Equinix, Inc. (EQIX) Q2 2013 Earnings Report, Transcript and Summary

Good afternoon, and welcome to Equinix conference call. [Operator Instructions] Also, today's conference is being recorded. If anyone has any objections, please disconnect at this time. Now I'd like to turn the call over to Katrina Rymill, Vice President of 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'll 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 has no obligation and does not intend to update or comment 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 its financial guidance during the quarter unless it is done through an exclusive public disclosure. In addition, we'll 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 sell-side analysts. In the interest of wrapping this call up in an hour, we would like to ask these analysts to limit any follow-on questions to just one. At this time, I'll 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 offer, 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 and an acceleration of growth in the second half. However, based on current visibility, we're now moderating our guidance for the full year. And bridging to our revised outlook, there are 3 primary factors, 2 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 in currency headwinds from Q1, which we already absorbed into our full year guidance when we maintained our initial forecast for the year. Second, our revised guidance includes a $16 million noncash 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 2 years to 3 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 3 things: first, soft 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 would compromise our long-term returns, we are making disciplined decisions to drive profitable growth and 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 margins. Interconnection growth is trending favorably in all 3 regions, with particular strength in the Americas this quarter, where cross-connect adds increased by 48% over the 4-quarter average as our IBX optimization efforts begin to play out and our key ecosystems continue to mature. In addition to our traditional contribution from network-to-network interconnection, we're also seeing acceleration in ecosystem-driven interconnection, 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 subsegment 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 trading ecosystem remains healthy as key trading platforms and participants expand globally with Equinix. This quarter, cross connects 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 Options Exchange, Chicago Mercantile Exchange and NASDAQ NLX deploying in London. Also, the over-the-counter derivatives market goes -- 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 Telstra. In addition, we are working closely with our top network customers to enable new services such as Verizon extending its 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 center architectures, with expansions from 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 3 new expansions to support demand. In Japan, we announced plans to open our first data center in Osaka, an important new market in Japan's second largest economy. Osaka will provide a second access point to the Japanese market, which is critical to our global interconnect customers. In Australia, we have approved the third phase expansion of our Sydney 3 data center to support continued growth in our Sydney campus, the most network-dense in Australia. We're 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 Zürich in June, a standalone 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 5 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 5 of our critical objectives that we established for 2013 and beyond. First, regarding our interconnection strategy, our net cross connects 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's making steady progress against this objective, with particular strength in the U.K. 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 retention, thereby reducing our future MRR churn risk while also increasing our operating margin and return on invested capital. Second, our operating margins continued to improve, increasing the level of cash we generate from operations after adjusting for the REIT-related cash costs and taxes. We continue to see a path to adjusted EBITDA margins of 50%, and we'll continue to balance our growth and profitability as we scale our business. Third, we're making nice progress against some of our key strategic initiatives, including the planned REIT conversion, and other tax optimization strategies. These initiatives will decrease our overall global tax rate whilst increasing our discretionary free cash flow and AFFO, both prior to and after the REIT conversion on January 1 -- 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 customers that drive our ecosystems. For example, in North America, we lengthened new customer contracts from 1 to 2 years to 3 years or more, which we believe will 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 2- to 3-year period, and this now has been changed to a 4 -- up to a 4-year period, resulting in an estimated $16 million decrease in nonrecurring revenue that otherwise would have been recognized in 2013 and, of course, therefore, will be recognized in the outer years. Fifth, we continue to see progress in our IBX optimization efforts and saw a 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 media and 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 were still slightly shy of our prior expectations. Based on this, together with the impact of the change in accounting estimate and weaker operating currencies, we're 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 2 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 from our presentation posted today. Global Q2 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. When adjusted for the change in accounting estimate and changing FX rates, revenues were above the midpoint of our guidance range at $532.4 million on 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 recurring 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 flows 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 below our expectation due to lower project costs related to the strategic initiatives and a smaller-than-expected advertising and promotion spend. Cash 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, lower-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 have 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 summarize 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 our 2013 estimated cash tax liability to 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 a successful conversion to a REIT and no material changes to the tax rules and regulations, we expect our effective long-term worldwide tax rate to ultimately decrease to a range of 10% to 15%, consistent with our expectation that approximately 50% of our revenues will be generated outside of the U.S. 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, and excluding the change in accounting estimate, a 2% increase over the prior quarter and up 10% over the same quarter last year. Cash flows 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 remained at very attractive levels. Interconnection revenues, as a percent of the region's recurring revenues, increased to new all-time high, including 1,600 net new cross 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 year. 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 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-40s 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 U.K. business continues to perform very well, with strength in the financial services, content and cloud verticals. However, the favorable U.K. 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 Q2 performance gap as they enter the 2014 operating year. Our Dutch expansion, 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 media and 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 on the prior earnings call, that 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, lower than the prior quarter due to MRR churn and the change in accounting estimate and weakening operating currency. On a normalizing constant currency basis, Asia-Pacific adjusted EBITDA decreased 7% quarter-over-quarter. MRR cabinet remained 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 from 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 2.8x our Q2 annualized adjusted EBITDA, a decrease compared to prior quarter due to the redemption of our $750 million 2018 senior notes. Now looking at Slide 12. Our Q2 operating cash flow increased substantially over the prior quarter's $147.2 million, primarily due to shifts in our working capital balances, including lower cash interest payments. Our DSOs 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 of $57 million. Absent these costs, our operating cash flow would have been $204 million, a significant increase over the prior quarter. As for 2013, we expect our adjusted discretionary free cash flow, excluding any REIT-related cash 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 capital -- for the quarter, capital expenditures were $122.9 million, below our expectation 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 them in 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 predicted and preventive maintenance programs. Overall, our maintenance capital was approximately 2% of our revenues, consistent with our expectation, but there should be no meaningful reinvestment requirement in our IBXs. Finally, turning to Slide 15. The operating performance of our 24 North America IBX and expansion projects that have been open for more than 1 year continue to perform well. Currently, these projects are 82% utilized and generate 35% cash-on-cash return on the gross PP&E invested. Our 8 old U.S. 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 and include a negative foreign currency headwind of $4 million versus our prior guidance rates. Q3 guidance includes a $6 million decrease to 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 noncash 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 an 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 in 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 we'll execute with discipline while balancing top and bottom line growth. We are winning the right deals that 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.

