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Edited Transcript of INAP earnings conference call or presentation 12-Nov-19 1:30pm GMT

Q3 2019 Internap Corp Earnings Call

Atlanta Dec 4, 2019 (Thomson StreetEvents) -- Edited Transcript of Internap Corp earnings conference call or presentation Tuesday, November 12, 2019 at 1:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Michael T. Sicoli

Internap Corporation - President & CFO

* Peter D. Aquino

Internap Corporation - CEO & Director

* Richard R. Ramlall

Internap Corporation - Chief Communications Officer

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Conference Call Participants

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* Daniel Louis Kurnos

The Benchmark Company, LLC, Research Division - MD & Internet, Publishing & Broadcasting Analyst

* Erik Peter Rasmussen

Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst

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Presentation

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Operator [1]

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Good morning, and welcome to the INAP Third Quarter 2019 Results Conference Call. (Operator Instructions) Please note this event is being recorded.

I would now like to turn the conference over to Richard Ramlall, Chief Communications Officer. Please go ahead.

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Richard R. Ramlall, Internap Corporation - Chief Communications Officer [2]

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Good morning, and thank you for joining us today. I'm joined by Peter Aquino, our Chief Executive Officer; and Mike Sicoli, our President and Chief Financial Officer. Following prepared remarks, we will open up the call for your questions. The presentation and earnings release we reference in the call are available on our Investor Relations page on INAP's website.

Today's call contains forward-looking statements as described in Page 2 of the presentation. These statements are not guarantees of future performance. Actual results may differ materially from these forward-looking statements due to assumptions, risks and uncertainties that are described in more detail in our filing with the SEC. We undertake no obligation to amend, update or clarify these forward-looking statements made as of today, November 12, 2019.

During this call, we will also present non-GAAP financial measures, which were not prepared in accordance with GAAP. A reconciliation of non-GAAP measures to the most directly comparable GAAP measures are included in today's earnings press release. Management believes that our presentation of non-GAAP financial measures provides useful supplemental information to investors regarding our results of operations and our non-GAAP financial measures should only be considered in addition to and not as a substitute for or superior to any GAAP measure.

Now let me turn the call over to Peter Aquino. Pete?

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Peter D. Aquino, Internap Corporation - CEO & Director [3]

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Thank you, Richard, and good morning, everyone. Let's turn to Slide 4 for our opening remarks. We had a solid third quarter with clear signs that we have settled in on a consistent run rate in operating performance. We are now on a good trajectory as we head into the final months of 2019 and into 2020. After several quarters of hard work on improving our data center portfolio, we're now set up for the next stage at INAP. On a normalized basis, the third quarter was fairly consistent with the second quarter, which gives us confidence that operations are on the right track.

During the quarter, the sales team inked new business across multiple markets. For example, we're pleased to report that we re-signed our multimegawatt anchor tenant into a long-term deal in our Phoenix flagship. We also added Lions Gate this quarter to that site as part of their multisite strategy. With our attractive metro footprint on the edge, we are partnering with our customers to offer solutions in both primary and Disaster Recovery backup sites. Today, we will also provide some color on our strategic initiatives as we zeroed in on a few actionable items. There are multiple opportunities under discussion as we speak. As you can appreciate, we cannot go into much detail on these specific transactions and make no guarantees of their outcomes, however, I can assure you that we are aligned with shareholders and engaged on these initiatives, including the sale of certain noncore assets.

Our recent amendment to our credit facility is designed to give us flexibility to continue these discussions. Our original thesis for profitable growth at INAP was first to take the necessary steps to get into a new baseline of products and services that are in high demand and drive sales traffic to our best Tier 3 facilities. I'm happy to say that we're no longer hurdling certain partner sites that were trending down. And as a result, we are experiencing less churn and growing our pipeline for larger deals.

Our backlog is still near $20 million as we substitute new sales for installs. With lower churn at INAP and new enterprise sales in both colo and cloud services across Phoenix, Atlanta, Los Angeles and Seattle this quarter, we're seeing good productivity progress from our direct sales team and channel partners.

INAP is well positioned for upside in many of the best high-absorption power markets in the country, and our sales team is having more adapts with deals over 250 kilowatts, to multimegawatt deals. And deals of this size would definitely help drive organic growth in our colo business.

Let's turn to Slide 5 to discuss INAP's attributes at a glance. This is our claims chart reflecting who INAP is today. We have 51 data centers in 21 markets around the world. Most of our business is driven by our 14 flagships that we operate and control primarily in North America. As we drill into specific high-absorption power markets, INAP has a lot of location hits with capacity that our marketing team is creatively promoting to gain more exposure.

