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Executives

Andrew McBath - Director, Investor Relations

James P. DeBlasio - President, Chief Executive Officer

George E. Kilguss III - Chief Financial Officer

Analysts

Jurgan Usman - Wachovia Securities

Sean Markin - Thomas Weisel Partners

Jonathan Atkin - RBC Capital Markets

Rodney Ratliff - Stanford Group Company

Thomas Watts - Cowen And Company

Eric Suppiger - Signal Hill

Srinivas Anantha - Oppenheimer

Jonathan Schildkraut - Jefferies & Co.

Colby Synesael - Merriman

Internap Network Services Corporation (INAP) Q1 2008 Earnings Call May 7, 2008 5:00 PM ET

Operator

Good day everyone and welcome to the Internap first quarter 2008 earnings call. Today’s conference is being recorded. For opening remarks and introductions I would now like to turn the conference over to Mr. Andrew McBath,Director, Investor Relations at Internap. Please go ahead.

Andrew McBath

Thank you Miranda, good afternoon. Thank you all for joining us today to discuss Internap’s first quarter results for the period ending March 31, 2008. I would like to start by reminding everyone that today’s call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All statements, other than statements of historical facts, including among others, statements regarding future and current positions or performance, business strategy and prospects, projected levels of growth, projected costs and expenses, projected capital expenditures and projected financing needs are forward-looking statements.

Forward-looking statements are not guarantees of future performance and involve risk and uncertainties that could cause our actual results to differ materially from those contemplated by these forward-looking statements. Internap's filings with the Securities and Exchange Commission, discuss important factors that could cause actual results to differ materially from such statements, in otherwise affect our business results or operations and financial condition.

You should not place any undue reliance on any of these forward-looking statements. Further, all forward-looking statements speak only as to the day in which they are made and the Company undertakes no obligation to update such statements for any reason. Joining me on today's call are Jim DeBlasio, President and Chief Executive Officer; George Kilguss, Chief Financial Officer and other members of Internap's senior management team. In addition to reviewing first quarter results, we will also discuss recent developments in Internap and update guidance for 2008.

During this call, we'll refer to some non-GAAP measures. We believe these measures are useful for the understanding our financial results and operations. These non-GAAP measures are not prepared in accordance with generally accepted accounting principles. Under the presentations and earnings section of the Investor Relations page on our website, we define these non-GAAP terms and reconcile these non-GAAP measures with the most directly applicable GAAP financial measures. At this time I’d like to turn the call over to Mr. Jim DeBlasio.

James P. DeBlasio

I would like to thank everyone for joining us today, as we review our first quarter performance. While we’re pleased to report record revenue and some encouraging business metrics the last several months have been challenging for Internap shareholder and employees; so, before reviewing our progress and some new and important customer wins, I will address the issues that’s around the delay of our 2007 10-K filing. I will then cover the proactive steps we have taken which are design to remediate these issues and return Internap to the positive trajectory we are on in early 2007 and all throughout 2006. Then after our CFO, George Kilguss reviews the financials, I will return with a discussion of our progress and detail some important new customer wins.

As you know we delayed our 10-K filing to investigate customer credits that exceeded the sales credits and billing allowances we had accrued in 2007. This delay was driven by two related issues; first we experienced CDN outages in the second half of 2007. These outages reflected integration challenges we experienced by moving traffic from the legacy VitalStream systems for Internap platforms; second, a large increase in customers requesting both credits and disconnects due to these problems explored flaws throughout processes.

As we previously reported these two issues result in a loss of approximately 175 customers over the fourth quarter of 2007 and into the first quarter of 2008. In RM side the complexities of the integration strained our operational and financial processes and required a significant proportion of time on the part of the entire Internap team that focus on addressing both short term and long term process improvements.

After a thorough review we have put systems and personnel employees to address and repair the issues and we have installed tools to examine the business on an ongoing basis to prevent recurrence of these issues. We have augmented operations with higher customer touch systems and process improvements, both in comprehensive internal reviews and with the systems from out side firms. We also continue to increase our liability and reach of our CDN platform.

Last week, we announced that we offered 12 more new CDN PoPs and they went live in our network doubling our points of presence globally and adding scale to our network. Given our reduced customer count and the result in delay in our revenue ramp for 2008 we are now forecasting that 2008 revenues will grow approximately 13% to 18% over 2007, a reduction from our prior year guidance that we had given for 2008. Adjusted EBITDA margins are forecast to be in a range of 17% to 20% of revenue.

Our outlook for 2008 capital expenditures remains unchanged at $45 million to $50 million. With these issues fairly behind us, we have refocused our attention to generate continued revenue growth and profitability. We are returning our focus to operational excellence and efficiency and driving customer growth back by our technical expertise and our world-class customer service.

As part of these process improvements we have eliminated layers of management to improve information flow and speed the decision-making. Specifically, we have removed the COO position from the reporting structure and for now I will take a greater role in the over side of Internap’s operations similar to my responsibilities in 2006 and into early 2007.

In short we are returning to a structure and focus that made Internap successful in the past, but with an even stronger set of internal processes and an even higher quality network. Over the past four months, our CTO, Tim Sullivan has assumed day-to-day responsibilities for the CDN product lines working closely with Phil Kaplan. In doing so, we have successfully tied our progress in CDN and closely to our engineering efforts.

Now that this transfer of responsibility is behind us, Phil who was in the room with me today will be transitioning out of the business over the next several months. I want to mention that this decision was completely voluntary and amicable on Phil’s part. He has agreed to be available to Internap through a consulting arrangement through the end of 2008. I would like to take this opportunity to thank him for his many contributions to the business.

Recent efforts by Tim and his team in carrying our CDN to best-in-class IP Networks have produced excellent reliability and performance. We have extended the 100% SLA from our IP business towards our CDN services and as I mentioned earlier last week we doubled our global CDN top presence.

Since over coming the integration delay in the third quarter of 2007 our CDN network reliability has been excellent. Third party performance and monitoring that takes place over this network confirms this day-by-day by completing more that 700 checks across a number of dimensions. We have also broadened our CDN portfolio with the addition of new products including managed servers and utility computing and more features that improve the value of our e-commerce and gaining customer applications.

