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Internap Network Services (NASDAQ:INAP)

Q1 2012 Earnings Call

April 26, 2012 5:00 pm ET

Executives

Andrew McBath - Director of Investor Relations

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

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

Analysts

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

Colby Synesael - Cowen and Company, LLC, Research Division

Mark Kelleher - Dougherty & Company LLC, Research Division

Christopher M. Larsen - Piper Jaffray Companies, Research Division

Rodney W. Ratliff - Capstone Investments, Research Division

Gray Powell - Wells Fargo Securities, LLC, Research Division

Operator

Good day, ladies and gentlemen. Welcome to the Internap First Quarter 2012 Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded. I will now turn the conference over to your host. Mr. Drew McBath, you may begin.

Andrew McBath

Thanks, Mimi. 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 and 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 future performance and long-term profitable growth, belief in our business strategy, including benefits to be achieved from investing in our company-controlled co-location, hosting and cloud services; timing for bringing new data centers online; expectations regarding the progress, timing and ultimate success of integrating Voxel into our business, including its impact on our financials and launch of new offerings; expectations regarding level of capital expenditures; cash operating expense and cash flow; and expected levels of churn.

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 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 first quarter 2012 results, we will also discuss recent developments.

Now let me turn the call over to Eric Cooney.

J. Eric Cooney

Thank you, Drew, and good afternoon, everyone. We appreciate you joining us for our first quarter 2012 earnings presentation.

I'll start with a brief recap of our results beginning on Slide 3.

Revenue growth continued into the first quarter, increasing 13% year-over-year and 7% over the fourth quarter 2011. In line with our company's strategic direction, the data center services business, including company-controlled data centers, managed hosting and cloud services, continues as the engine for growth of the company. With the completion of the Voxel acquisition on December 30, we have consolidated the Voxel revenue and segment profit with Internap's data center services revenue and segment profit for the first quarter of 2012.

Segment profit and segment margin were very strong in the quarter, improving on a year-over-year basis by 18% and 240 basis points, respectively. These improvements were attributable to both solid organic growth in the Internap data center services business unit, as well as acquisition-driven growth resulting from the addition of Voxel.

On Slide 4, we're highlighting the sources of change in revenue from the fourth quarter 2011 to first quarter 2012. The data center services business unit, including company-controlled co-location, hosting cloud services, and now, Voxel, are clearly the engine for top line company growth. In total, with data center services unit contributed $4.6 million of incremental revenue, offset slightly by a sequential decline in IP services revenue of $0.4 million in the first quarter.

As you recall, we previously disclosed that Voxel was expected to generate approximately $3.5 million in revenue for the fourth quarter 2011, and was expected to grow 25% annually. Voxel is performing well as part of the Internap team and remains on track with this revenue growth profile.

We delivered another quarter of solid adjusted EBITDA, as you can see on Slide 5. Adjusted EBITDA totaled $12.2 million or 18.3% of revenue. This represented a 3% sequential decline, but an increase of 33% over the first quarter of 2011. Similar to prior years, the sequential adjusted EBITDA decline was driven by higher cash operating expenses during the first fiscal quarter, including certain wage and payroll tax costs which reset in January.

The strong 33% year-over-year improvement in adjusted EBITDA was primarily driven by organic growth in Internap's data center services revenue and associated improvements in data center services segment profitability, with a modest positive impact from the addition of Voxel for the first quarter.

I'll cover segment results on Slide 6.

Data center revenue for the quarter totaled $39.9 million, an increase of 13% sequentially and 27% year-over-year. Segment profit in data center services was up 46% year-over-year and 25% sequentially to $19 million. While the majority of the year-over-year growth in data center services revenue and segment profitability was organic, the addition of Voxel, along with its expected 25% annual revenue growth rate, bodes well for the future of long-term profitable growth in this segment.

