Equinix Inc (EQIX) 2013 Q2 法說會逐字稿

Good afternoon, and welcome to Equinix conference call. All lines will be able to listen-only until we open for questions. Also, today's conference is being recorded. If anyone has any objections, please disconnect at this time. I would now like to turn the call over to Katrina Rymill, Vice President, Investor Relations, you may begin.

Thank you. Good afternoon and welcome to today's conference call. Before we get started I'd like to remind everyone that some of the statements that we will be making today are forward-looking in nature, and involve risks and uncertainties. Actual results may vary significantly from those statements, and may be affected by the risks we identified in today's press release, and those identified with our filings with the SEC, including our most recent form 10-K filed on February 26, 2013. And our most recent form 10-Q, filed on April 26, 2013.

Equinix does not intend, has no obligation and does not intend to update our comments on forward-looking statements made on this call. In addition, in light of regulation fair disclosure, it is Equinix's policy not to comment on financial guidance during the quarter, unless it is done through an exclusive public disclosure. In addition, we will provide non-GAAP measures on today's conference call. We provide a reconciliation of those measures to the most directly comparable GAAP measures, and a list of the reasons why the company uses these measures, in today's press release on the Equinix Investor Relations page at www.Equinix.com.

We'd also like to remind you that we post important information about Equinix on the Investor Relations page of our website. We encourage you to check our website regularly for the most current available information. With us today are Steve Smith, Equinix's CEO and President; Keith Taylor, Chief Financial Officer; and Charles Meyers, President of the Americas. Following our prepared remarks, we will be taking questions from [financial] analysts. In the interest of wrapping this call in an hour, we would like to ask these analysts to limit any follow-on questions to just one. At this time, I will turn the call over to Steve.

Okay, thank you, Katrina. Good afternoon and welcome to our second-quarter earnings call. I'm pleased to report that Equinix achieved another strong quarter of financial results, and we delivered against our key operating goals in the first half of 2013. This quarter we saw strong performance across our verticals, with particular strength in cloud and IT services, and continued uptake of our global offering, with strategic wins across each of our regions. Before I provide further detail on these Q2 highlights, I'd like to provide color on our outlook for the remainder of the year, as outlined in our press release.

As I believe everyone on the call is aware, our prior guidance contemplated a steeper slope in our growth for the second half of 2013. We continue to expect strong operating performance in an acceleration of growth in the second half. However, based on current visibility, we are now moderating our guidance for the full year. In [bridging] to our revised outlook, there are three primary factors, two of which are nonoperating in nature, included in this adjustment, which are depicted on slide 3. First, we continue to operate in a volatile currency environment, and are building into our forecast an additional $11 million in negative impact from currency fluctuation. This is in addition to the $21 million of currency headwinds from Q1, which we already absorbed into our full-year guidance, when we maintained our initial forecast for the year.

Second, a revised guidance includes a $16 million non-cash decrease in revenues, and adjusted EBITDA, related to a change in accounting estimate that extends the amortization period for nonrecurring installation revenues. This is reflective of a focused effort to move strategic customers to longer-term contracts. The majority of these customers are critical to the strength and vibrancy of our ecosystems. For example, in North America, we have generally lengthened our new customer contracts from less than two years to three years or more, which brings even more stability to our business, long-term.

Third, we are tempering revenue acceleration for the second half of the year by $31 million at the midpoint of our revised guidance. This adjustment is primarily attributable to three things. First, stock performance in Germany, which accounted for approximately half of this change. Two, a longer sales cycle in our enterprise segment; and three, a reduction in average deal size driven by our focus on ecosystem opportunities. While these factors create a gap to prior expectations, we remain confident in our long-term strategy, which is resulting in strong yield per cabinet, improving margins, and deepening interconnection.

Rather than chasing deals that we believe will compromise our long-term returns, we are making disciplined decisions to drive profitable growth, and can continue to win the right deals that deliver superior value to our customers and drive acceleration of our ecosystems. This strategy is supporting a steady upward trend in quality bookings, and is clearly evidenced by our strong second quarter results, which I'd like to cover now. As depicted on slide 4, revenues were $525.7 million, up 1% quarter over quarter, and 15% over the same quarter last year. Revenues were above the midpoint of our guidance on a normalized and constant currency basis, increasing over 3% sequentially and 17% over the same quarter last year.

Adjusted EBITDA was $244.2 million for the quarter, above our prior guidance, and on a normalized and constant currency basis, up 4% quarter over quarter, and 16% over the same quarter last year. Our MRR per cabinet remains firm, and we see continued health in new deal pricing, customer mix and operating margin. Interconnection growth is trending favorably in all three regions, with particular strength in the Americas this quarter, where cross-connect adds increased by 48% over the four quarter average, as our IBX optimization efforts begin to play out, and our key ecosystems continue to mature.

In addition to our traditional contribution for network to network interconnection, we are also seeing acceleration in ecosystem driven interconnections, with strong growth in financial services and record performance in cloud and IT services, bringing our total cross-connects to over 120,000 globally. As guided during our last call, the headwinds associated with our optimization program are beginning to ease, allowing churn to step down even as we continue our highly disciplined approach to customer renewals. This proactive effort to ensure we have the right customers with the right applications and the right IBXs, is resulting in strong operating results as evidenced by our healthy MRR per cabinet yield.

Each of our industry verticals performed well this quarter, and I'd like to provide you with a few highlights. Cloud and IT services continues to be our highest growth vertical, delivering record bookings this quarter, including a significant number of new logos. Our 1,150 cloud and IT service provider customers generate 24% of our revenue, and use our IBXs as a source for customer acquisition and revenue generation in their own businesses. Software-as-a-service, in particular, continues to be an exploding sub-segment for Equinix, as many of these providers realize they require a global, highly interconnected footprint to deliver the application performance their customers expect.