With the integration complete and our internal processes addressed and improved, Internap as emerged as a stronger company. In fact we’re already seeing signs of progress. We have a more robust product set, greater capacity and better performance across our products than at anytime in this company’s history and as evidenced by the wins with PTS and software our bungled service offering is attracting larger customers.

We have secured a number of new customer wins recently some of which I will review with you in a few moments. The fundamental strength that Internap’s business has not changed; we are increasing our available data center space and environment of strong market demand. Our IP performance leads the industry and our IP traffic is up 25% on a sequential basis. Our CDN is now able to deliver rich media and extremely high quality to attract large enterprises and with the integration of VitalStream now complete there is no question that it’s addition was critical to Internap’s long-term growth.

The acquisition significantly expanded our market opportunities and gives our sale teams the ability to address fast growing markets that include new media and digital entertainment. The improvements we have made will speed our return to what has made a successful in the past and to what has attracted many of you as investors in this company and that is a strong product portfolio, award winning customer service and an intense attention to detail around the operation of discipline and forward progress of the business.

I’m happy today to have George Kilguss, Internap’s new Chief Financial Officer with me to provide more details in the quarter. George is highly engaged with the business and I believe he will prove to be a great asset to Internap and it’s shareholders.

I will now turn the call over to George for a review of our first quarter finance. George?

George E. Kilguss III

Thanks Jim and good afternoon everyone. As mentioned in our fourth quarter conference call, our first quarter 2008 results realign our business reporting units into IP, data center and CDN and eliminate the other revenue category that includes certain term fees and professional services. In order to represent a more comparative finance view we have reclassified approximately $1.1 million in Q4 2007 and approximately 697,000 in Q1 2007, of term fees and professional services from other revenue to our IP, CDN and data center business units.

We also reclassified associated direct cost related to other revenue of approximately 38,000 in Q4 2007 and approximately 117,000 in Q1, 2007. This reclassification has no impact on total revenue for prior periods but does modify previous fitted revenue totals of the individual business units to provide a consistent presentation for both year-over-year and quarter-over-quarter results. The reclassified revenue by quarter for the last five quarters is also available in the supplementary data sheet in the Investor Relation section of Internap’s website.

Internap’s first quarter ended March 31, 2008 was one which presented several challenges for the company. Our credit issue, delayed filing and repositioning of our CDN business unit have impacted our growth during the quarter. Revenue for the first quarter totaled $62.1 million, an increase of 15.9% over the same period a year ago. Increases in data center, IP and CDN revenue, all give the company's year-over-year increased in total revenue. On a sequential basis however, revenue increased only 0.7% over our fourth quarter of 2007. Increases in Data Center and CDN revenues contribute to a quarter-over-quarter increase, which was partially offset by a decline in IP Services revenue.

Adjusted gross profit for the quarter totaled $30.7 million, an increase of $5.8 million over the first quarter of 2007, which produced an adjusted gross margin of 49.5% up from 46.5% for the same period, a year ago. When compared to the fourth quarter of 2007, gross margin was down slightly by 40 basis points. While the company experienced margin expansion in both IP Services and CDN, these margin gains were offset by a decrease in Data Center margins of 260 basis points.

A sequential decline in first quarter Data Center adjusted gross margins were directly attributable to a planed deployment of an additional 6000 square feet of hardware site date center space in the quarter. Adjusted EBITDA in the first quarter totaled $9.6 million up almost 72% when compared to the same period in 2007. Adjusted EBITDA margin grew 70 basis points year-over-year to 15.4%. Increased profitability in our date center segment from 2007 levels mentioned earlier was the primary contributor to a year-over-year adjusted EBITDA margin improvement. Sequentially adjusted EBITDA was lower by 452,000 in the first quarter as compared to our 2007 fourth quarter.

Operating expenses excluding cost to sales, depreciation, amortization and certain line type items totaled $21.1 million for the first quarter of 2008 producing an EBITDA ratio of 34% which is in line with what we’ve seen over the past several quarters but up when compared to the same period in 2007. Higher product development cost and increased sales and marketing as a percentage of revenue pushed the ratio higher year-over-year.

EBITDA is an important cost indicator for us and we will work to manage this ratio to appropriate levels. On a GAAP basis Internap recorded 735,000 of net income in the first quarter compared to a loss of $10.7 million to the same quarter of 2007. Normalized net income which excludes the impact of stock-based compensation expense and certain one-time items totaled $3.1 million, an increase of 14.1% over the first quarter of 2007. Our balance sheet of March 31 2008 continues to remain strong.

Intenap’s cash balance, which includes cash short-term investments and restricted cash totaled $64.4 million down $11.3 million from December 31, 2007. The decrease was primarily a result of the reclassification of approximately $7 million of auction rate securities from short-term to long-term investments. In February and March our broker conducted several auctions that failed to draw enough figures for these securities. We therefore determined that these securities should not longer be classified as short-term investment. Because these securities are AAA rated municipal securities whose underlying assets are student loans which are substantially backed by the federal government, we believe our liquidity in the credit markets improve so these instruments will return.

Accounts receivables, which totaled $33 million net of allowance for doubtful accounts improved in the quarter with days sales outstanding decreasing to 48 days down from 54 days in the fourth quarter as collection and dispute issues were remedied and accounts receivable balance returned to normal levels. Total funded debt consisting of bank debt and capital lease obligations totaled $12.8 million as of March 31, 2008 down from $21 million from the previous quarter.

Total liabilities also decreased in the quarter by $3.7 million $76.6 million at March 31 reducing the total liabilities to equity ratio of 0.221 when compared to our stockholders equity, $341 million. Cash generated from operations totaled $6 million for the first quarter and it’s augmented by in addition of $2 million of cash relived from restricted instruments. These sources of cash were more than pursuing by spending in the period.

Capital expenditures for the three months ended March 31, 2008 totaled $10.1 million as we continued to rollout owned and data center footage in the first quarter and invest in our CDN and IP infrastructure. As previously discussed we anticipate committing a total between $45 million and $50 million to capital projects during the fiscal year.

Turing to our operating units IP services revenue in the first quarter was $31.1 million up $1.8 million a 6.2% over the first quarter of 2007. Year-over-year growth in IP volume was more than offset by negative pricing decline. Compared to the fourth quarter, IP Service revenues decreased by 5.5% or $1.8 million; one-time equipment sales to QTS in the fourth quarter and lower level FCPs built in the first quarter are the primary drivers of the sequential decline.