IP services revenue decreased modestly quarter-over-quarter and year-over-year to $27.1 million, while IP segment margin was 62.4%, a decrease of 210 basis points compared with the fourth quarter of 2011. As we've mentioned before, IP services generates strong cash flow for the business and serves as a key element of competitive differentiation for the data center services business. As enterprises become increasingly reliant on the Internet for their basic productivity applications, we see the need for high-performance, high-availability connectivity to their hosted IP environments as a central differentiator for Internap's offering. The combination of our route-optimized IP, application acceleration and content delivery technologies and expertise uniquely positions Internap in the field of IT infrastructure suppliers.

As we've done over the past few quarters, I want to provide you an update on our data center expansion efforts, which can be found on Slide 7.

Construction in our Los Angeles facility, which will yield 55,000 net-sellable square feet when fully deployed, is well underway and remain on track for our third quarter 2012 opening. We're also on schedule for our third quarter opening of our Atlanta data center expansion. With the completion of our headquarters staff relocation from the facility last month, we've begun demolition to convert this former office space into 31,000 net-sellable square feet of premium data center capacity. As our existing 11,000 net-sellable square feet of data center footprint approaches full utilization, the timing of this expansion will be quite opportunistic. The first phase of this expansion project will include approximately 12,000 net-sellable square feet, which is on track to come online in the third quarter 2012. Investment in these premium data center assets is a foundational element of our strategy to drive the long-term profitable growth that is clearly being reflected in the upward trend of data center segment margins.

On Slide 8, I'd like to discuss an announcement we made earlier today regarding the immediate availability of our automated online high-performance Agile Hosting services across a global footprint. This launch marks one of the first key technology milestones resulting from the combination of Internap and Voxel.

On Slide 8, we've lifted some of the features this service provides to Internap customers. These include standard hybridization, which allows virtual and physical servers to be seamlessly mixed to meet specific application requirements; on-demand, ordering, payment and deployment functionality to speed provisioning; simplified interface and intuitive order flow; and finally, broad geographic expansion across 5 global locations, including New York, Dallas, Silicon Valley, Amsterdam and Singapore. We are particularly excited by this product launch, as we feel it is a good example of the type of 1-plus-1-equals-3 synergies that we anticipated when we contemplated the combination of Voxel and Internap.

To bring this solution to market, we successfully leveraged technologies, people and process across the combined organization and launched this new offering to market in less than 120 days post-completion of the business combination. I am very proud of the entire team for completing this initial product launch and take it as a positive sign of the potential for value creation from the 2 companies.

Moving to Slide 9. We also announced today that we are providing managed hosting and IP services to CipSoft, an online gaming company based in Germany. CipSoft introduced one of the world's first graphically massively multiplayer online role-playing games, Tibia, in 1997. With more than 300,000 active players today, Tibia ranks among Europe's most successful online games. CipSoft required a scalable infrastructure that could seamlessly meet new demand whether organic or driven by heavy spikes in traffic due to biannual game updates. Internap has a very strong presence in this vertical. In fact, we serve 1/3 of the 25 largest online gaming companies in the world and 4 of the top 5 fastest-growing.

Our ability to provide better performance, availability and support has helped us build an extremely strong franchise among these latency-sensitive, highly-demanding customers.

Before I hand over to George for his review of the financial results, I wanted to recognize the press release we issued earlier today, announcing George's departure from Internap, to take a position as the CFO for VeriSign. I would like to first congratulate George on an exciting opportunity to serve as CFO for a company with a market valuation in excess of $6.5 billion. Clearly, this is a good career opportunity for George. Second, I'd like to thank George for the great work he's done for Internap over the last 4 years. During his tenure, George has driven continual improvement within the finance organization. He has been an agent for positive change within the broader organization and he has served as a trusted advisor to both the board and for me as the CEO.

The team of finance professionals he has built over the past 4 years is a credit to George's leadership skills. And while we are certainly sorry to see him go, we take comfort that this team will be able to confidently take the Internap finance organization positively forward from here. George?