As we have discussed, the history of INAP during strategic discussions over the past few quarters with advisers, it was clear that many interested parties were dated in their view of the company. Some recall the company as being a small retail colo player with a network routing advantage.

But today, INAP is transformed into a Tier 3 data center operator in high absorption power markets with assets that rival the best-in-class. We compete not only in uptime and quality of infrastructure, but we also offer comprehensive private cloud and connectivity solutions powered by our performance IP software as a differentiator.

For enterprises running mission critical workloads, the network is a must-have service. Many of our peers in the industry are now looking for ways to improve data center connectivity, and we are already there with 100 POPs.

Moving to Slide 6. Let's review where INAP has a significant strategic presence today. INAP has a very strong presence in North America. Using market data from structured research, you can see that INAP has either a data center flagship, private cloud, and/or a network presence in most of the best high-absorption power markets in North America.

We are in 13 of the top 19 markets, primarily with a data center flagship. And more importantly, demand for infrastructure in these metro markets is also expected to continue to grow over the next several years.

Our customers depend on this reach for multisite and multiproduct requirements, and it's been a meaningful company attribute that we'd like to promote. Our objective over time is to increase our market share of the larger wholesale deals in these markets, and given our excess capacity, we are laser-focused on this upside.

Turning to Slide 7 for a global view on absorption. Globally, INAP has a presence in 17 of the top 25 growth markets in the world. Expansion potential in markets that we are already in, could make sense down the road. From a growth upside perspective, many data center and technology research firms suggest that the majority of enterprises still operate their own infrastructure on-prem today. With recent trends towards outsourcing to data center providers who can support a hybrid and multicloud approach, offer connectivity and reliability through Tier 3 data centers, INAP is well positioned as a potential partner, both domestically and internationally. We will continue to look for ways to gain scale over time to offer more to our customers, either through partnerships or more transforming transactions via consolidation. In the meantime, we're focused on day-to-day operations.

At this point, I'd like to hand the call over to Mike Sicoli, to go through our financial report. I'm very excited to reintroduce Mike to you all today as INAP's new President and CFO as of October 1. Mike joins me as a partner at the top of the management team, along with our Chief Operating Officer, Andy Day, to craft the next chapter for INAP into 2020. Many of you know that Mike and I have teamed once before in a successful turnaround and exit of RCN back in 2010. And since then, he's been no stranger to The Street as a public company CFO, and he's jumping right into action at INAP, not missing a beat.

Mike?

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Michael T. Sicoli, Internap Corporation - President & CFO [4]

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Thanks, Pete. Good morning. I'm really excited to join the INAP team at such an important time in the company's history. And of course, it's great to be working with Pete again.

Please turn to Slide 8, quarterly financial summary. Overall, this was a pretty flat quarter compared to last quarter. Total revenue was $72.9 million in the third quarter, a slight decrease sequentially and a 12% decrease year-over-year. The year-over-year decrease was primarily due to planned data center exits and churn from several large customers.

Adjusted EBITDA in the third quarter was $23 million, with adjusted EBITDA margin of 31.5%. Adjusted EBITDA was down $1.4 million sequentially as reported, but pretty flat on a normalized basis, due to the fact that we converted the Santa Clara facility to an operating lease, experienced seasonal cost increases, and certain accrual releases from the second quarter did not repeat in the third quarter.

The year-over-year decline was due mainly to lower revenue partially offset by cost reduction initiatives. Specifically, the impact of the Santa Clara conversion on the third quarter adjusted EBITDA was approximately $700,000. Balance sheet impact was actually shown in the second quarter as the lease amendment was signed in June.

With respect to our finance leases, there's significant concentration with the top lease representing 30% of the total balance, the top 5 leases representing 70% of the total balance and the top 10 leases representing over 90% of the total balance.

We're currently in amendment discussions regarding the top lease, which may result in this lease converting to an operating lease sometime between now and year-end. If this lease were to convert to operating, the total finance lease liabilities balance would be reduced by approximately $80 million, and reported adjusted EBITDA would be reduced by a run rate of approximately $1.7 million per quarter. There would be no change to cash flows. Capital expenditures in the third quarter were $8.6 million compared to $7.4 million last quarter and $11.4 million last year.