Revenue churn this segment was also slightly higher than historical levels as maturing contracts were renewed at lower price points, reducing contracted revenues. These revenue loss were partially offset by reduced cost as we were able to continue to improve efficiencies and drive the incurring cost out of the network. IP gross margins for the quarter was 62.7%, up 90 basis points from Q4, but down 100 basis points compared to the same quarter a year ago reflecting the general pricing trends in the industry.

In our Data Center segment revenue grew 39.2% year-over-year and 5.9% sequentially to $25.2 million. The year-over-year sequential increases were driven by data center footprint expansions and continued pricing strength. Adjusted gross margin in this segment were up 28% up 700 basis points year-over-year. This increase over the first quarter of 2007 was primarily the result of pricing strength within new contracts and contract renewals. Sequentially, data center margins declined 250 basis points and were impacted by the continued planned roll out on additional square footage and corresponding level utilization rates and partner sites.

Approximately 2600 square feet of additional company controlled space and 4100 square feet of additional partner space was occupied in the quarter. CDN and add services revenues grew 15.9% compared to the fourth quarter. The increase was due to the including of approximately 600,000 of incremental credits in fourth quarter results and increased usage in each segment. CDN gross margin totaled 66.1% of revenue generating almost $4 million of adjusted gross profit in the quarter of 2008. Compared to the prior quarter CDN adjusted gross margin rose 900 basis point primarily due to lower customer credits.

Despite the strong growth included of 311 new customers in the first quarter we lost 40 net customers resulting in 3,749 of total customers as of March 31, 2008. Customer losses in our CDN unit related to network outages experienced late in 2007 associated customer service profit issues, with the primary contributors to this decline.

Before I hand the call back to Jim, I would like to leave you with some additional comments. I’ve been asked by some of you, about my first impressions on the company and my decision to join the company as a CFO. My personally feel that Internap has a superior portfolio products, a solid balance sheet and dedicated team of experienced professionals, but I incurred a long list of objectives from myself and my teams accomplish this year; my first goal will be to gain your trust and to live up to the great responsibility provided to me to run the financial operation of your company. I look forward to speaking with each of you in the coming months, at Investor meetings, conferences and on our quarterly calls. And with that said I would like to turn the call back to Jim.

James DeBlasio

Thanks George. It’s pleasure to have you on board. I would like to take a few minutes to review our recent progress in our business units and from within our customer base before opening the call up to your questions. Our enterprise customer base and the diversity among that base is an area of strength for Internap. The end-to-end nature of our bungled product offering enables us to deliver internet business solutions to customer across key verticals in the growth economy. That results in a diversified customer base in which no single customer represents more than 2% of our revenue. During Q1 and in recent weeks we have made specific customer announcements across a number of vertical and many of these are in the fastest growing areas of the economy.

Let me provide you with some color on some of our recent wins. Register.com one of the leading URL registration and small business service providers are using three of the services in our bundled offer to manage and drive their business. Register has been experiencing significant growth and shows to outsource their data center, IP and content delivery needs to Internap based on the quality of our service. They tell us that the ability to work with one vendor for all of their needs provides them with significant efficiencies and allows them to spend more time being innovative and creating new applications to continued to grow their business.

As you know for many years the financial services vertical has relied on Internap for IP networking and data center co-vocation, the recently announced Y3 search; one of the most trusted names in investment information is using Internap CDN to deliver a live video broadcast on market trends and forecasts to their top clients. Like video requires the highest performing and most reliable CDN and Internap is delivering. Combined the Y’s announcement with our news of our ibox TV and you will see that Internap CND and managed servers are being selected to deliver some of the most demanding media content globally.

Ibox broadcast live Spanish language programming to over a million viewers a day and they trust Internet as their IP infrastructure provider. Another historically strong vertical for Internap as been e-commerce and that trend continues in Q1. PC Universe with over 250,000 IT products for 700 manufacturers is using our performance IP networking and Data Center provocation, to run its e-commerce website.

Finally, let me point out that an early indicator we hope to turn into a positive trend for the company and that is online Ad Delivery bundled with our CDN. We announced two online radio station wins this quarter. LKCM Radio Group that owns nine country stations in Texas and Oklahoma, and Beethoven.com a Canadian based internet radio station providing 24/7 classical music broadcasts.

These two broadcast groups cover different ends of the musical spectrum but they share a similar trade, they're using Internap CDN and Ad Delivery of the new markets to reach a broader audience and monetize the music content. This wins gives us confidence that the bundled service message is resonating well in the market. Couple of these wins with others in the high growth sectors and this should give you a sense of our momentum.

For example, in the entertainment sector we announced deals to power and extreme content to popular websites like sugar publishing, the sun dance film festival and the free others network in addition to Ibox. Looking to other high growth sectors, our intelligent IP service directs traffic to provide on-line gamers the best possible experience for game rail, a leading provider of multiplayer online games and we get deploy our full controlled platform or FCP for Teliacs a voice over IP company.

Turning to some of our larger customers, we signed two multi-million dollar, multi year deals in the last six months with QTS and SoftLayer. Both are performing well and driving increased levels of profitable revenue for Internap. I’d like to give you a quick update on SoftLayer. As you recall the first stage of this deal was announced November 2007 as a $16 million, five year agreement..

On April 1, we completed the turner for this first phase by installing more than 100 racks, over 10,000 square feet and connected their systems to IP performance. In February this year we expanded the SoftLayer agreement to $40 million over five years. We are now turning our attention to the second place of deployment in our Chantal Virginia Data Center where our cabinets are ready and SoftLayer is beginning to stack and test their equipment.

We have begun provision our performing IP connectivity and are in the early stages of testing our CDN for implementation there as well. This is an example of how Internsp’s team can implement and scale with large customers. We are very pleased with the progress and the positive implications for Internap. Deals like QTS and SoftLayer not only provide increasing monthly and quarterly revenue but they are strategically positioned to repel our solution into new customer basis while leveraging the sales force and growth drivers of our partners business.

Another good example of the strategy is the agreement we announced yesterday with Rockfish Interactive. Rockfish is a top-notch web development firm, with fortune 500 clients. Including Tyson Foods, Abbot Laboratories and Wal-Mart. Rockfish had selected Intenaps managed servers and CDN to rapidly deploy Interactive web based application for it’s clients online applications. Rockfish selected Internap base and the quality of our CDN and a broad suite of related applications including our EPI’s that easily integrated the Rockfishes infrastructure.