George E. Kilguss

Thanks, Eric, and thank you for your kind words. Before I go into my quarterly remarks, I just wanted to take this opportunity to thank both Eric Cooney, and the Board of Directors for their leadership and constant support during my tenure as Chief Financial Officer. I also want to thank my staff for their efforts in helping to shape and execute the improvement plans we put in place over the past 4 years. Internap has built a solid financial foundation, which I am sure will leverage to derive continued profitable growth in future periods.

I'll start my comments on our quarterly results on Slide 10, which covers our income statement comparisons. First quarter 2012 revenue totaled $67 million, a $7.6 million increase compared to the same period last year, representing year-over-year growth of almost 13%. Compared with the fourth quarter of 2011, total revenue rose by $4.2 million, an increase of approximately 7%. Our first quarter results reflect the acquisition of Voxel, as well as solid organic growth in data center services. Total segment profit grew by 18% year-over-year and 9% quarter-over-quarter to $35.9 million, a record high for the company. Total segment margin expanded 240 basis points year-over-year and increased 110 basis points quarter-over-quarter, also representing a historic high. Segment profit and segment margin continued to be driven by solid growth in core data center services, a larger mix of higher margin, company-controlled co-location and hosting services. Total cash operating expense of $23.6 million increased 12% year-over-year and 17% quarter-over-quarter. The increase resulted from a combination of recurring operating cost assumed in the Voxel acquisition, as well as operating expense increases associated with higher payroll taxes, bonus accruals and annual sales events in the quarter when compared to our fourth quarter of 2011.

Cash operating expense to revenue was approximately 35%, roughly aligned with the same period 1 year ago. We expect our cash operating expense to remain at similar quarterly levels during 2012. Adjusted EBITDA increased 33% compared with the first quarter of 2011, and declined 3% quarter-over-quarter to $12.2 million. Adjusted EBITDA margin was 18.3% compared with 15.5% in the first quarter of 2011, and 20.1% in the previous period. Higher operating costs in the first quarter were more than offset by improved segment profit, relative to the first quarter of 2011. Sequentially, seasonal higher general and administrative costs outweighed the quarter-over-quarter increase in segment profit.

GAAP net income was approximately $100,000, an improvement over the first quarter of 2011 and declined from the prior quarter, which included a $6.1 million partial release of our deferred tax assets which was triggered by our acquisition of Voxel. Normalized net income, which excludes the impact of stock-based compensation, deferred tax benefits and certain items management considers nonrecurring, was $1.6 million or $0.03 per share.

Turning to a summary of our cash flow and balance sheet on Slide 11.

CapEx outpaced adjusted EBITDA in the quarter by $4.6 million as we continue to invest in our higher-margin, company-controlled data center footprint. Our capital expenditures in the first quarter totaled $16.8 million, roughly in line with the $17.7 million we invested in the previous period. Projects in the most recent period included our new data center in Los Angeles and the expansion of the Atlanta facility. At the end of the first quarter, cash and cash equivalents totaled approximately $31 million. Funded debt totaled $59 million, remaining flat compared with the balance at 12/31/2011. Capital leases increased to $7 million over the prior quarter due to the relocation of our new corporate office headquarters here in Atlanta.

On Slide 12, I'll cover our segment results in more detail.

Data center services revenue totaled $39.9 million in the quarter, an increase of $8.4 million year-over-year and $4.6 million sequentially. In addition to solid growth and our company-controlled co-location and managed hosting services, the quarter's revenue growth also reflects the first full period incorporating Voxel results. We are pleased with the Voxel revenue trajectory in the quarter, and we expect the recent launch of the Voxel.net e-commerce portal will continue this positive momentum.

Increasing portions -- increasing proportions of our higher-margin services, specifically co-location, so the company-controlled data centers and hosting services, also helped to improve profitability. Absolute segment profit in data center services improved 46% year-over-year and 25% sequentially. Data center segment margin increased 620 basis points compared with the first quarter of 2011 and 460 basis points over the fourth quarter of 2011.