Beyond the software-as-a-service segment, our infrastructure-as-a-service customer base is also showing growth. Equinix customers are beginning to adopt hybrid cloud architectures by leveraging direct connections to cloud service providers inside our IBXs. We expect the growth of cloud and cloud-based services to be a major driver of growth for Equinix. In the financial services, the electronic trade ecosystem remains healthy as key trading platforms and participants expand globally with Equinix. This quarter cross-connect in the financial ecosystem grew 30% year-over-year driven by our Chicago, London, and New York campuses. We now have over 120 exchanges and trading venues inside Equinix up from 75 just last year.

Growth is driven by new exchanges joining the ecosystem, such as Lmax and the [Moscow] exchange in London, additional growth is coming from exchanges establishing a local presence in foreign markets such as the Swiss Stock exchange in Tokyo, and the Chicago Board of Options Exchange, Chicago Mercantile Exchange and NASDAQ NLX deploying in London. Also the over-the-counter derivatives market, as it goes electronic, this entirely new asset class is contributing to our strong growth. In the content and digital media vertical, we saw steady demand as media companies leverage our global platform to efficiently distribute content across the globe.

Our new digital advertising ecosystem, referred to as Ad-IX, is helping customers reduce latency and increase ad bid rates, a critical performance metric for digital advertising, by as much as 50%. New wins include Rocket Fuel, which recently expanded to leverage BrightRoll's video advertising platform exclusively inside Equinix. In networks, we continue to deliver solid results and gain market share with key accounts such as AT&T, CenturyLink and Telstar. In addition, we are working closely with our top network customers to enable new services such as Verizon extending it's private IP service with Equinix, and more generally we see wireline service providers leveraging Equinix to connect enterprises to a range of cloud services.

The wireless segment continues to perform well as their infrastructure migrates from voice to data centric architectures with expansions for both network operators and key wireless enablers such as Syniverse. And finally, in enterprise, we continue to make headway with CIOs as they begin to adopt cloud services, and understand the strategic implications that their data center strategy has on data movement and storage, network efficiency and application performance. We see early, but accelerating, interconnection growth between cloud and enterprise verticals, indicating that our success in attracting cloud supply is resulting in driving enterprise demand.

However, broad public cloud adoption, outside of the small to medium business, is still in the early days. As a result, we find sales cycles are longer than our other verticals, and average deal sizes remain small, but are resulting in high-quality, new logo growth across every region. Shifting to expansion activity, we are continuing to build our global data center platform to support our ecosystem strategy. Today, over 62% of our recurring revenues come from customers deployed across multiple regions, up from 58% last year. Over 78% of our recurring revenues come from customers deployed across multiple metros, showing that customers are utilizing our global reach. As a result, we are continuing to invest in our global platform.

Asia-Pacific is our fastest-growing region, and we are investing in three new expansions to support demand. In Japan, we announced plans to open our first data center in Osaka, an important new market and Japan's second-largest economy. Osaka will provide a second access point to the Japanese market, which is critical to our global intranet customers. In Australia, we have approved a third phase expansion of our Sydney 3 data center to support continued growth in our Sydney campus, the most network dense in Australia. We are also proceeding with Phase 2 of our Hong Kong 3 site targeting content, network and financial customers. In Europe, we opened our fifth IBX in Zurich in June, a stand-alone data center that is tethered back to our downtown location with access to over 90 network service providers.

We are experiencing strong demand for this site, which is already 16% booked. And in the Americas, we continue to progress with our five previously announced expansions in Ashburn, Dallas, Rio de Janeiro, Silicon Valley and Toronto. And finally, we are opportunistically expanding ownership of assets as it makes economic and strategic sense. In July, we purchased our New York 2 IBX, part of the Secaucus campus, where our financial services ecosystem is the most robust. Purchasing New York 2 gives us control over a key component of our campus, and provides space for future expansion. We now own 18 of our 98 IBXs, and owned assets generate approximately 28% of our revenue. So, let me stop here and turn it over to Keith to review the financials for the quarter.

Thanks, Steve and good afternoon to everyone on the call. So, before I turn to the Q2 results, I'd like to take this opportunity to review our progress against five of our critical objectives that we established for 2013 and beyond. First, regarding our interconnection strategy, our net cross-connect showed nice growth this quarter, and interconnection revenues as a percent of our total recurring revenues, increased to record levels in both the Americas and Asia Pacific regions. Europe is making steady progress against this objective with particular strength in the UK. These efforts present themselves in our MRR per cabinet yield metric in each of our regions. And over the longer term, will increase the level of customer renewal and attention, thereby reducing our future MRR churn risk, by also increasing our operating margin and return on invested capital.

Second, our operating margins continue to improve, increasing the level of cash we generate from operations after adjusting for the REIT related cash cost and taxes. We continue to see a path to adjusted EBITDA margins of 50%, and will continue to balance our growth with profitability, as we scale our business. Third, we're making nice progress against some of our key strategic initiatives, including the planned REIT conversion, another tax optimization strategy. These initiatives will decrease our overall global tax rate, whilst increasing our discretionary free cash flow and AFFO, both prior to and after the planned REIT conversion on January 1, 2015.

Fourth, as we discussed, we've been working hard to extend the term of our customer contract, particularly those key strategic customer that drive our ecosystems. For example, in North America, we've lengthened new customer contracts from one to two years to three years or more, which we believe will have extend the overall life of both the installation and the customer relationship. This change in contract term and customer life has caused us to revisit the term by which we amortize our deferred installation revenue. Previously, we amortized this revenue type over a two to three-year period, and this now has been changed to up to a four-year period resulting in an estimated $60 million decrease in nonrecurring revenue that otherwise would've been recognized in 2013. And, of course, therefore will be recognized in the other years.