Deals with high quality firms like Rockfish allow Internap to expand with the multiple customers simultaneously and you should expect to see more of these moving forward. Customer demand is driving CDN network enhancements that I mentioned earlier. We have added new features that run better offering and build scale like doubling our pops globally. We are continuing to drive scale in our data center business and we are doing so in the same modular disciplined manner that has served well over the past few years.

Growth from new customers that I describe to you plus the strong pipeline of sales activity confirms that wins of our strategic just in time build plans, which calls for more than 30,000 square feet of capacity to come online in 2008. As traffic grows across our combined IP and CDN network driven by data center customer growth we can achieve scale in our business and drive operating leverage though our financial model.

Leading indicators within our first quarter give us confidence that our strategy boards well for growth as we moving to 2008. Today it described how we identified the operational issues that caused us to revise your guidance and how we quickly and directly addressed those issues and scale for growth. Well this activity has delayed our sales cycle and forces to reset our outlook for 2008. We continue to built scale, that will enable customers of all sizes across the globe, to drive more content and traffic across our network.

As our traffic grows, we can realize the increase in revenue and financial benefits that follow-up. Internap is in a solid and profitable financial position backed by a strong balance sheet and now a high performing 100% reliable content delivery network. We have differentiated solutions that address significant opportunities in fast growing markets and our entire organization is focused and motivated to deliver strong results as we move forward.

Thank you very much for your time today. Now, I’ll be happy to open the call for your questions.

Question and Answer Session

Operator

(Operator Instructions) We have question from Colby Synesael with Merriman.

Colby Synesael - Merriman

Thank you for taking my questions. First obviously with the reduced guidance I was wondering if you could talk about where we are seeing the biggest change from a segment perspective; in other words, has the expectations been reduce significantly for adjust CDN or you pointed back also for either the data center or IPP’s. Also I was wondering if you could talk about just customer concern; obviously with all the news that we’ve heard over the last few months, I would assume that that’s impacting your sales cycle and could also be potentially impacting customers who could be actually leaving because of this. Is this behind now or are you still seeing that impact? Thank you.

James DeBlasio

Thanks Colby, thanks for your question. I think all three are related here, so with regard to the guidance I think that goes into the customer as well as the sales cycle question that you asked. Well, we are seeing in the business as I mentioned earlier through the integration delays that took place and the customer credits that we experienced you see the delay and the ramp of revenue that we had talked about on our last conference call. The last conference call we mentioned we had a back end mode of ramp of revenue and strong demand and the last two quarter of the year will be our strongest quarters. This delay that took place has pushed out that ramp where as you see the results for the fist quarter of $62 million, the ramp is still strong, it’s still there but it’s been pushed out where we have. The fourth quarter is not pushed into the first quarter of 2009 and with regard to our customer base and our sales cycle, the fact that all of our employees will focus on the integration getting it up and running and addressing the credit issue has delayed our sales cycle. At this point, we can say that none of our customers had the prospects that have turned away from us, but they've all required addition attention and we still feel very comfortable on the ramp that’s in front of us and in achieving that ramp and that’s why we changed the guidance from the 25% to 18%; a range that we feel very comfortable with and that that we know we can achieve.

Colby Synesael - Merriman

Okay. If I could just get one more question in; you guys had mentioned in your press release that you had a one-time benefit in IP Services in the fourth quarter of '07 and I think you mentioned that was specifically for I think SoftLayer or maybe that’s Quality, just curious why you didn’t mention that last quarter but thought it was necessary to mention it this quarter.

James DeBlasio

Yeah that was about a $900,000 equipment sale Colby that we had with QTS in the third quarter and we did call it out in our earnings script and our prepared remarks in the fourth quarter and it was part of the larger QTS deal that we had as you know that’s $15 million over five years -- over three years rather and last year in addition to the normal IP and CDN related traffic, OTS asked us to provide some third party equipment to build up one of their data centers which we did and called it out as such in the fourth quarter.

Operator

We will take our next question from Jurgan Usman with Wachovia Securities.

Jurgan Usman - Wachovia Securities

A couple of questions; first of all can you disclose your churn of growth as for the quarter and also if I take a look at them based on my calculation I believe the ARPU actually decline this quarter versus last quarter. I was just wondering is it because of the customers that you disconnected because if I am mistaken, those are mostly small customer -- are you signing up new smaller customers and on top of that I guess -- I think that this is the first time that is see many testing services declining sequentially maybe you can provide a little more color on that. Thanks.

James DeBlasio

Let me go with the last part of you set of question first Jurgan and then I will ask George to provide some more color on the ARPU and the other question you have as well. So, the decline in IP managed services and it’s based on what was included in the fourth question. Now in the fourth quarter we had roughly 900,000 of equipments revenue. Well, I just mentioned before that was called out back in the fourth quarter for QTS as well as some high SEP, our premise based box, IP sales or the last quarter -- in the fourth quarter we were at roughly $1.8 million, this quarter we are at in the 1.2sh range of I believe an FCP and George can check me on that, but I think it’s roughly correct. So we had a reduction in both, the one time product equipment sales, QTS related win IP as well as some FCP reductions.

Jurgan Usman - Wachovia Securities

All right.

George Kilguss III

Okay. To answer your question Jurgan on the gross ads, as I mentioned we had 311 gross new ads in the period?

Jurgan Usman - Wachovia Securities

And your churn for the quarter?

George Kilguss III

The churn was 1.9%, total churn.

Jurgan Usman - Wachovia Securities

And what’s your expectation going forward in terms of churn, I would expect probably -- is it going to go back to your normal figure of 1.2% to 1.3% I guess by the end of the year?

George Kilguss III

So, we looked at our churn; we had noticed that coming out in the third quarter, our churn has improved or improving in the month of March. We continue to focus on that and we are trying to get a lower and we’ll do our best to continue to manage that number.

Jurgan Usman - Wachovia Securities

Forgive me on this again, so lets say if you exclude that 150 customers that you disconnected in Q1 what is your run rate of churn?

George Kilguss III

I’m sure it will be closer to the 1.6% range.