In our IP services segment, revenue totaled $27.1 million, down from $27.9 million 1 year ago and $27.5 million in the prior quarter. The 1% sequential decline is attributable to lower per-unit pricing, which is partially offset by traffic growth. IP segment margin returned to historical levels of 62.4%, down by 210 basis points sequentially and flat when compared to year ago levels. The sequential margin decline was a result of lower sales in the quarter, accompanied by slightly higher cost resulting from increased traffic and network reconfiguration and expansion costs.

In the first quarter, revenue churn declined sequentially in both business units. Data center churn was 1.4% compared with 1.6% in the fourth quarter. IP churn came in at 1.5%, a 40 basis point decline versus the previous period. As a result, total company churn improved from 1.7% in the fourth quarter of 2011 to 1.5% in the most recent period, a level we expect to maintain throughout 2012.

On Slide 13, I'd like to provide more color on the positive trends we are seeing in the data center services segment, which we expect to be Internap's primary growth driver moving forward. Our success is primarily attributable to growth in the customer base and an increase in the average revenue per customer. We've done a good job over the past 2 years of driving ARPU higher by cautiously expanding our portfolio of IT infrastructure services tailored for the enterprise. This approach has helped to grow customer wallet share among key existing accounts and increase the size of deals sold to new logos. Our ARPU this quarter increased 8% year-over-year, while we continue to expand the customer base organically. Our data center services customer account rose 6% year-over-year as Internap's unique selling proposition of best-in-class performance, platform flexibility and support resonates with our enterprise customer.

As depicted on Slide 14, first quarter total debt-to-annualized EBITDA was 2.2x, well below the average of 3x for our data center peers. Likewise, we maintain the debt-to-capital of 36% versus 64% for the peer group. Our announced data center expansions are fully funded, as we have approximately $48 million of debt capacity under our current credit agreement and $31 million of cash on our balance sheet.

As a reminder, in 2012, we expect to spend between $60 million and $70 million of capital expenditures, of which between $8 million and $12 million is maintenance capital expenditures, while $52 million to $58 million is related to expansion CapEx. We maintain significant cash generation capability, as evidenced by our discretionary cash flow defined by EBITDA less maintenance CapEx.

Annualizing our first quarter EBITDA and taking the midpoint of our maintenance CapEx guidance suggests an annualized discretionary cash flow of approximately $39 million, with roughly 85% of our 2012 capital budget allocated towards future growth or success-based capital tied to customer insulation requests, we maintain our capital flexibility. Days sales outstanding improved to 24 days in the first quarter, reflecting continued discipline in our collection procedures and free screening credit policies.

In summary, our continuing strength of the company is our transition into faster growing data center service markets and our solid financial position, which provides the flexibility to aggressively invest in key growth initiatives within the industry.

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 15.

We are pleased with another solid quarter of execution, with revenue up 13% year-over-year, another record quarter of segment profit and margin and adjusted EBITDA up 33% year-over-year, we are confident the strategic focus is taking the company in the right direction. Further, with these results underpinned by strong organic performance from the data center services business, we are confident that the focus should remain on execution and the company controlled co-location, managed hosting and cloud services throughout 2012. The integration of Voxel was well on track through the first quarter of 2012. Both the revenue growth of the Voxel business and the launch of our Agile Hosting offering provide good indications of the potential for this business combination to create long-term incremental shareholder value. We are confident that we are on the right path in terms of our strategic focus on data center services as a basis for long-term profitable growth. As we look forward, 2012 is all about execution of this strategy. We'll be seeking to leverage the recent and upcoming data center expansions in Dallas, Los Angeles and Atlanta, as well as drive further growth from our expanding hosting in cloud services offerings.

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

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Clayton Moran of Benchmark.

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

A few details on the quarter. I guess, 3 questions. First, can you give us the Voxel revenue for the quarter, and any one-time integration expenses? And then second, the last 2 questions are on this supplemental data sheet. Just looking at some of the data center changes in terms of net-sellable and customer-occupied square footage. It looks like in your controlled space, the -- you've only added about 1,000 square feet in the last quarter to customer-occupied the last few quarters. Just wondering if you could talk about what's going on there, why that's seemingly slowed. And then on the partner side, there was an uptick in both sellable and occupied space. Also wondering what's going on there.