Fifth, we continue to see progress in our IBX optimization efforts, and saw significant step-down in churn this quarter to 2.4%. For the second half of the year, we expect MRR churn to remain at approximately 2.5% per quarter, in line with our prior guidance. So, for the first half of the year, we're seeing solid market conditions as we scale our global platform with particular strength in the cloud vertical, solid performance across our network financial digital medium content verticals, while enterprise remains a substantial opportunity for us, the sales cycle is longer, as CIOs sort through the benefits of a hybrid cloud architecture.

This quarter's gross bookings were our third best, despite the increased production over last quarter, we are still slightly shy of our prior expectations. Based on this, together with the impact of the change in accounting estimates, and weaker operating currencies, we are tempering our revenue targets for the second half of the year. We still expect to grow faster than the broader market, and expect both Q3 and Q4 growth rate to increase sequentially over the first two quarters of 2013 on a constant currency basis. Separately, I wanted to note that it's our intention to release our annual guidance on the fourth-quarter earnings call this year, to better align with our budgeting and strategy process going forward.

Now, turning to our second-quarter results, let me start on slide 5 of our presentation posted today. Global future revenues increased to $525.7 million. Excluding the change in accounting estimate, revenues were $531.5 million, a 2% increase over the prior quarter and up 16% over the same quarter last year. Our Q2 revenue performance reflects a $4.5 million negative currency headwind when compared to the average rates used in Q1. And a $900,000 negative impact when compared to our FX guidance rates. But, adjusted for the change in accounting estimate and changing FX rates, revenues were about the midpoint of our guidance range at $532.4 million, or a normalized quarter-over-quarter increase of 3.4%.

Turning to slide 6, we wanted to highlight the diversification of our revenues across our regions, our verticals, and our product categories. Of note, global interconnection revenues increased to 16% of current revenues, from 15% last quarter, a key metric that we remain focused on as we continue to develop our ecosystems. Global cash gross profit for the quarter was $356.6 million, flat versus prior quarter, and up 13% over the same quarter last year. Cash gross margins were a healthy 68% of revenues, consistent with our guidance, despite absorbing the change in accounting estimate. Global cash SG&A expenses decreased to $112.4 million for the quarter, slightly lower than expectations due to lower project costs, related to the strategic initiatives, and a smaller than expected advertising and promotion spend.

Cash and SG&A expense was flat at 21% of revenues, compared to the same quarter last year. Global adjusted EBITDA increased to $244.2 million for the quarter, or $250 million excluding the change in accounting estimate, a 3% increase over the prior quarter, and a 15% increase over the same quarter last year, and above the top end of our guidance range. Adjusted EBITDA growth reflects increased revenue performance, more than expected utility costs, and lower than planned SG&A spending. Our adjusted EBITDA margin was 46%. Our Q2 adjusted EBITDA performance reflects a negative $2.3 million impact when compared to the average rates used in effect in Q1, and an $800,000 negative impact when compared to our FX guidance rates.

Global net loss attributable to Equinix was $28.7 million, primarily due to the debt extinguishment charge of approximately $94 million. This was effectively our make-whole payment, plus the write-off of the unamortized debt issuance costs related to the redemption of our $750 million 8.125 senior notes. Absent this charge, we would have had pro forma net income of $40.5 million, an increase of 13% over the prior quarter. Our pro forma fully diluted earnings per share would've been $0.79, a 12% increase over the prior quarter. Now, moving to our comments on REIT. We continue to move forward with our plans to convert to REIT starting January 1, 2015, and currently do not expect a delay to this time frame.

On slide 7, we summarized the various expected REIT cash costs and taxes, similar to our discussion last quarter. In the third quarter, we expect to incur approximately $11 million in cash costs related to the REIT program, primarily related to professional fees, which is reflected in our Q3 guidance. With respect to income taxes, we've modified downwards, for 2013, estimated cash tax liability, they now range between $150 million and $180 million. On a year-to-date basis, we've paid $57.3 million in REIT related cash taxes. We continue to make progress towards optimizing our global tax structure, and as part of this initiative, we've implemented a new organizational structure that centralized the management of our EMEA business activity into the Netherlands, effective July 1 of this year.

As a result of this, we expect our effective tax rate to be lower in subsequent periods as the new structure begins to take full effect. Assuming that successful conversion to our REIT, and no material changes to the tax rules and regulations, we expect our effective long-term worldwide tax rate to ultimately decrease to the range of 10% to 15%. Consistent with our expectations, that approximately 50% of our revenues will be generated outside of the US. Turning to slide 8, I'd like to start reviewing our regional results beginning with the Americas. Overall health of the Americas business remains strong as reported revenues were $312.4 million, excluding the change in accounting estimate, a 2% increase over the prior quarter, and up 10% over the same quarter last year. Cash flow margins remain at 71%.

Also, the level of global deal flow from the Americas region continues to be strong, a testament to the success of our global footprint and service offering. As reported, adjusted EBITDA was $152.6 million, an increase of 4% over the prior quarter, and up 8% over the same quarter last year, even after absorbing the higher corporate overhead spend on the strategic projects such as REIT. Americas adjusted EBITDA margin was 49% for the quarter. Americas net cabinets billing decreased by approximately 100 in the quarter, largely due to the timing of customer installations, and cabinet churn.

MRR per cabinet rose slightly and remains at very attractive levels. Interconnection revenue as a percent of the regions recurring revenues increased to a new all-time high, including 1600 new net cross-connect additions in the quarter, up 48% increase above the rolling four quarter average. And now, looking at EMEA, please turn to slide 9. As reported, EMEA revenues were $125.6 million, and excluding the change in accounting estimate, an increase of 6% sequentially, and up 24% over the same quarter last y ear. As reported, adjusted EBITDA was $49.3 million, consistent with the prior quarter. Adjusted EBITDA margin was 39%, lower than the prior quarter, due to the tax reorganization work performed.