Jurgan Usman - Wachovia Securities

And then just one last question, if you don’t mind on the data centers, it looks like data center growth this quarter is less than 40% versus I guess above 40%, 45% to 50% in the past. I was just wondering if it was because of the capacity concern that you are having. I mean what do you expect to grow there, the sort of services here? Thank you.

James DeBlasio

We haven’t given any guidance Jurgan with regard to our trade on data center year-over-year, but that has historically been one of our leading growth areas -- engines, growth engines in the business and we see the growth that we have experienced in recent years continuing. The demand is strong, we are putting more and more data center space in place; 40,000 square feet of our own data centers space implied this year as well as close to 20,000 our partner side space implied this year and that too it’s already out there that we have available for sale. We have a lot of data center space ready to be sold and we have the sales team that is taking orders to sell it, so I’m looking for some robust sales in co-locations to go forward.

Operator

And your next from Jonathan Atkin with RBC Capital Markets.

Jonathan Atkin - RBC Capital Markets

Yes, maybe just kind of following on that last question. Is it fair to assume then if you look at the three different revenue categories that data center -- as we move through -- towards year-end ‘08 is the dollar growth quarter-on-quarter in data center services going to be greater than for IP which in tern will be greater than CDN or how would kind of rank that -- not the growth rate, but the absolute dollar growth among those categories and then I have some questions about headcount if you can maybe tell us where you were at quarter-end and any kind of little bit changes recently as well as how many sales people -- I know you're right size in terms of sales force or any changes planned on that front?

James DeBlasio

Great. Let me take the growth rates Jonathan, then I’ll ask George to comment on the headcount numbers. So the growth rates, in terms of dollar you are absolutely right. The larger dollar growth will be in the Coop business and then we have the two business following and in terms of percentage growth, our largest percentage growth rate will be in our CDN business illustrated prior to this. It will be up a small base of roughly $18 million. It will be the largest percentage growth rate that we will have in terms of businesses.

George Kilguss III

At the end of the quarter, we had 442 employees. We are going to end -- of those we had 53 -- 80 producing sales reps, 80 sales reps

Jonathan Atkin - RBC Capital Markets

Is that the level you expect to be at going forward or any changes anticipated?

James DeBlasio

We will think a little bit higher additional sales reps into the mix and train them, get them up bridge and get them producing into the mix.

Jonathan Atkin - RBC Capital Markets

What are you finding in terms of the availability of talent, is it a competitive market there or are you able to attract good candidates based on what's happening else where in the sector?

James DeBlasio

We have got a lot fielders out into the market Jonathan, so we are attracting some really good talent; we got a very tight screen as I have spoken about earlier in terms of who we bring into the business and certain folks that we bring in are making the cut and they are exiting, but a small percentage of those and we are continuing to hire more people. We have increased our AE sales force from roughly 45 that we had at the end of last year up to the numbers that George had mentioned in 60 and we continuing to add more. We consistently want to be looking out for new talent to bring new and fresh talent into the business. People who can hit the ground running and have some good experience selling CDN, IP, collocation or all the three where I think you need a real good funnel of sales people coming in to reprise those that will make us my performance perspective.

Operator

We have next from James Breen with Thomas Weisel Partners.

Sean Markin - Thomas Weisel Partners

Hi guys. Thanks for taking the questions. It’s actually Sean Markin. I was just curious you mentioned that on the revenue in the EBITDA guidance everything was kind of pushed out a quarter, which was why things were taken down. I was just wondering on the CapEx you kept that intact, what kind of gives you the confidence that those projects are going to be necessary this year instead of partly pushing some of that out one quarter?

James DeBlasio

The CapEx is primarily for our collocation builds Sean and as I mention we got 40,000 square feet that we are putting in place this year, 10,000 is already in play and our saving facility and the process of being filled and we got demand another 30,000; that’s across a of variety locations that are all Internet bound locations and we haven’t seen the demand when we’ve seen it strong. What’s happened is we have seen that this trajectory of revenue push out and in order to be prudent what we did is we used our guidance accordingly and what we are attempting to do is get back as I mentioned earlier; get back to that level of performance that all of you have to come to know Internap for; a company that meets and in case of exceeds guidance that we put out to the street and that is really important for us. We get back to the base of factor renewal for us in 2006 and 2007. A lot of you who followed us for a long period of time know what I’m talking about. When we realize the stumbles that we have, how that has been reflected in our stock price and fully accept that, but now it’s up to us to drive operational performance in the same discipline we had in the past and bring customers on and make believers out of people. I’ll go with you on the phone once again through our operational performance. We've done it before and we'll do it again. You know where we are right now and now it’s our way and our time to get ourselves out of it.

Operator

We hear next from Rod Ratliff with Stanford Group.

Rodney Ratliff - Stanford Group Company

Thank you for taking the call. Can you talk a little bit about the trends in the performance IP segment. I guess just looking at the raw numbers that was a little disappointing there and I’m sure you are disappointed as well Jim, but it seems that you have also seen a decline in traffic growth and that’s not a good combination with the industry trend of decline; could you just talk about that a little bit please?

James DeBlasio

Sure Rod, we actually seen traffic growth go up 25% on sequential basis quarter-to-quarter and that’s some pretty good news that we are seeing here. So the strong traffic growth, we are seeing a lot of larger deal and what we’ve done and been able to do in the past Rod is to drive cost out of our network and we do that to bring scale on the network and we’ve been doing that for the last two year. So by driving cost out we are able to attract larger deals at lower prices and still maintain the margins that you see and that we reported and continue to report. What we've done though is we've been attracting those larger deals, but the smaller deals we haven’t been going after. That’s because of a distraction that took place both in the fourth quarter and early first quarter for the customer credit issues and the integration issues that I've talked about. That distracted the sales force and pushed out the sales cycle, so I'm expecting that as we continue to bring on larger deals in IP we'll also get back to our focus on bringing in those deals in the sweet spots for Internap, which is the small-to-medium sized customers and we can take on business with them in the IP range and then we growth with them as their businesses growth. So, we're focus on that and our sales team is focused on that as we go forward. When you take out the FCPs that were low in the first quarter and the QTS deal; the equipments that are in the fourth quarter; IP revenues are relatively flat quarter-over-quarter.