J. Eric Cooney

Sure. I'll go ahead and take those, Clay. So first of all, with regard to Voxel's revenue, we're not actually intending to break out or delineate Voxel's financials going forward. But to give you some indication, we are reiterated the Voxel financial figures we provided when we announced the transaction, specifically that Voxel was expected to deliver $3.5 million in revenue in the fourth quarter of 2011, and that Voxel was expected to grow at an annualized rate of 25%. And then finally, we stated that Voxel was on track with that revenue growth plan. So bottom line, we think that gives you a pretty good ability to estimate Voxel's revenue contribution in the first quarter of 2012.

And you asked about one-time integration charges, and the short answer is there really were no material integration costs or expenses in the first quarter of 2012.

Finally, your question about the net-sellable square footage, you are reading the charts correctly in that company-controlled increase, just under 1,000 occupied square feet Q4 to the first quarter. And likewise, our partner's square footage also increased just under 1,000 square feet in the quarter. The rationale behind that is, at least in terms of the partner revenue is we -- you will recall, we previously stated that opportunistically, we do continue to sell into partner facilities, primarily when driven by strategic customer -- existing Internap customers who are looking to expand their footprint with us. And we do that on a case-by-case basis, and we do that based on the relative profitability of the deal. Hopefully, as evidenced by the improvements in data center segment margins, you'll recognize that we continue to make the right decisions there and drive profitability up into the right.

In terms of the company controlled, I would simply point you to the overall trend in our data center businesses really as a reflection of the health of that business. Phrased differently, while we'd, of course, like to see greater increase in occupied square footage on our company-controlled data centers, I'm not overly concerned by the first quarter results with just under 1,000 incremental square feet.

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

Okay. Eric, on the partner side, the data sheet says you added 6,000 net-sellable and you added 5,000 to customer-occupied.

George E. Kilguss

Yes. Clay, this is George Kilguss. The reason for the increase is really the Voxel company net-sellable and occupied, their facilities are in all partner facilities as of today, and we record them in our numbers. So the increase really going from 61 to 67 is primarily the Voxel occupy there.

J. Eric Cooney

Clay, the numbers I gave you were -- let's say, the underlying Internap organic figures, exclusive of the addition of the Voxel partner footprint.

Operator

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

Colby Synesael - Cowen and Company, LLC, Research Division

So first, I want to talk about churn. Churn, obviously, very good numbers. If I remember correctly though, I thought churn had been delayed in the fourth quarter and we're expecting it to come up in the first quarter and that didn't happen. I think messaging is that you actually expect it to be flat with where it was in the first quarter through the course of the year. So trying to just understand what's going on there. And then also from what we understand, the Voxel integration thus far has really been all about planning, there really hasn't been any big heavy lifting going on. And, George, for example, I think you just kind of referenced it, maybe at some point, you guys are considering moving Voxel into Internap facilities. Should we be expecting any meaningful cost associated with that transition, whether it's in the second or third quarter? And just want to make sure we're modeling it appropriately.

J. Eric Cooney

I'll take your first one regarding churn and you are correct to that essentially in the first quarter, we delivered slightly better churn than we had perhaps expected when we released our fourth quarter financial results. Again, with first quarter 2012 coming in at 1.5% churn. And we did in fact, in George's remarks, provide guidance as well for the remainder of 2012, that we expect that 1.5% churn level to be a pretty good number for the company throughout the remainder of 2012. So yes, I think your interpretation is correct. Our churn figures are perhaps a little bit better than we might have expected in the last quarterly results presentation.

Colby Synesael - Cowen and Company, LLC, Research Division

Anything you have to point to in terms of why that is?

J. Eric Cooney

I'm sorry?