Normalized and on a constant currency basis, our adjusted EBITDA increased 5% over the prior quarter, and 7% compared to the same quarter last year. Looking at the second half of the year, EMEA adjusted EBITDA margins are expected to increase in the low to mid-40%s, as the majority of the work from the tax reorganization is complete. The EMEA region delivered a mixed second quarter when reviewed on a country by country basis. The UK business continues to perform very well, with strength in the financial services, content and cloud verticals. However, the favorable UK performance was offset by soft German performance, due to a combination of factors including the broader macroeconomic environment, and sales force execution.

Our German team hired new sales leadership, and a number of new account executives. They're working very hard to close the future performance gap as they enter the 2014 operating year. Our Dutch, French and Swiss teams are making good progress against their operating targets, with newly opened facilities in each of their countries. MRR per cabinet remains firm across the EMEA markets and verticals, while average deal size decreased over the prior quarters, consistent with our selling and go-to-market strategy. EMEA interconnection revenues increased to greater than 7% of recurring revenues, adding 900 net cross-connects in the quarter. Net cabinets billing increased by approximately 900.

And now looking at Asia-Pacific, please refer to slide 10. Asia-Pacific had solid sales momentum this quarter, driven by wins in cloud, digital and media content, and financial verticals. As reported, Asia-Pacific revenues were $87.6 million, a 2% decrease over the prior quarter, and a 33% increase over the same quarter last year, when excluding the change in accounting estimate. It's important to note, given the large $1.1 million MRR churn at the end of Q1 that we discussed in the prior earnings call, the sequential decrease in Asia-Pacific revenues was consistent with our expectations. We've already rebooked more than 70% of the space attributed to the Singaporean churn, and expect the entire space to be rebooked by the end of Q3, at better average price points.

As reported, adjusted EBITDA was $42.3 million, more than the prior quarter due to MRR churn, and the change in accounting estimate, and weakening operating currency. On a normalized and constant currency basis, Asia-Pacific adjusted EBITDA decreased 7% quarter over quarter. MRR cabinet remains strong with a 4% sequential increase on an FX-neutral basis. Cabinets billing increased by approximately 300 compared to the prior quarter. We added 700 net cross-connects in the quarter, with continued positive shift in copper to fiber.

And now looking at the balance sheet. Refer to slide 11. Our current liquidity position remains healthy, and we ended the quarter with $1.2 billion of unrestricted cash and investments. Looking at the liability side of the balance sheet, we ended the quarter with net debt of $2.7 billion, about 2.8 times to annualize adjusted EBITDA, a decrease compared to prior quarter due to the redemption of or $750 million 2018 senior notes. Now, looking at slide 12. Our Q2 operating cash flow increased substantially over the prior quarter to $147.2 million, primarily due to shifts in our working capital balances including lower cash interest payments. Our [DESO]s increased to 35 days, an increase over the prior quarter, largely due to the timing of quarter end.

Our Q2 operating cash flow included REIT-related cash costs and taxes up $57 million. Absent these costs, our operating cash flow would've been $204 million, a significant increase over the prior quarter. As for 2013, we expect our adjusted discretionary pre-cash flow, excluding any REIT related costs or taxes, to remain between $620 million and $640 million, and adjusted free cash flow to be greater than $175 million. Now looking at capital expenditures, please refer to slide 13. For the quarter, capital expenditures were $122.9 million, below our expectations due to the timing of cash payments to our contractors, and favorable spend management.

Ongoing capital expenditures were $40.2 million, which included less than $10 million in maintenance and efficiency enhancement and single points of failure capital. Definitely, given the number of questions we get on capital expenditures, and a breakdown of our costs to keep in the good working order, we provided you slide 14. This slide depicts the level of investment we've made in building and improvements versus plant machinery and equipment, and the maintenance protocol, with OpEx and CapEx assigned to these assets. The most important aspect of this slide is the type of meaningful assets under plant machinery and equipment, and the respective lifes. It's fair to say, the economic life of our IBXs, and these critical assets will likely extend to 30 years or greater, given the level of spend in both our predictive and preventive maintenance programs.

Overall, our maintenance capital is probably 2% of our revenues, consistent with our expectation that there should be no meaningful reinvestment requirement in our IBXs. Finally, turning to slide 15, the operating performance of our 24 North American IBX and expansion projects that has been open for more than 1 year, continue to perform well. Currently, these projects are 82% utilized, and generate 35% cash on cash return of the gross PP&E invested. Our eight oldest US IBXs grew 4% year-over-year, as customers continue to purchase additional power and cross-connects. At this point, I'll turn the call back to Steve.

Thanks, Keith. Let me now shift gears and cover our outlook for 2013 on slide 16. For the third quarter of 2013, we expect revenues to be in the range of $538 million to $542 million. It includes a negative foreign currency headwind of $4 million versus our prior guidance rates. Q2 guidance includes a $6 million decrease in both revenue and adjusted EBITDA due to the change in accounting estimate. Cash gross margins are expected to approximate 68%. Cash SG&A expenses are expected to range between $126 million and $130 million. Adjusted EBITDA is expected to be between $236 million and $240 million, which includes $11 million in professional fees, related to the REIT conversion, and negative foreign currency headwinds of $2 million.

Capital expenditures are expected to be $180 million to $200 million, including $50 million of ongoing capital expenditures. For the full year of 2013, we expect revenue to range between $2.135 billion to $2.145 billion. As a reminder, this guidance includes a $16 million decrease to both revenue and adjusted EBITDA due to the change in accounting estimate. This is a non-cash change only, and a result of a longer estimated life for customer installations. Full-year guidance is also adjusted for $11 million of negative foreign currency headwinds from our prior guidance range. On a FX-neutral basis, and normalized for the accounting change, we expect full-year revenue growth of 15.5%. Full-year cash gross margins are expected to approximate 68%. Cash SG&A expenses are expected to range between $465 million and $475 million.

Adjusted EBITDA for the year is expected to range between $985 million and $990 million, which includes $26 million of professional fees related to our REIT conversion, and adjusted for $5 million of negative currency headwinds from prior guidance. We are guiding to a slightly higher adjusted EBITDA margin for the year, as we continue to manage our discretionary and incremental spending programs. We are tightening our 2013 capital expenditure range to be between $575 million and $625 million, including $165 million of ongoing capital expenditures. We are investing in our business at a very attractive risk return profile, and we do continue to achieve our targeted returns.