Our first question comes from Jonathan Schildkraut with Evercore Partners.

I guess 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. Maybe where the headcount is and what's going on with productivity. And then maybe if you can relay that kind of productivity commentary relative to the bookings activity in the quarter.

[indiscernible] So yes, we are continuing to ramp force. I think we are planning to add some initial heads in the second half of the year. I think 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 underperformers out, and we're trying to sort of keep a buffer in the system so that we can continue to do that and try to ramp the productivity. As Steve commented in the script, there are a couple of factors that are impacting productivity a bit. I think 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, when you close those, they can spike averages. So averages were down a bit. But again, I think there's a general optimism that we're catching our -- we've got a lot of traction, we've got 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're short of our targets, I think 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 at our more mature verticals. And we're seeing deals slip as decision cycles are protracted. And they're more -- it's less losing deals as it is deals slipping into a subsequent quarter. And in terms of enterprise, I think it's really a drive to opportunity in many respects, but they're really the -- the enterprise are 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're seeing a pretty irreversible trend towards hybrid cloud architectures, but it's just taking some time for that to shake out. And so our guidance really reflects a pragmatic view of the 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 there's -- we're making good traction as we are definitely seeing bookings continue to increase from an overall trend line perspective, particularly in sort of small to midsize sweet spot for our business and consistent with our strategy.

Our next question comes from Mike Rollins with Citi Investment Research.

I was wondering if you could talk about 2 things, the first on, I believe it's Slide 15. It talks about how the older IBXs have slowed down 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, just 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 then to take that size of the funnel and convert it was the issue?