Colby Synesael - Cowen and Company, LLC, Research Division

Is there anything that you can point to that explains that, whether it's that customer chose not to leave or it just wasn't as big of an impact as was anticipated? Or just anything there?

J. Eric Cooney

The customer impact we were referring to in Q4 that specifically to drive churn higher in the first quarter happened essentially as anticipated. I think the delta between what we projected and what we delivered was actually in call it the core run rate underlying business, ultimately just delivered slightly better result than we were perhaps expecting at the fourth quarter results announcement.

George E. Kilguss

And, Colby, this is George. So as it relates to your question as far as cost savings, the potential cost savings with consolidating some of the Voxel operations into Internap company-controlled facilities. Clearly, over the long-term, that is the plan. But just as like our customers are in multiyear contracts, Voxel's also entered into multiyear contracts with their vendors. So as those contracts mature, we absolutely will look to move some of those facilities, the ones that makes sense, into Internap company-controlled data centers in order to achieve some cost savings. But I don't expect that to happen in fiscal 2012.

Colby Synesael - Cowen and Company, LLC, Research Division

But if I even take that going the opposite direction, so what about additional costs? So for example, there's 2 different cloud platforms that you guys are both on. When we think about software integration, back-office integration, are there actually some costs that we could actually see pop up in the second quarter that we wouldn't necessarily have seen in the first quarter that maybe we should be modeling in?

George E. Kilguss

No, no. You shouldn't be modeling any incremental cost along those lines.

Operator

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

Mark Kelleher - Dougherty & Company LLC, Research Division

Wanted to talk about the Agile Hosting services. As that ramps up, is that revenue included in the Voxel revenue? When you're looking at Voxel growing 25% year-over-year, is Agile Hosting services part of that or is it something else?

J. Eric Cooney

The Agile Hosting revenue will be included as part of our data center services business segment revenue. However, the Agile Hosting platform was not contemplated in the context of that 25% annual growth rate. That was a synergy, if you will, of the combination of the 2 companies. I characterize it as a 1-plus-1-equals-3 synergy. And if we're successful in growing that product offering, that would represent an incremental upside relative to the 25% annual growth rate we articulated.

Mark Kelleher - Dougherty & Company LLC, Research Division

Okay. And could you just sort of address what you envision as the competitive environment for Agile Hosting services? Who are you going up against and how do you go to market with that? How are you going to sell that?

J. Eric Cooney

Well, it's essentially an online, mass-market, if you will, offering. It's characterized by being highly-automated. We tend to target relatively small customers, at least in terms of their initial IT infrastructure purchases. They tend to be customers that are fairly technically savvy, because they're self-configuring, self-provisioning the platform. And in a lot of cases there, if you will, credit cards-like procurement process. So that's the profile of the Agile Hosting offering. In terms of the go-to market, it's not so much a direct sales go-to market as it is more of a traditional online marketing at SEO pay-per-click investment to drive traffic to that website. Having said that, it, of course, leverages much, if not all, of the underlying IT infrastructure that Internap and Voxel had brought to market. So our value proposition as it relates to performance, availability, platform, flexibility, and of course, customer support, all is evident in the Agile Hosting offering, and those customers will derive those benefits.

Mark Kelleher - Dougherty & Company LLC, Research Division

Okay. And just one last question. The Dallas facility came online recently. Can you give us an update on how the uptake there is? And what the competitive environment is in pricing down in Texas?

J. Eric Cooney

In terms of the uptake, I would say we're pleased with the progress we're making in the Dallas market. We did actually a fair bit of incremental recruitment to our sales and organization in the local market. We did some of that in fourth quarter and early in Q1. We're starting to see those folks are -- ramp up quite nicely. In terms of the competitive environment, pricing environment in Dallas, I would say, status quo, I think it's clearly a competitive market. There are, obviously, other premium data center providers there. But I wouldn't characterize any, let's say, recent changes in the competitive pricing environment. I would characterize it as a stable competitive landscape with stable pricing.