So, in closing, we delivered a solid first half of 2013 with strong interconnection growth. We see continued momentum, and will execute with discipline while balancing top and bottom line growth. We are winning the right deals to enhance our vertical ecosystems, and are committed to delivering firm MRR per cabinet yield, strong margins, superior returns on capital, and profitable long-term growth. So, let me stop there and turn it back over to you, Heather, for some questions.

(Operator Instructions)

Jonathan Schildkraut with Evercore Partners.

I'd like to get an update on what's going on with the sales force. I know that you guys were still ramping in the quarter, and maybe where the headcount is, and what's going on with productivity. And then, maybe if you could relay that kind of productivity commentary relative to the bookings activity in the quarter? Thanks.

Let me take that. So, yes, we are continuing to ramp force. We are planning to add some additional heads in the second half of the year, that will probably take us on a worldwide basis somewhere in the 220, 230 range. In the Americas, we have added some, as we continue to manage under performers out, and we're trying to keep a buffer in the system so that we can continue to do that, and try to ramp productivity. As Steve commented in the script, there are a couple of factors that are impacting productivity a bit. The median is still pretty strong. It dipped slightly this quarter. Averages were down, and that is attributable, really, to the deal size mix. As we've said before, when you take averages can be a bit deceiving because when you have large deals in the pipe, and you close those, they can spike averages.

So, averages were down a bit. But again, there is a general optimism that we've got a lot of traction. We had a record quarter in cloud, and in content and digital media, solid performance in financial services, and network. Network continues to deliver very strong price points, actually strong pricing across the board. Really, some softness, though, in enterprise. And, we talked about that. Even though we are short of our targets, there's some real reasons for optimism in enterprise. We're seeing solid funnel growth. Very simply we're not converting the funnel at the same rate as our more mature verticals, and we are seeing deals slip as decision cycles are protracted. It's less losing deals, as it is deals slipping into a subsequent quarter.

In terms of enterprise, I think that it's really a drive opportunity in many respects. Enterprise is really the buyers, or the buy side of the ecosystem, and they gain value from the platform by leveraging the critical mass that we have in both network, and, increasingly, are seeing in cloud. So, we are seeing a pretty universal trend towards hybrid cloud architectures, but it's just taking some time for that to shake out. So, our guidance really reflects a pragmatic view of bookings productivity for that particular segment, through the remainder of the year as that plays out. So, that's a bit of color. Again, I think we're making good traction as we are definitely seeing bookings continue to increase from an overall trend line perspective, particularly in that small to midsize sweet spot for our business and systems strategy.

Mike Rollins with Citi Investment Research.

Hi, thanks for taking my question. I was wondering, if you could talk about two things. The first on, I believe it's slide 15. It talks about how the older IBXs have slowed down to about 4% year-over-year revenue growth rate. And, I was wondering if you could talk about how investors should think about the growth of the relatively more mature data centers you have, and just your latest thoughts on that? And then secondly, going back to the sales productivity. Can you give us some more details of what went wrong, relative to your expectations? Particularly in Germany and the average deal size. Was it competition where you just chose to focus more on smaller deals? Or was it just the size of the funnel? And being able to take that size of the funnel and convert it was the issue? Thanks.

Charles, do you want to take the second question first?

Sure. (multiple speakers) Mike, let me take the back half of the question, and then I'll give it back to Steve to take the first part. The direct answer to the question, in terms of what happened, one is what I just talked about relative to the enterprise opportunity, and it's just maturing more slowly. As I said, there, the funnel is strong. And that's actually a fairly consistent theme across the verticals. But that funnel is not converting at the same rate and we are seeing deal cycles, sales cycles, a bit more protected.

Relative to the deal mix, as we referred to, we saw a reduction in average deal size, and that we were talking about that as a contributing factor. And, as I talked about a lot in previous calls, we manage business to a certain deal mix range that we believe is going to provide us with solid growth, and deliver blended returns to fit the business models. As we reviewed the results for Q2, we saw it really was a shift towards the smaller deal size was consistent with our ecosystem strategy. We are still seeing and winning some portion of our large deal flow.

Particularly for certain applications or magnate-type customers, there's no doubt the market clearing prices for some larger deals are dropping below what we see as acceptable, particularly when we consider the opportunity cost of selling our premium capacity at lower price points. So, it's really a matter of rather than chasing growth for growth sake, we are really maintaining the deal discipline and staying focused on long-term value creation. And we're just taking a pass on deals when they don't meet our hurdles. In terms of how that affects the bookings trajectory and the results, you have to remember that even the large yield portion of our bookings is fairly small.

It can take 10 to 15 smaller deals to deliver the bookings of a large deal. So, if one drops out because we determine it's not consistent with our model, than it can take 10 or 15 smaller deals to deliver that same set of bookings. So, it takes some time for our marketing and sales execution capability to scale up to that challenge. But again, the other side of the coin on that, is that this deal discipline and execution is really diving the solid revenue per cap, stronger deal pricing and healthy interconnection, all of which are evident in our Q2 results.

And, on the middle part of that question, you can take the last piece of that on the slide 15. Mike, on the German situation, first of all, the overall business in Europe has continued to perform well. But it's important to keep that in context. But, the forecast in the second half in Germany did weaken as we exited the quarter. A little bit tied to the German market, with some softness in the German market in our primary verticals there. But as Keith mentioned in his script, we did have some sales execution challenges.

We are addressing those now with sales leadership, and individual performers. The enterprise slowdown was felt in that market a little bit, too. So, there was some slowdown in sales cycle converting that Charles talked about in the North American market, and a little bit of softness in the financial services. Could have been tied to the hangover from the New York Stock Exchange/Deutsche Borse failed merger. That stymied the market from connecting into the activity we had in Frankfurt. So, those are the factors that affected the German market.

