in existing centers that are asking for this space, because they're maxed out. And then can you talk about L.A. in particular, what gives you confidence in the demand trend for L.A.?

J. Eric Cooney

Sure. So we'll try to take them one at a time here. In terms of our CapEx spend, it would be incorrect to infer from the visibility we've provided in the presentation around our CapEx expenditure that we've seen any change in terms of demand or supply in the marketplace for data center services. In fact, to be quite clear, we're still seeing strong growth for data center services across the markets Internet plays in. The only reason we're providing the visibility that George articulated is obviously because we're quite sensitive to the fact that -- take 2011 as an example, we're forecasting $65 million to $75 million of CapEx that exceeds our EBITDA for 2011. So we're sensitive to investors asking the intelligent question, hey, that's a fairly aggressive CapEx spend rate. If something changed in the marketplace, what would be your ability to react to those changes and adjust your capital expenditure to reduce it to much more modest levels. And the message is we could reduce our CapEx expenditure quite quickly to much more modest levels if market conditions changed. In terms of the data centers, the Dallas, Los Angeles, and subsequently Atlanta expansions, I think a couple of things. One with regard to Dallas and Los Angeles, those are obviously new markets for Internap but their new markets only in the sense that we don't currently own a company-controlled data center in those markets. They are not new markets at all in terms of local, established Internap direct sales presence, and we've had that sales presence for quite some time, evidenced the fact that we have successfully been selling into partner data centers in both Dallas and Los Angeles. So from that we derived 2 benefits. One is let's say local market knowledge and therefore, local market knowledge of demand and supply trends, and we also derived the benefit of local market, let’s call it brand recognition. So for both of those reasons we feel pretty confident in our ability to hit the ground running in those markets and generate incremental colocation bookings.

Operator

[Operator Instructions] Our next question is from Mark Kelleher of Dougherty.

Mark Kelleher - Dougherty & Company LLC, Research Division

If we go forward and we look at the data centers opening, we look at the cloud offerings that you've got. Your data center services is beginning to dominate the revenue here. And it's just going to continue to do that. Is there a point in time that you might think of unconnecting the IP services from the data center services to move toward a more network neutral stance, is that in the cards down the road some way?

J. Eric Cooney

If by unconnecting you mean moving away from what we feel is our competitive differentiation in that we provide a better, higher performing, higher availability network offering, you know my answer to that question would be no. In other words, from our perspective, we provide all of the benefits of carrier neutrality that a customer would want, namely selection of multiple carriers plus, we provide a better performance and better availability across those multiple carriers. So from our standpoint and we've certainly not heard this message or request from many customers to change our positioning from our current network enhanced data center services offering to something let's say more akin to what others provide. We view that as a net selling point for our data center services. The high-performance IP.

Operator

Our next question is from Jonathan Atkins of RBS (sic) [RBC] Capital Markets.

Jonathan Atkin - RBC Capital Markets, LLC, Research Division

It's RBC Capital Markets. On the hosting business and similar from what you expect from cloud, are you expecting to get first time adopters to those services? Or are you going to be displacing a competitor? And then specifically with regard to OpenStack, I wondered if you can elaborate a little bit more about what you're providing -- are customers asking for it, or do you view it simply as an enabling technology that meets certain demand set?

J. Eric Cooney

So in terms of our expectations for customers either first-time cloud users or displacing competitors, we're already seeing both, candidly. There are examples where our competitors have, for whatever reason, dissatisfied a customer. Maybe it was a customer support problem, maybe it's a performance issue, and they're looking for an alternative and we've satisfied their needs. But also exactly as you'd expect we're a burgeoning high-growth cloud services market, there are plenty of enterprises who are, for the first time, dipping their toe in the cloud infrastructure market and we're seeing a pair of [ph] of those as well. In terms of OpenStack, candidly our rationale for bringing that offering to market was really to afford our customers the broadest range of choice amongst the cloud services providers. Specifically, we see a large majority of enterprises today, very comfortable with a VMware-based platform and all of the features and functionality that come along with that, but the flip side is OpenStack offers many of the same features and functionality and potentially at a significantly lower cost point. So depending on the enterprises, let's say primary drivers, or key elements of their business decision, there are applications where OpenStack will be a very clear and compelling choice. And similarly there'll be applications where the customers prepared to perhaps pay a higher price but derive the benefits from a more fully featured suite of product offering. So we just think OpenStack in combination with the VMware clouds uniquely positions Internap with a very broad, compelling cloud services offering.

Jonathan Atkin - RBC Capital Markets, LLC, Research Division

And then with respect to the first-time adopters of cloud or as hosting the zeros that you're taking on, are these competitive situations, or because of the breadth of your platform, it's more of you against the internal IT team, and the company kind of examining total cost of ownership?

J. Eric Cooney

It's typically competitive situations. While it's true that -- or at least we believe it's true that none of the other enterprise cloud providers offer the range of choices that Internap now does, it's still absolutely true that in any specific category or vertical, there are select competitors for our cloud offerings. So there are OpenStack cloud providers. There obviously are VMware cloud providers, and individually we compete with them all.

Operator

There are no further questions at this time. I'll turn the call back over to Drew.

Andrew McBath

Thanks, Latoya. Thanks, everybody, for joining us today. We look forward to visiting with you on our fourth quarter results in a few months here. Thanks again.

Operator

Ladies and gentlemen, this concludes today's conference. You may now disconnect. Good day.

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