Similar to last quarter, third quarter CapEx was spent mainly on success-based projects to fund customer installations. You may note that the historical CapEx figures are slightly different than what we reported previously as we determine that certain additions to property and equipment that were outstanding in accounts payable were not included in the supplemental disclosures of cash flow information. The amounts on the supplemental disclosure have been corrected as well as the related adjustments to accounts payable in net cash provided by operating activities and purchases of property and equipment and net cash used in investing activities. There was no impact to total cash flow, the income statement or the balance sheet.

Net loss attributable to shareholders was $23.9 million in the third quarter compared to $18.6 million last quarter and $15.5 million last year. The sequential increase in net loss was due mainly to the exit, restructuring and impairment costs of $3.8 million recorded in the third quarter. The year-over-year increase was due primarily to lower revenues and higher interest expense, partially offset by cost reduction initiatives.

Now let's turn to Slide 9, U.S. business unit results. U.S. revenue was $56.9 million in the third quarter, a decrease of 1% sequentially and a decrease of 13% year-over-year. Sequential decrease is primarily due to lower nonrecurring revenue in colocation. As I noted previously, the decrease year-over-year is primarily due to planned data center exits and churn from several large customers in 2018. U.S. business unit contribution was $24 million in the third quarter, a 6% decrease sequentially and a 21% decrease year-over-year. The sequential decrease is primarily due to the conversion of our Santa Clara facility to an operating lease, lower nonrecurring revenue and seasonal cost increases. The decrease year-over-year is primarily due to lower revenues, partially offset by cost-saving initiatives.

Now let's turn to Slide 10. International business unit results. International revenue was $15.9 million in the third quarter, an increase of 2% sequentially and a decrease of 8% year-over-year. The sequential increase is due to higher nonrecurring revenue in cloud in INAP Japan. The decrease year-over-year is primarily due to churn from large customers in 2018. International business unit contribution was $5.8 million in the third quarter, a 3% increase compared with last quarter and a 1% decrease from last year. The sequential increase is primarily due to higher nonrecurring revenue. The decrease year-over-year is primarily due to lower revenues, partially offset by cost savings initiatives.

Moving to Slide 11. Cash flow and balance sheet. Net cash provided by operating activities was $5.5 million for the third quarter compared to $11.4 million last quarter and $9.4 million last year. The sequential and year-over-year variances were primarily related to changes in working capital timing. Cash and cash equivalents were $10.9 million at the end of the third quarter.

We've added 2 non-GAAP measures to our cash flow disclosure, adjusted free cash flow and adjusted unlevered free cash flow to better illustrate our performance. Adjusted free cash flow, defined as cash provided by operating activities plus cash paid for nonrecurring costs, less CapEx, was negative $2.6 million in the third quarter compared to $6.1 million last quarter and $200,000 last year. Adjusted unlevered free cash flow, which is adjusted free cash flow plus cash paid for interest was $14.1 million in the third quarter compared to $21.7 million last quarter and $17 million last year.

At quarter end, total debt outstanding under our credit facility was $428.6 million and finance lease obligations were $270.1 million. $172 million of our finance lease obligations are excluded from debt for bank covenant purposes as they were operating leases at the time of the refinancing. Our leverage ratio, calculated per the definition in our credit facility, was 6.6x in the third quarter compared to 5.9x last quarter and 5.5x last year.

On October 31, we disclosed an amendment to our credit facility to increase the cushion under our leverage and interest coverage covenants, and push out the step-downs on those covenants until March 31, 2021. This amendment gives us more time and flexibility to evaluate and execute on the various options available to us in the strategic review process. And we appreciate the continued support of our lenders.

In terms of updated guidance for 2019, we expect revenue in the range of $290 million to $294 million, adjusted EBITDA in the range of $94 million to $96 million, and CapEx between $30 million and $32 million, demonstrating our expectation of continued stability in the business through year-end.

Now I'll turn the call back to Pete.

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Peter D. Aquino, Internap Corporation - CEO & Director [5]

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Thanks, Mike. Let's turn to Slide 12 for our closing remarks. We have accomplished most of the portfolio changes that we set out to complete early on to create INAP 2.0. The third quarter was a mark of consistency. Now it's all about execution from the new baseline of revenues and expenses, while continuing corporate development with a focused approach to gain scale in the future. Regarding near-term strategic options, we're always open to selling noncore assets and redeploying those resources to fuel our growth products.

Looking ahead, I believe INAP has an advantage over data center providers, given our flagship locations and high-absorption power markets. Our available capacity to close larger enterprise deals greater than 250 kilowatts is very attractive and is helping us to build a better pipeline. Landing these larger deals will foster sustainable organic growth, and it's a positive culture shift for the company sales team.