I'd like to deal with the first question on the oldest assets growing 4% quarter over quarter, sorry year-over-year. It's important to note -- number 1, a lot of these assets are reaching us at a critical level of occupancy. And so, number 1, a lot of that growth does come from pricing to the extent that there is some level of optimization in those older assets. It does come from new power circuits and more cross-connects. But one of the things that I don't want it to be lost on the people listening on the call here, some of these assets are highly valuable to us.

And we'd rather let those assets, like an LA1, we'd rather maintain, cordon off some of that space for a unique set of customers. And so, instead of selling it to whomever, if it's a network oriented IBX like they typically are, we're going to reserve that capacity for that future opportunity. And so sometimes that can retard the year-over-year growth. So, it's fair to say that we are being disciplined about filling up those assets. Going forward, it's reasonable to expect a 3% to 5% year-over-year increase, and that's how I think about those assets.

Thanks, that's very helpful. Thank you.

Brett Feldman with Deutsche Bank.

Thanks for taking the question. You noted that you have really come out of the optimization project, which was very much concentrated in North America, and we saw a positive revenue churn response in the quarter, in line with what you had expected. But, when I dig into the non-financial metrics for North America, we saw a slight decline in cabinets even though revenue churn was lower across the business. And, presumably, tenant quality has improved as a result of this, and yet the MRR per cabinet has been flat. It didn't grow even though we've seen more interconnections. And so, I was hoping maybe you could help us make a bit more sense of this trend, and maybe give us an idea as to what appropriate expectations are for your North American business during the balance of the year?

Sure, Brett, this is Charles. The key thing to remember is that it takes time, generally, as we do some of these optimizations and customers are moving to multi-tiered architectures, for example, if then when you replace that revenue, inherently, implementations mature over time and the yield per cabinet come back, and matures along a normal path. So, what you are seeing is, I actually am quite satisfied that we see, and we've always talk about that the cabinet's billing is a fairly erratic number. It depends a lot on the timing of churn, the timing of customer installations, and you see we big cab adds in Q1.

It's just a more erratic number. And, that as we look at this quarter, I'm comfortable with where it's at. I'm very pleased to see that we are keeping the yield per cabinet strong, and very much towards the high-end of what we've talked about in the past. Again, it's just a matter of -- and if you look at interconnect, what we're seeing now is both a waning of the network consolidation activity that was providing pressure there, and the effects of the optimization, where typically we are trying to optimize out less interconnected business, replace that with small to midsize deals that we believe are going to ramp up from an interconnection perspective.

So, as I look at the non-operating metrics, I have a very high level of confidence that those are trending in the direction that we would expect, and are reflective of the long-term strategy. So, again, that's just really a matter of us doing the right thing, continuing to have the deal discipline, and it will take shape in the metrics over time.

So, just a follow-up on that bit. We drive our models here, and I'm trying to think about the growth variables in the North American region. Should we be increasingly, for example, be putting more weight on, say, adoption of interconnections as a reason why you grow revenues, say, versus, cabinet additions? I just want to try to understand what the key growth model is in North America right now?

I don't necessarily think so. I think that our ability to add cabinets continues to be strong. Our bookings in our sweet spot are -- in fact, our bookings are growing nicely. There is this pressure created from us needing to, perhaps, replace some large deal volume with a larger number of smaller cabinet deals. And that's one of the reasons why, as we continue to ramp on that, it's growing. We're definitely selling new cabinets in addition to, hopefully, growing the interconnections. I definitely wouldn't see a change in that trajectory. Again, it is going to be a little bit lumpy. But, we are going to continue to do both of those things.

Great. Thanks for answering the question.

David Barden with Bank of America.

Hey guys, thanks for taking the question. So, Keith, I want to ask the usual question about trying to figure out the guidance. So, if I just ignore the current fees, and I ignore the accounting changes, the revenue this quarter was $532.4, and the EBITDA was $250.8 million. So, you have $13 million of sequential revenue growth, and you have $8 million of sequential EBITDA growth. If I look at the third quarter guidance, we are looking at $550 million of revenue, which is an $18 million revenue increase. And we are looking at $246 million of adjusted EBITDA, which is a negative $5 million, which implies that there's going to be $23 million of brand-new expenses showing up quarter over quarter.

Which if I look at the history of the Company as far back as I go, I can't even find a quarter were you've had anything like that. So, I'm trying to understand how that expense profile changes so dramatically. Personally, I find it hard to believe that it's going to be that dramatic. But, this is an opportunity to reset guidance and reset expectations and you don't want to miss. So, I wonder if you could walk us through that. And, the second thing I would like to ask is just on the REIT stuff. If there's any inside baseball that your professional fees are buying you, that gets you some color as to where the working group stands, and what's next in this process and when. Thanks.

Sure. Thanks for the questions, David. First and foremost, you hit the nail on the head. So, what I'm going to do is just orient everybody on the call, and certainly you, David. So, when we started the year, we said we could do roughly $2.2 billion of revenue, we said greater than $2.2 billion. As you are aware, there's $34 million of currency, and a $16 million accounting adjustment. That's a $50 million non-controllable movement, if you will, in our revenue line. That takes you to [$2150 million]. We are guiding to midpoint [$2140 million]. And the reason that we are explaining the $31 million, as you know, is because based on the first quarter, the $21 million shortfall from FX, we said we could capture that, and Steve and Charles have done a good job of explaining that.

So, from that perspective, you then move over to EBITDA, and you say about 15.5% revenue growth. Now, let me look at EBITDA, what's going on there? Well, we told to we could do [$1010 million]. So, as you are aware, doing [$1010 million], if you take out the $16 million, again, from the accounting adjustment, and the $14 million -- if you will -- attributed to currency, that's $30 million. We are guiding you to [$990 million] at the top end of our guidance range. If you add back those two items alone you get to [$1020 million]. And so, the real shift that you are seeing here is, we also told you we are going to spend $20 million in REIT costs. That number has now gone up to $26 million. So, on an apples to apples basis, you are looking at $1046 million. That's EBITDA.