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

Sure. Mike, let me take the back half of the question, and then I'll give it back to Keith to take the first part. I think the direct answer to the question in terms of what happens, one is, 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 I think that's actually a fairly consistent theme across the verticals. But it's not -- that funnel is not converting at the same rate, and we're seeing deals -- I'm sorry, deal cycles, sales cycles a bit more protracted. 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've talked about a lot in previous calls, we manage the business to a certain deal mix range that we believe is going to provide us with solid growth and deliver blended returns that fit the business model. As we review the results for Q2, we saw it really was a shift towards the smaller deal sizes consistent with our ecosystem strategy. We're still seeing and winning some portion of our large deal flow, particularly for certain applications or magnet-type customers. But there's no doubt that 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's sake, we're really maintaining the deal discipline, stay 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 a large deal 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 we -- one drops out because we determine it's not consistent with our model, then it can take 10 or 15 smaller deals to deliver that same set of bookings. And 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 that's disciplined in execution is really driving the solid revenue per cap, strong new deal pricing and help the interconnection, all of which are evident in our Q2 results.

And on the middle part of that question -- Keith, you could take the last piece of that on Slide 15. Mike, on the German situation, first of all, the overall business in Europe is continuing 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 were 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 were 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 Börse failed merger. I think that stymied the market from connecting into the activity we have in Frankfurt. So those are kind of the factors that affected the German market.

And Mike, the deal with -- the first question on the oldest assets growing 4% quarter-over-quarter -- sorry, year-over-year, I think it's important to note, number one, a lot of these assets are reaching sort of a critical level of occupancy. And so number one, a lot of that growth does come from pricing to the extent that there's some level of optimization in those older assets. It does come from new products there, some more cross connects. But one thing that I don't want to be lost on the people listening on our call here is some of these assets are highly valuable to us. And we'd rather let those assets like in LA1 -- we'd rather maintain and cordon off some of that space for our 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're being disciplined about filling up those assets. Going forward, I think it's reasonable to expect a 3% to 5% year-over-year increase, and that's sort of how I think about those assets.

Our next question comes from Brett Feldman with Deutsche Bank.

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 we had expected. But when I dig into the nonfinancial 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 sort of flat. It didn't grow even though we've seen some more interconnection. And so I was hoping maybe you could just 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. Yes, I think the key thing to remember is that the -- it takes time generally when we're -- when you -- as we do some of these optimizations and customers are moving to multi-tier architectures, for example, then when you replace that revenue inherently, implementations mature over time and the yield per cabinet come back and sort of mature along a normal path. And so I think what you see is -- I actually am quite satisfied that we see -- and we've always talked about that the cabinets billing is a fairly timing of customer installations, assuming a big cab adds in Q1. It's just a more erratic number. And I think that as we look at this quarter, I'm comfortable with where it's at. I'm very pleased to see that we're keeping the yield per cabinet strong and very much towards the high end of what we've talked about in the past. And again, I think it's just a matter -- and if you look at interconnect, what we're seeing now is, I think, both a waning of the network consolidation activity that was providing pressure there and the effects of the optimization where, typically, we're trying to optimize out less interconnected business, replace that with small to midsize deals that we will later going to ramp up from an interconnection perspective. So as I look at the nonoperating 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 strategies. So again, I think that's just us -- really a matter of us doing the right thing, continuing to have the deal disciplined, and I think it will take shape in the metrics over time.

So just to follow up on that. We sort of drive our models here, and I'm trying to think about the growth variables in the North American region. Or should we be increasingly, for example, be putting more weight on, say, adoption of interconnections as the reason why you grow revenues, say, versus cabinet additions? I just want to true 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 and our sweet spot are -- in fact, our bookings are growing nicely. I think there is this pressure created from us needing to perhaps replace some large deal volume with a larger number of smaller cabinet deals. And I think that's one of the reasons why as we continue to ramp up on that. But it's growing. We're definitely selling new cabinets in addition to hopefully growing the interconnection. So I definitely wouldn't see a change in that trajectory. Again, it is going to be a little bit lumpy, but I think we're going to continue to do both of those things.

Our next question comes from David Barden with Bank of America.

So Keith, I guess I want to ask the usual question. I'm trying to figure out the guidance. So if I just ignore the currencies and I ignore the accounting changes, the EBITDA -- the revenue this quarter was $532.4 million and the EBITDA was $250.8 million. So you had $13 million of sequential revenue growth, and you had $8 million of sequential EBITDA growth. If I look at the third quarter guidance, we're looking at $550 million of revenue, which is an $18 million revenue increase, and we're 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 where you've had anything like that. So I'm trying to understand kind of 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 kind of just 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 gives you some color as to where the working group stands and what's next in this process and when.