Finally, we have kept a sharp eye on market conditions regarding leverage. Our peer group, mostly private, appear to be equally challenged with relatively high leverage. I understand that others are contemplating raising new money to delever, selling noncore assets or completely exiting to gain scale with others. All of this sounds very familiar to us. The company, with its advisers Moelis and LionTree, are being very creative in its strategic review in order to drive an outcome that lifts INAP to the next level of transformation into 2020.

So operator, at this point, we're happy to take questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question comes from Dan Kurnos, The Benchmark Company.

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Daniel Louis Kurnos, The Benchmark Company, LLC, Research Division - MD & Internet, Publishing & Broadcasting Analyst [2]

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Just a quick housekeeping, Mike, actually, just on your comments around the top lease possibly shifting to operating. Is that contemplated already in the forward guide? Or were you just giving that impact in the event that it occurs?

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Michael T. Sicoli, Internap Corporation - President & CFO [3]

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Sure. Thanks for the question. It's not contemplated in the guide currently because we're not sure when it might happen. But we're just providing information so that if and when it happens, you understand how to think about it.

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Daniel Louis Kurnos, The Benchmark Company, LLC, Research Division - MD & Internet, Publishing & Broadcasting Analyst [4]

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Great. I appreciate kind of the forward heads up. And then, Pete, just 2 questions. First, just on the sales front, consistency is good. You guys have had some wins. Obviously, you're talking about lower churn. I'm just trying to get a handle on when we get back to sort of sequential growth here. When we start to see the manifestation of some of those wins. And if we look at kind of your portfolio of assets here, your names, city, key data centers, flagships are growing in occupancy. It's that other that kind of had the big downtick. So just kind of help us think about where the focus is and when we start seeing kind of a resumption of sequential improvement?

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Peter D. Aquino, Internap Corporation - CEO & Director [5]

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Yes, thanks, Dan. I think for the most part, we've accomplished a lot to get rid of the data centers that were downward trending through those exits. The 6 exits were quite painful, but we're through them, and we're seeing positive BNoC now on a more consistent basis, which means we're now teetering on the edge of just having a baseline we can grow from. We wanted to put new charts into our deck today to show where we have a presence. And as you know, the absorption attraction in some of the best markets that's provided there by structured research is really interesting for all of us here because we overlap most of the best markets. So the upside potential of scoring, where there's high demand, makes a lot of sense. So we have the right products. We have Tier 3 data centers. We're in the right markets, location, location. So now we got to execute. So I think we're kind of on the edge now teetering a lean forward and really well positioned to do that. The sales team has got momentum, channel partners are more engaged. We've been meeting with them at the executive level as well. So my sense is it's -- we're right there. So we're really pushing to -- for organic growth at this point.

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Daniel Louis Kurnos, The Benchmark Company, LLC, Research Division - MD & Internet, Publishing & Broadcasting Analyst [6]

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And then just on the strategic without specifics, obviously, a lot of properties have come to market recently. I don't know if you view the market as crowded from that perspective. But I just kind of love to hear what you guys are thinking, sale of noncore assets. There's a ton of money out there. So how easy is it to have conversations? How serious are people? How difficult is the environment making it for you guys to do something near-term to help shore up financials into '20?

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Peter D. Aquino, Internap Corporation - CEO & Director [7]

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I would say it's not difficult as much as opportunistic. There's a lot of activity, as you know, in the industry, both from the REIT perspective with interaction in digital down to smaller portfolios, making trades. I think the difference could be those that are so-called ready now as opposed to want to get their act together to prepare for a combination down the road. The discussions are fruitful. I mean we've met a lot of great people who would make really good partners, and we continue those discussions. But I think it's more opportunistic than anything. And I'm pretty positive about it.

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Operator [8]

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The next question is from George Sutton of Craig-Hallum.

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Unidentified Analyst, [9]

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This is [James] on for George. Just one quick one, looks like you had a little bit of a sequential improvement in the international business. Could you maybe talk about kind of what's driving that and what you're seeing outside of the U.S.?