And so how that manifests itself, really, in the Q3 numbers, and certainly how it translates into Q4, if you think about the guidance that we give from an EBITDA perspective for Q3, we said mid-point we're going to do about $238 million. There's $2 million of incremental currency hit as we said. That's $240 million. As you know, revenues are going to go up roughly $14 million on an FX basis. So, $14 million up. What we should deliver, if you see that drop-down to EBITDA line, roughly $254 million. So, what's causing the back step? Well, number 1, next quarter, as we said in some prepared remarks, there's going to be $11 million of professional fees going through Q3's numbers.

The amount of energy in there, and the amount of consultants and contractors inside our building, today, to take the Company and move it towards the REIT is substantial. So, there's an $8 million incremental investment just next quarter for all these people, hundreds of people who are in our building, working on this project. Second thing, salary and benefits are going to go up $6 million. Thirdly, as you know, Q3 is always our higher utility quarter. We are going to spend more on utilities, just by pricing $4 million. And then there's a small adjustment to ramp up benefits of $2 million. So, bottom-line, you're basically, all of that benefit you're going to get, you are going to roll it basically to professional fees, and, if you will, this pricing environment.

But, by the time you get to Q4, you are effectively going to get all of that back. So, when I adjust all the numbers and I say, okay, if you take out currency, and you take out the accounting change, how is the business going to perform? You're almost at 48% EBITDA margin absent those REIT related cash costs, that $26 million. That tells you exactly what Charles said, and what Steve has alluded to. The overall performance of the business, we are seeing, obviously, strategic performance, global platform, better margin, overall, the business is performing at a higher level. And so that margin you're going to get, effectively, in the fourth quarter. So, that reconciles you to the key differences that you've alluded to.

REIT next steps.

REIT, next steps. Again, certainly we're spending a lot as it relates to our advisement. There's nothing I can tell you, because I don't know anything regarding the working group. And so, from our perspective, we are going to continue to march down the road to deliver on the REIT conversion by January 1, 2015. Again, evidenced by, if you will, the level of spend and effort going on in this Company towards not only the REIT conversion, but all the other global tax work we are doing. We are wholly comfortable that we will convert as planned on January 1, 2015. (multiple speakers). Go ahead.

If I could just ask one quick follow-up. I mean, you threw this new slide 14 into the deck to try to address working cap, or I'm sorry, maintenance capital expenditures. Is that meant to be Equinix's official view of what you would bake into an AFFO calculation were you to provide one? Is kind of a 2% revenue number? Or, are we just talking apples and oranges still?

Well, David, I certainly think we are moving down that path. Certainly, we're just trying to give you a sense of the things that we think about when it comes to maintenance CapEx, and the level of reinvestment we need to make. I still think we have some work to do on the definition of AFFO. And clearly, we are working on it, as you can appreciate, we are looking at our peer group. We are certainly looking at AMT, and we're looking at the Navy definition. But only when we get, if you will, the green light from the IRS, do I think we will come out and give you a very detailed and descriptive point of view on what that AFFO calculation is. Suffice it to say, though, when you look at discretionary free-cash flow, we continue to believe that's a really good surrogate right now.

And overall, as some have written, currently there's some level of conservatism in there, given the fact that it includes all of our ongoing CapEx. So, our general view is we are moving down the road, but we are not there yet to define what the AFFO metric will be. So, use this more as just an interpretation of economic life of the asset is 30 years or greater. The accounting life is different than, effectively, the economic life. Part of it is due to GAAP accounting, part of it is due to interpretation. And this just gives you a pretty good idea of what our spend is going to look like.

Perfect. Thanks, guys.

Jonathan Atkin with RBC Capital Markets.

Yes, I was wondering given what you said about average deal size, and also the types competition you are seeing for deals at larger end of the spectrum. Can you put that in context of your business [suites] offer, and that's something that you are still expanding in Virginia, and possibly into other markets? And then, more broadly, I wondered if you could maybe discuss, from a strategic point of view, any impacts that you would expect from the efforts on the part of some of the existing data center REITs to focus more on productivity type services?

Sure, yes, it's Charles. Let me we respond to both those. I think that business suites, as we've talked about, it's something that we are having good success with, and something that we think is a continued important part of our product continuum, as we evolve with customers. And so, as we said, some customers, as they move to a multi-tiered architecture, depending on the size and performance characteristics of the thing, do consider a range of options. And many of them, if they are extraordinarily large in size, go to a wholesale alternative, as that third tier of their architecture. Many, however, depending on, again, the size and performance characteristics, and their desire to have a single source provider, very often, Equinix, they are saying we would like you to be able to provide us with a solution, a more economic solution for large footprint.

So, business suites has been that for us. We have seen, and continue to see, strong funnel. We are converting that funnel successfully. And so, the answer is, we are absolutely looking to expand that, not only in Ashburn where we have an expansion under way now, but also in other key markets where we believe, selectively, customers will want to have the full range of infrastructure with us. So, that's a little bit of perspective on the business suites. And, in terms of what -- relative to other providers that may be adjacent to us in the wholesale space, for example, focusing on connectivity, that, of course, is completely unsurprising to me given the economics of our business and the relative appeal of the economics of our business, vis-a-vis a more raw wholesale offering.

But, when you look at it, the real value, and in terms of the amount of time that it takes to build the global reach and scale and scope of network density that we have, is simply not something that happens quickly. So, there are ways that they might vis-a-vis their own offers relative to other wholesale players, be able to differentiate themselves and perhaps improve their win rate in an otherwise highly competitive environment. I think that it may help some of those players with that. But, I don't really view it as, in any way, a substitute for the level of performance in network density that Equinix can provide.