Rodney Ratliff - Stanford Group Company

The other side of the coin again just based on what I was modeling; the content delivery network at segment surprised me to the upside. Could you talk a little bit about the growth prospects there? I am sure that if there is anything that excites you about the orders to date, that was probably one of the things that did?

James DeBlasio

Yes and that's been our focus Rod and selling CDN and selling the bundled offer and pushing up products to a broader spectrum of customers and we are beginning to get the traction I have spoken about in the CDN space and the deal sizes are getting larger and the bundled offer is a real differentiator for our customers and our sales people know it. We are closing deals that are larger on a daily basis and I am hoping to have reports to read out to all of you on some additional successes in the coming quarters in CDN and so the trends are looking good and I expect them to continue.

Rodney Ratliff - Stanford Group Company

Just a couple of more very quick ones here; one or two sellable answers a piece, on the data center segment, I know that you don't typically report revenue per square foot but how are you trending there; are we still seeing a nice up trend?

George Kilguss III

Yes revenue per square foot is increasing sequentially and obviously year-over-year.

Rodney Ratliff - Stanford Group Company

Can you talk about that in percentage terms?

George Kilguss III

Sure, on a sequential basis it was up about 5.9% year-over-year and 39.2%.

Rodney Ratliff - Stanford Group Company

Okay, 39.2 you said.

George Kilguss III

Year-over-year and that’s correct and 5.9 sequentially.

Rodney Ratliff - Stanford Group Company

And just a last housekeeping question or I can wait and do a call back with you; can you give me a detail data center stat of the company and partner site.

George Kilguss III

Sure do you want the total square footage for the company of 185,645 square feet of which 819,550 square feet was in partner sites and a 103,690 square feet was in Internap owned sites.

Rodney Ratliff - Stanford Group Company

And of that build in billing?

George Kilguss III

The occupied?

Rodney Ratliff - Stanford Group Company

Yeah.

George Kilguss III

That will be 185,000 totaled a 131,572 is occupied or 76%. Of the 81,955 total partner sites, 62, 983,000 was occupied towards the Internap sites; 78,589,000 was occupied.

Operator

We take our next question from Tom Watts with Cowen.

Thomas Watts - Cowen And Company

In terms of -- I know you say as a normal part of process you have some turnover on your sales force and there’s been some turnover soft turnover as well. Has that been -- how has that effected sales force productivity? You’d mentioned training people up and getting them online has been one of the barriers to growth.

George Kilguss III

Tom we have experienced some turnover in our sales force; the majority of it has been performance related where we have asked sales people because they weren’t making their quotes and also we have some sales people that have left. It’s a very competitive market as you know and the some folks have gone to other firms. but the bulk of it has been performance related, other people have been leaving and now we are -- one of things that we are at a level of sales people that’s about 59% higher than this time last year, so we are benefiting from having more feet on the street, more trained people selling our products. The quotes are much higher. I think the number of people that we got out there are increasing as well and then we are always looking for new talents, so we haven’t a number of hit that 70; we are looking forward 75, 78 people. We are always looking to bring more people in knowing that some are going to leave.

Thomas Watts - Cowen And Company

And then do you feel that you could bring sales people on faster; will that allow you to grow quickly?

James DeBlasio

In certain markets it does -- naturally we are focusing and in certain markets that’s not the case, but I think right now we have people telling me, our sales leaders telling me that we need roughly 70 people this first around the glob. We really meet the needs of our customers and sell our product to get to a quarter level which will drive some performance in the business and we are at the mid 60s right now driving to 70.

Thomas Watts - Cowen And Company

Okay and then on your cash side you actually have a very healthy cash balance, your cash burn in the quarter was quite limited. Are there things that you could do to help the business by -- through investment? Would that be buying more caller facilities than using parents facilities, should it be a share buyback on just a single strength in the business? How should we think about how the cash balance might used constructively?

James DeBlasio

Well, one of things we are doing right now is a putting our capital in place to build that more core location space in our own sites and then we are always looking for any opportunities to meet customer needs at partner sties, around the country and around the world and we got some really good relationships developed with some of our partner collocation facilities, where we get some very competitive rates and we are able to meet the customer needs and not have to build our own space and still maintaining growing margins in terms of the capital for Coop.

Thomas Watts - Cowen And Company

And as you are looking out into ’09, I assume we should assume additional construction, because we see some construction in new markets?

James DeBlasio

It’s possible; the construction we have in place right now and the square footage that we’re putting in place throughout all of ’08 should take us well into ’09 and not give us a need to have any additional capital for our own build of collocation in ’09, at least to the first half of ’09. If demand is far in excess of anything we can think of then we ought to revisit those plants.

Thomas Watts - Cowen And Company

Okay and George could you just comment on -- since you have come one board have you made any significant changes in the financial processes of the company when either of you -- can you give us a little bit more inside into how guidance is built up? How we should view the achievability of the guidance you have, but your visibility is on the remainder of the year and also any comments your discussion not to provide -- not to update guidance when you give us all the other information about the adjustments for last year.

George Kilguss III

Well with regard to your first question, I have been here for about a month now and as most of my team leads, I looked at the organization, reviewed all the processes and we have installed new processes to date and policies that center around some of the efficacies that happened with the credits and some other debt to practices polices with regard to time of a close and timing of a definition. So we put a number of processes in place and are looking to continue to expand those processes over the next few months. With regard to our revised guidance, we look at the deal that came out in the first quarter, we've gone deep into the numbers, understanding the trend of the details and what’s behind those numbers and in doing so, we've remodeled up from a bottom up perspective our leaderships and our costs and we grouped it to give way in -- regarding the revenue model is today and taking those consideration with the place, we’ve also taken consideration with some of the trend that we're seeing with regard to churn and pricing trends and we’ve put them back in our model and we continue to reforecast those and based on our credit results we’ve come up with the guidance range that we've guaranteed today.

Thomas Watts - Cowen And Company

And so does the remainder of the year essentially assume the continuation of trend that you saw in I’ll say in first quarter or in February, March?

George Kilguss III

Some of those trends remain clearly, but as Jim pointed we are recruiting revenue with a model. We are relatively flat from the fourth quarter and it doesn’t appear to me to be anything specifically wrong in the business, it just seems to be that we have been pushed up by about a quarter. We have had some sales cycles that have been delayed, but our network is sound, our performance is good and we are getting -- we are putting on more customers each and every quarter and so with these things behind us we are looking forward to meet guidance as laid out.