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Peter D. Aquino, Internap Corporation - CEO & Director [10]

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Yes, [James], for the most part, our international business is a cloud-based business with network connectivity. Canada is driving a lot of new sales of the leadership of internationals out of Canada, Toronto, Montréal. So we have a really good traction with the Canadian Group. Also inside sales out of Chicago is doing quite well too. From a quota perspective, they're very consistent, and we really like the rhythm that they have, and they tend to also shop internationally as well. As you know, we have a presence in Amsterdam and all through Canada and London, we have a new pod in London for cloud. So there's a lot of focus on getting the international segment to really catch up. And you can see it from the contribution margin starting to move in the right direction. We're still a little bit short of colo DNA in international. So we're kind of in search of that. But for the most part, it's a cloud and network DNA, if you will, in the international group that's got a lot of consistency now.

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Michael T. Sicoli, Internap Corporation - President & CFO [11]

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And in this particular period, as I mentioned earlier in the prepared remarks that there was higher nonrecurring revenue as well, which as you know, nonrecurring revenue can fluctuate from quarter to quarter. But the business is pretty stable as well, as Pete mentioned, didn't have as much impact from the higher churn events that impacted the U.S. side last year.

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Operator [12]

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The next question is from Erik Rasmussen of Stifel.

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Erik Peter Rasmussen, Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst [13]

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Maybe just a clarification, I kind of missed the commentary about the -- if you did the top lease. You -- if that were to convert to an operating lease, there could be some headwind to EBITDA margins. Is that an expectation? Should we be modeling that at this point? And then I have a couple of questions.

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Michael T. Sicoli, Internap Corporation - President & CFO [14]

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Yes. What I said is that we are in discussions right now about an amendment to that lease. And if it were to be amended, we believe it would flip to an operating lease which would result when flipped in roughly a $1.7 million expense hitting EBITDA. However, the finance lease balance would go down by approximately $80 million. So the headline leverage impact of that is like 12x. So in terms of reported leverage, it's actually pretty delevering, pretty enhancing from that standpoint. It's just a flip between finance lease and operating lease. So it does manifest itself in lower EBITDA, but cash flow is the same. It's just in a different bucket. And the reason we brought it up is because we are in active discussions about it. Hasn't happened yet. What I mentioned in the prepared remarks is we expect it to happen at some point between now and the end of the year. So unlikely to have a big impact on Q4 regardless, but I wanted to give folks a heads up so that as you're thinking about 2020, you have the best information.

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Erik Peter Rasmussen, Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst [15]

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Okay. That's helpful. And then maybe just back on the strategic alternatives. It seems like it's a pretty similar message that we heard last quarter. You actively engaged with some parties that are interested. What's been sort of the major holdup? And I guess, at this point, now that you have good financing, the credit facility in place and the amendment that you talked about, what's the sense of timing for a deal or whatever that new review comes up with?

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Peter D. Aquino, Internap Corporation - CEO & Director [16]

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Well, the timing is -- certainly, we're working on it right now. We've hired advisers at the end of the first quarter. We're finishing third quarter. That's a lot of time in and we've scoured the earth on trying to figure out the best outcomes for us. I think we're getting close. As I mentioned today, I think we're narrowing down to a couple of actionable items. Some could be noncore sales, could be something different, maybe potentially transforming. We just have to keep at it and make sure we end up in the right place. The time that we attained with the creditors we really appreciate that. Because certainly, we don't want to rush to do a bad deal. So we're focused on keeping our heads down, hopefully. By the end of the year, we'll be close, but we're in the mix right now. So nothing more to add to that.

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Erik Peter Rasmussen, Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst [17]

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Okay. And then maybe just the midpoint of your guidance for the year assumes Q4 would be down a little bit from Q3. So that's 3 quarters in a row. Obviously, you're going through the data center exits and the model's been trying to stabilize. But how should we be then thinking about growth next year, just to try to help us out because there's clearly a lot of moving parts to the model, but I think it would be helpful to sort of right set expectations, at least get some top-level ideas as we head into 2020?

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Michael T. Sicoli, Internap Corporation - President & CFO [18]

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Yes, I think the right way to think about Q4 is flat, not down. So that's pretty straightforward. I think heading into next year, as Pete mentioned, there's a lot of positive signs about the potential for organic growth. Those tend to take longer to materialize than we might think on the front end. So when you're coming off of a prolonged period of decline, sometimes it can be flat for a little while before it actually does grow. So in terms of my expectation of the business, it feels pretty flat today with the potential to get back to growth sometime in 2020.

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Operator [19]

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This concludes our question-and-answer session. I would like to turn the conference back over to Pete Aquino for closing remarks.

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Peter D. Aquino, Internap Corporation - CEO & Director [20]

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Thank you, operator, and thank you, everyone, for your attention today. We look forward to future communication. Have a nice day.

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Operator [21]

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The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.