Operator

Our next question comes from Chris Larson of Piper Jaffray.

Christopher M. Larsen - Piper Jaffray Companies, Research Division

Congratulations, George. We will -- it's a shame to see you go, but understandable. One of the comments you made in your remarks, George, is that you expected -- I'm not sure if I'm characterizing this right, cash OpEx to remain flat. And I was just wondering where you were referring about the absolute dollar figure remaining flat? So as the revenue scale, we'll see margins come up with it? Or were you referring to the margin amount? and then along the lines of Dallas, if you could give us, Eric, maybe some thoughts on any presales activity that you've begun for L.A. and any comments you can give us around that? And then lastly, on Voxel, I wondered if you could talk a little bit about cross-selling it into your existing base and maybe any early success stories? I certainly understand the Agile Hosting being one of the plus-3s, but anything that where you're selling it into your base that you can talk about?

George E. Kilguss

So this is George. Thank you very much for your comments there, which relation to operating expenses, I was referring really to the absolute dollars that we had in the quarter. So we would expect to add revenues and profits to entries to get some leverage in the business plan going forward.

J. Eric Cooney

Chris, in terms of the Los Angeles market presale, for Internap, in the context of a retail co-location sales model, we don't rely our expect really significant volumes of presale activity into our data centers. Essentially, we're selling relatively small footprints with relatively short lead times in terms of the customer's decision to move their co-location environments. Having said that, we, obviously, undertake a fair bit of activity in the local markets, Los Angeles, in this case, in terms of company awareness, brand awareness, to let folks know that we're opening up a new data center in that market. Recognize also, though, that Internap has been established in the Los Angeles, Southern California market for a number of years, quite actively with the direct sales force and quite successfully selling in this case, partner data center services. So there's a lot of Internap sales relationships with relevant key customers. We'll just simply be looking to put those future data center footprints into Internap company-controlled facility in the L.A. market.

Your last question with regard to cross-selling of the Voxel platform. I mentioned in the last quarterly release, that we had undertaken some initial direct sales force training. And that really went both ways to a certain extent. Training the Voxel sales organization a little bit on the Internap products and services, and also conversely, the Internap sales reps on the Voxel products. And we are most definitely seeing the benefit of that broader platform of services as part of our ongoing dialogue with our customer base. At the end of the day, our value proposition is heavily reliant on a message of platform flexibility, which really means a wide diversity of IT service offerings from co-location to managed hosting to cloud. Voxel added some really compelling elements to our hosting and cloud offering that basically gives us a much stronger, much more complete consultative sales message for our target customer base. So yes, we are seeing evidence of traction and success leveraging the cross-selling opportunities of Voxel into Internap's traditional direct sales customers.

Operator

Our next question comes from Rod Ratliff of Capstone Investments.

Rodney W. Ratliff - Capstone Investments, Research Division

I was just wondering, going back to some of the legacy products, what does the attach rate for performance IP and how was the progress been on XIPs since you guys introduced it?

J. Eric Cooney

So the attach rate for the Internap to co-location with Internap IP is very high. And by very high, it's...

George E. Kilguss

It's about 63%, Rod.

J. Eric Cooney

The majority of our customers that purchase internet co-location are absolutely purchasing Internap IP. Your question about the XIP product, the accelerated -- TCP Acceleration product, I would say is an added bonus for our -- both our IP transit and our, of course, our co-location data center services customers. In terms of the revenue contribution, it's a very modest revenue contribution, but it's important in terms of its incremental message for our performance IP story. In other words, the XIP TCP Acceleration, in combination with our traditional MIRO route optimization technology and in combination with our content delivery network technology, really just completes the triad, if you will, of technology elements that deliver high performance IP for the company.

Rodney W. Ratliff - Capstone Investments, Research Division

Good, good. Fast forwarding to today's release about Agile. I'm wondering, is that purely a product announcement? And forgive me if I've just missed the data point on this. Is it purely a product announcement or are there already some customers live on that product?