Operator

We will take our next question from Eric Suppiger with Signal Hill

Eric Suppiger - Signal Hill

Good afternoon. first off, I am just curious, in terms of the guidance that you gave, the revenue guidance it would suggest a healthy acceleration or back end loaded year in terms of revenues; can you talk a little bit about how you envision the linearity of the revenue growth for the -- over the reminder of the year?

George Kilguss III

Sure and you right, it is backend loaded. We’ve also said that the remaining two quarter of the year would be our strongest quarters and a lot of this is driven by the fact that we have our communication space coming on in the second and third quarters of the year. We have a lot of space coming in play, so that’s driving a lot of it and then the other driving factor is the traction in our CDN business. As we gain more traction in this slow and steady climb, as we get more and more customers and with field sizes that are increasing onto our base of CDN, then we start to see some significant risk and that takes off in the third and fourth quarter.

Eric Suppiger - Signal Hill

So, the CDN piece is going to see some nice acceleration in the second half, is that right?

George Kilguss III

Yes.

Eric Suppiger - Signal Hill

Okay. Just to be clear you talked about 311 gross new ads, but if I read this right you had a net decline of 40 customers. Does that suggest that you had 351 disconnects during the quarter?

George Kilguss III

That’s correct.

Eric Suppiger - Signal Hill

Can you give us a feel for how you would expect that -- what would be your target range for disconnects during the course of the quarter?

George Kilguss III

Well, what I could tell you historically disconnects have averaged probably about 85 to a 100 disconnects per month. So we had a significant amount of disconnects in a particular quarter as it related to some of our problems associated with -- the problems we have in CDN and the credit issue. So, we would hope that they would return to normal levels and we don’t know anything why it wouldn’t.

Eric Suppiger - Signal Hill

Okay. Are you going to be looking for a person to replace a sales per cap line or what are you doing in terms of that -- you’d said that you are going to have somebody taking some responsibility right now, but long-term are you going to have a replacement?

James DeBlasio

Well what I mentioned is that we eliminated our COO role and for now myself and Tim Sullivan will be assuming those responsibilities and it’s similar to the role I had back in 2006 and 2007, operational role as well as CEO and with Phil transitioning out of the business, Phill will be with us for a while and Phill is right here; I can ask him comment on it in a second, but he’s going to feel cozy around the next couple of months and then stay as an advisor, as a consulting to moved all of us as we continue throughout the year and then beyond.

Philip Kaplan

Thank Jim. I guess, well I am going to make a little aside comment first, because I just really want to thank Jim DeBlasio and Internap board of directors for the opportunity to have been able to make a significant impact to this company and I really believe in the future of Internap and if you want to once again emphasis, my departure is completely voluntary and where we are -- I’m a entrepreneur and I’m going to do what entrepreneurs do and that -- so it’s more like I’m going somewhere than I’m leaving somewhere and I look forward to keeping the relationship with Internap and I hope to be able to work with Internap closely in the future and I think that, the company is in very good hands here with Jim here to drive over all performance, with Tim Sullivan who is already doing an excellent job of managing the network operations of the CDN and other parts of the network and now with George joining the company to drive return on it’s initiatives overall. So, I think the company is in good shape and I'll certainly be in available to help on an ongoing basis and Internap can still realize it’s vision of being the best place for customer to deliver the applications in content. As we say in our marketing we are the ultimate online experienced.

Eric Suppiger - Signal Hill

It doesn’t sound like there is a search for a new CSO, is that right?

Philip Kaplan

Yeah. That’s correct.

Eric Suppiger - Signal Hill

Okay and then lastly, the systems -- you did have some challenges with the systems that you inherited from -- with the CDN. Is the billing system with the CDN; is that fully integrated with your Data Center and IP Services billing at this point if your customers were bundled services, is the billing all combined at this point?

James DeBlasio

I’m going to ask Tim Sullivan to comment on that, okay?

Tim Sullivan

Yeah, this is Tim here and the answer is absolutely yes. We’ve -- part of what we did towards the end of last year and early this year is actually integrate the builling pieces which were problematic at times when were going through some of the issues last year, but it’s all done, it’s integrated and we’re moving forward.

Eric Suppiger - Signal Hill

Can you give us any flavor for what kind of growth you’re seen in customers that are buying the bundled services across all three services offerings?

James DeBlasio

Well, I can tell you that about 34.6% of our customers are in a bundled situation right now and that’s up from about 33% from the previous quarter, so it is increasing as a percent of total customers.

Operator

We will take our next question from Chad Bartley with Pacific Crest.

Chad Bartley – Pacific Crest Securities

Hi, thank you for taking my questions. I apologies if I missed this. I was curious if maybe you can give me an update on gross margin target for 2008 and then in terms of housekeeping, George can you give us any kind of inside on what you might expect for depreciation this year it’s really flat around $6.6 million this quarter and then any guidance on tax rate would be helpful? Thanks.

James DeBlasio

Okay, Chad let me, this is Jim. Let me take the question with regard to the gross margin guidance, and George can take the tax and the other question that you had. We have not given any guidance with regard to gross margin for the company. What we had given guidance on is the EBITDA margin as percent of revenue and what we have said is that we expect that EBITDA margin to be anywhere from 17% to 20% in 2008 as revenue.

George Kilguss III

On depreciation it will increase slightly but not significantly, so I would say, it should be close to around $27 million for the year depreciation. As far as from a tax perspective, we do have our substantial NOL’s which total approximately $350 million. We will have some A&T tax obligations but we would look to take advantage of our NOL as appropriate.

Chad Bartley – Pacific Crest Securities

Yes, I realized your not a necessarily cash tax payer. It look like the -- I guess the effect of ax rate was around 27% in Q1. I didn’t know if we should carry that forwarded in terms a GAAP model or not?

James DeBlasio

That’s a fair assumption.

Chad Bartley – Pacific Crest Securities

That - that’s a fair assumption.

James DeBlasio

Yea, we have some A&T obligations.

Operator

We hear next from Sri Anantha with Oppenheimer.