(multiple speakers) the rest of world, the way to think about the business suite question is that we will take the learnings that Charles and his team have executed in the North American market and apply a hybrid model outside of North America to focus on those types of opportunities. But again, they will be focused on magnetic ecosystem pullthrough-type deployments that have that pullthrough effect throughout the ecosystem and the interconnected business.

Thank you. And then just a real quick on Germany. If I understood the commentary, and some of the challenges there, that all will link to the legacy operations is not related to Ancotel?

That's correct. The core issues were with the sales execution, just in the verticals across the core market. The Ancotel business is doing fine. The asset continues to be a differentiate for us in Europe. We are tracking networks and content because of the network entity there. So, it's playing exactly into the ecosystem strategy, as we thought it would.

And then finally, Steve, I think during your prepared remarks, if I heard it right, you talked about public cloud adoption by SMBs being a bit slower, and I wonder if you can clarify what you meant by that, if I heard that correctly?

Yes, what we mean by that is we are seeing uptake in the hyper-cloud deployments as the public cloud players continue to deploy across Equinix. The biggest activity that we all read about, obviously, is behind AWS and the other small to medium business models out there. So, there's a lot of activity there. We're seeing some of it, some of it goes to the cloud at their location. But as enterprises mature, the type of workload they want to put in, to source into data centers like [co-lo] model, they are getting more and more sophisticated about understanding the hybrid model, how they can take advantage of connecting to the networks and the public cloud nodes in our data centers, and that is taking time.

Got it. Thank you.

[Frank Feldman] with Raymond James.

Great, thank you. With the lengthening of the contract periods, what implication does that have for your pricing power. In the past, you've had shorter contract lengths as you effectively could be raising pricing a little more quickly. Does this imply that things are getting more competitive or you are trying to lock in customers for longer periods? Any change in the pricing power in your model currently?

Yes, Frank, this is Charles. No. I would say, in fact, those multi-year deals, many of them, we really had very focused effort on long-term deals, particularly with our core strategic customers. And many of those continue to include [PI]s, annual PI's, which is consistent with the model and something, that people understand the reasons for that. And it's typically baked into those. Our overall pricing remains firm. We look at each of those renewals, and sometimes we do, for example, say we are willing to make some concessions to get even longer durability and term in the contract.

And we are willing to make those trade-offs as appropriate. No, I think that I definitely don't think there's been a shift in the pricing power, there. Our objective is just to make sure that we have a long-term, productive relationship with critical strategic customers that are not only fundamental to our business because of their inherent scale, but equally or more importantly, because they are central to our developing ecosystem.

Okay. Thank you. Are there any meaningful wholesale leases that you have currently on the cost side that are coming in? And what's your expectation for rent increases where you do have leased space relative to what it's been in the last couple of years?

Yes, Frank, we certainly have a number of leases. Obviously, we have almost 100 data centers around the world in different incarnations, as you can appreciate. So there's certainly some that will be forthcoming over the next few years. But there's no sea wave of renewals that are forthcoming. Our team, our real estate team, does a very good job of getting ahead of the negotiations, working with the landlord. And certainly, some of the ones we have done in the past, yes, there has been some level of increase that's anticipated, that we've anticipated certainly, that the landlords anticipated.

But that's just baked into our offering plan, and our operating model. It goes back, a little bit, to the comment that Charles made. There's an understanding of PI both from the customer side, when you look at it from our side, there's an expectation that there will be some level of PI in our lease arrangements and that's just a given. So, we continue to work very hard on renewing them. Again, recognizing our lease costs are a relatively small piece of our overall cost bucket. And recognizing most of our leases are on a very long-term lease arrangement with multiple renewal periods. We feel very good about, if you will, our lease position at this stage.

Okay, great. Thank you.

And our last question comes from Sterling Auty with JPMorgan.

Yes, thanks for squeezing me in. I just want to make sure I understand, in terms of the large deal dynamics that you are talking about, are we talking about a scarcity value in those large deals? Are we talking about a competitive dynamic within those types of deals? And then, separately, when you talk about the sales cycles on some of the enterprise stuff, is it because of budgeting, or because of their decision on which way they want to take their [compute] architecture?

Sure. Relative to the large deals, I would say we actually continue to see -- one of the great things about being the market leader, is you have visibility to the deal flow. And we tend to get visibility to virtually all the deal flow. So, there is still plenty of, and perhaps increasingly, an increasing amount of large deal opportunity out there. And, there are some of those where there is a particular requirement relative to performance, latency, global reach, et cetera, that we are still well positioned and will pursue those deals, and win them at win rates that we have become accustomed to. However, there's also a portion of the deal flow that, in part due to the competitive entity of the wholesale space, the market clearing prices dropping to a level that we simply view as unattractive.

I think that if you go back several years, you would say, okay, there were probably a portion of those because the premium, if you will, was smaller that we would have won. That I think now you are saying, we are unwilling to go to the price-point there, and are therefore not closing it. That's the general dynamic. And that's causing a slight shift towards our sweet spot in the small to midsize deals. But, that's generally these large deal dynamics. On the enterprise side, it is not really a budgetary issue. It is really more related to the fact that these customers are taking time to sort through what exactly hybrid architectures mean to them. And they are moving from trying to figure out how to get their infrastructure out of their own basements, and figuring out what portion of that goes to co-lo, what portion of that is well-positioned to move into a public cloud setting.

Perhaps due to the need for versatile workloads, and what does it mean to implement a hybrid cloud? Often times, as they come to grips with that, they realize that the network density that Equinix provides is a very compelling reason to center their hybrid cloud or infrastructure around Equinix. But, that is a nontrivial assessment on the part of an enterprise CIO, and anybody who's sold into the enterprise realizes that those sales cycles can be protracted, and they often start with smaller deal sizes. And that's really the dynamic that we're experiencing.

That concludes our Q2 call. Thank you for joining us today.

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