J. Eric Cooney

It is a product announcement, and there are customers that are live on that platform today. We went, actually beta on it, if you will, several weeks ago. So we've been testing it and working out the early kinks. But it is a new product offering, primarily in the sense that we've put an online portal, a new online configurator, as a front end on to the underlying engine and transmission of our dedicated hosting and cloud hosting offering. So the underlying engine and transmission is much the same as it has been and this was the Voxel platform I'm referring to. The newer incremental work is to a certain extent, on the engine and transmission, but I would say the heavy lifting has been done with the online configurator and the new web portal.

Rodney W. Ratliff - Capstone Investments, Research Division

Okay. And I think an answer to another analyst's question earlier, I don't remember which guy it was. But somebody made a reference. It seems as though it may be more targeted toward the SNB market. Is that a fair assessment? Because you yourself -- I think Eric said something about it primarily being something that would be credit card-swiped? So is there -- would there be auto renewal with it or would it be something that, well, I guess, you follow the logic with that, right?

J. Eric Cooney

So I wouldn't necessarily say it's "targeted" to the SNB market. In other words, there are some very large Fortune 500 companies who are depending on the specific application workload, spinning up and spinning down servers either on an on-demand or in a longer-term committed basis, and just doing that by an online configurator and swiping a corporate credit card to do so. They tend to be smaller purchases, at least in the initial dollar value. So your Fortune 500 companies aren't doing the preponderance of their outsourced IT infrastructure by an e-commerce web portal. But again, there are definitely large enterprises leveraging for certain application workloads. In certain scenarios, an online e-commerce self provisioning portal.

Rodney W. Ratliff - Capstone Investments, Research Division

George, congratulations.

George E. Kilguss

Thanks, Rod.

Operator

[Operator Instructions] Our next question comes from Gray Powell of Wells Fargo.

Gray Powell - Wells Fargo Securities, LLC, Research Division

I just had a couple. So the sequential improvement in data center gross margins, I think, it's about the best we've seen in the last 2 years. Can you just give a little bit more detail as to the drivers there and where do you see data center gross margins peaking?

J. Eric Cooney

I mean, I'll maybe take the second question first and let George dive into some of the details. But where do we see data centers segment margins peaking? To answer that question, you really need to dissect the components of our data center services business into co-location, hosting and cloud services. And if you break it down that way, you see co-location services and at least internally, we hold ourselves up against what we consider to be best-in-class co-location providers. And we can look at companies that meet that characterization and see companies delivering north of 60% segment margin on their co-location services. But certainly, we are targeting ourselves up into the right, let's say, in the co-location environment and we've previously mentioned numbers of pushing our internal co-location margins north of 50%. In the managed hosting and cloud services, without being too specific, suffice it to say that segment margins are even higher than they are on co-location services. So again, the net impact is that trend we showed in the presentation of steadily increasing in fact, over the past 3 years, steadily increasing segment margins in the data center services business, we would obviously expect that to continue as we expand the relative proportion of our data center services revenue.

George E. Kilguss

And, Gray, this is George. If you wanted a little more detail on that. Clearly, as Eric pointed out, we -- the more we sell into our company-controlled facilities and sell our related services and hosting in cloud, we get a higher margin contribution even in our core business, we increased that margin from about 42.9% last quarter up to about 46% and then the combination of Voxel, which is higher-margin business as well, helped drive the remainder of increase to about 47.5%.

Gray Powell - Wells Fargo Securities, LLC, Research Division

Got it. Okay, that's very helpful. Okay. And then just different topic. Longer-term, if I just want to look at, I guess, the data center side, where do you see the mix shaking out between traditional co-location and managed hosting?

J. Eric Cooney

From Internap's vantage point, our go-to-market strategy is really all about being an IT services provider that offers our customers hybrid combination of co-location, hosting and/or cloud services. And by hybrid, I mean, giving our customers...

Operator

Thank you. Ladies and gentlemen, this concludes the conference for today. You may all disconnect and have a wonderful day.

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