Srinivas Anantha - Oppenheimer

Yes, good evening. Couple of questions, Jim I know you guys previously talking about bundling and could you just talking about the progress on that front and what percentage of your IP customer are taking CDM services are ultimately on that front and second one just on data centers, I am still trying to understand like, does it make sense for the Internap to own their own data centers rather than just having a collocating and prater data centers. Clearly your value is coming here by providing IP or selling CDM services on top of that front, so just on the capital intensity prospective and if you could just remind us why does Internap want to own their core of assets rather than just collocating in partner data centers and on gross margins I am actually surprised, the gross profit just on the CDM seem to have dipped so much or improved so much, could you talk about what is the yearly driving that, thanks.

James DeBlasio

Sure thanks Sri. Let me answer your bundling question your collocating and I’ll ask Jorge to comment on the CDN margin question. With regard to the bundling office, it’s been a focus of our sales teams to drive the bundled offer and a lot of our customers are driven to us by the factor we offer a bundle of solutions. More services and product that anyone else offers, so they can come to one vendor to provide all their services and as George mentioned earlier we do track the amount of services that we and the customers that we deal with in a basis and that number is growing, its growing by -- of course the 2% quarter-over-quarter and we track it and its the focus of our sales team, so we believe we are starting to get some traction there as more and more folks come to you know us as a bundled solution and the fact that we have 100% performance now and highest SOA’s we’ve every had, our CDN product line only makes that bundle more attractive and then with the offers that we have along with the edges there for manage service are utility completing, differentiates us as a customers, to the customers. Now with regard to color in our own versus buy, for me it is all about the margin we can generate and the cash flow we can generate from the investment. Now if the investment of owned sites generates a greater amount of margin and greater amount of positive cash based upon that investment then the own site will be the way I go. What we are fining is in some cases we are getting some very competitive rates on our partner sites and we had build a plan for Atlanta, in our Atlanta facilities to build that own facilities; instead we went to a partner site and the rates on the per square foot and the terms and the lease that we had from our partner was very competitive, much -- almost a portion in terms of putting our own capital and we make the same margin and we make an even improved cash flow in return on the investor capital. So it's all about the acceleration on cash flow for us in terms of thinking about the way we own or buy our partner sites and on the margin side, the increase is primarily related to credits that were incurred in the fourth quarter, pushing down gross margins in the fourth quarter, so gross profit margin returning to the mid 60%, 66.1% level.

Srinivas Anantha - Oppenheimer

Jim one quick follow-up question. Obviously your sentiment on the stock is pretty negative for you. Is there some metrics that you guys would want to -- would before writing to investor say that they could track the progress in an ongoing basis clearly, it just seems to me when if you just looking at the IP and Color the stocks should probably be worth much more but obviously but doesn’t seem to reflected here. Is there something that you could either talk about or is there something that’s you guys would probably provide an on ongoing basis so that at lease investors get your -- some comfort that at least operational things seem to be on the right track, Thanks.

James DeBlasio

Thanks Sri, it’s a great question and I think some of the metrics that would be probably be helpful to all of you; the tracker performance would be the change in the bundled offer that we talked about. How is our bundled offering, our strategy taking both in the marketplace and are we attracting more customers. That’s something that we certainly can be providing on an ongoing basis. ARPU and ARPU by customer segment, product segment would be helpful. I think I can give you a good indication of who we stack up verses the competition when you’re going through your models and those two would be two that I would suggest that we can provide and then probably the third would be acceleration of our CDN growth. So, you can see the performance of CDN and track the margins as we grow our CDN business.

Operator

We will take our next question from Jonathan Schildkraut with Jefferies.

Jonathan Schildkraut - Jefferies & Co.

Thank you for taking the questions. Most of my question by now have been asked and answered, but I did want to ask two question; one of bad debt expense if we can get some numbers around that and then my second question has to do with the guidance again and I know that you spend a little time on this and that we should expect that back half of the year ramp, but to look at -- see where we are coming out of the quarter and you add a roughly $248 million run rate at the midpoint of your guidance, it implies about $270 million of revenue which means, incrementally we're talking about $22 million or so, over the next quarter. If you were to grow rate ably that would mean the incremental revenue growth around $3.5 million a quarter which on an organic basis would be your best quarter in the last three years, but what we are talking about is not our ratable growth so maybe a little less than the second quarter and then the significant ramp in the back half of the year in order to makeup and I'm just wondering how I can get some comfort around that ramp as we enter into the back half of the year, thanks.

James DeBlasio

So let me take the question with regard to the guidance and the ramp and what’s driving it and then George could take the other question with regard to bad debt, and the ramp that we are suggesting as in the model here is driven by our collocation, data center space coming on line throughout the year and we’ve got 30,000 additional square feet coming on line the second quarter and the third quarter of this year. So by the end of the year we will additional 30,000 square feet, 40,000 in total plus 20,000 partner site square feet. So a lot of square footage in terms of collocation as we take the space down; we’ll see the ramp coming though towards the end of the year and the demand is strong as it has been. Now the first quarter, as you go through the models, the first quarter remember was depressed by the customer credits that came through, that George articulated earlier well slightly but it came down because of that. As you build you jump of plain for the year. So we have the collocation growing and we are expecting our IP business to get back on track and continue to grow and we’re expecting some growth, some significant growth our of our CDN business as we put more and more customers on the CDN network.

George Kilguss III

And now with regard to bad debt expenses -- bad expenses for the quarter total 655,000 which is down from $1.2 million at first quarter but decrease of about 560,000.

Operator

And will take a follow-up question from Tom Watts with Cowen.

Thomas Watts – Cowen and Company

Jim, could you just comment on the manage hosting; give us some sense of how that’s going to play into the company’s future and how aggressively it might move into that?

Tim Sullivan

Okay, this is Tim. It plays because the folks that -- the customers that we have that do CDN for the most part have a need also for the managed services and we have strengthened our business in this area. We put together a team to address customer issues, we think we have a very competitive offer at this point and this is a growth area for us and on a CDN.

Thomas Watts – Cowen And Company

Okay. Will that be reported on end of the CDN line or that will be a separate manage hosting line

Tim Sullivan

Well reported under the CDN line.

James DeBlasio

So operator I think that’s going to be our last question.

Operator

Certainly, that does conclude today’s conference call. We like to thank you all for your participation. Have a great day.

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Source: Internap Network Services Corporation Q1 2008 Earnings Call Transcript
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