Sure. Thanks for the questions, David. I think first and foremost, you sort of hit the nail on the head. And so what I will really 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 say greater than $2.2 billion. As you're aware, there's $34 million of currency and a $16 million accounting adjustment. That's a $50 million, if you will, noncontrollable movement, if you will, in our revenue line. That takes you to 21 50. We're guiding a midpoint 21 40. And the reason we're 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, "Look, 15.5% revenue growth. Now let me look at EBITDA. What's going on there?" Well, we told you we could do 10 10. And so as you're aware, doing 10 10, if you take out the $16 million again from the accounting adjustment and you do -- and the $14 million, if you will, attributed to currency, that's $30 million. We're guiding you to 90 90 at the top end of our guidance range. If you add back those 2 items alone, you get to 10 20 And so the real shift that you're seeing here is we also told you we're 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're looking at 10 46. That's sort of 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 midpoint, we're going to do about $238 million. There's $2 million of incremental currency head, as we said. So that's $240 million. As you know, revenues are going to go up roughly $14 million on an FX basis, so $14 million up. But we should deliver, if you see that drop-down to the EBITDA line, roughly $254 million. So what's causing the backstep? Well, number one, next quarter, as we said in our prepared remarks, there's going to be $11 million of professional fees going through Q3's numbers. The amount of energy and the amount of consultants and contractors inside our building today to take the company, move it towards the REIT is substantial. And 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 benefits are going to go up, $6 million. Thirdly, as you know, Q3 is always our higher utility quarter. We're going to spend more on utility, just like pricing of $4 million. And then there's a small adjustment benefit to us of $2 million. So bottom line, you basically -- all of that benefit you're going to get is going to roll basically to professional fees and this, if you will, this pricing environment. But by the time you get to Q4, you're going to get -- you're effectively going to get all of that back. And so when I adjust all the numbers and I say, "Okay, if you look at -- if you take out the currency, if you take out the accounting change, how is the business going to perform," you're almost at 48% EBIT margin, absent those REIT-related cash -- those cash costs at $26 million. And that tells you exactly what Charles said and what Keith alluded. The overall performance of the business, we're 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. And so that sort of reconciles you to the key differences that I think you've alluded to. REIT, next steps, again, certainly, we're spending a lot as it relates to our advisors. There's nothing that we can -- there's nothing I can tell you because I don't know anything, nor does the team know anything, regarding the working group. And so from our perspective, we're going to continue to march down the road to deliver on our REIT conversion by 1/1/15. And again, a testament, they're evidenced by, if you will, the level of spend and effort going on in this company towards not only the REIT conversion but all of the other global tax work we're doing, we're wholly comfortable that we'll convert it as planned on 1/1/15.

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

Well, David, we certainly think we're 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. Clearly, we are working on it as you can appreciate, we're looking at our peer group. We're certainly looking at AMT, and we're looking at the Navy definition. Only when we get, if you will, the green light from the IRS do I think we'll 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 the discretionary free cash flow, we continue to believe that's a really good surrogate right now. And overall, as some have written, 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're moving down the road, but we're not yet there -- we're not there yet to define what the AFFO metric will be. We use this more as just an interpretation. If 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.

Our next question comes from Jonathan Atkin with RBC Capital Markets.

I was wondering, given what you said about average deal size and also the price competition you're seeing per deals in larger end of the spectrum, can you put that in the context of your business suite software? And is that something that you're 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 leads to focus more on connectivity-type services.

Sure, yes. This is Charles. Let me respond to both of those. I think that -- again, business suites, as we've talked about, is something that we're 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've said, some customers, as they move to a multi-tiered architecture, depending on the size and the performance characteristics of those things, do consider a range of options. And many of them, if they're extraordinarily large in size, go to a wholesale alternative as that sort of third tier in their architecture. Many, however, depending on, again, the size and performance characteristics and their desire to have a single source provider of very often, Equinix, they are saying, "We would like you to be able to provide us with a solution, a more economic solution for a large footprint." And so business suites has been that for us. We've seen and continue to see strong funnel. We're 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 underway 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 perspective on the business suites. And in terms of what the -- relative to other providers that may be adjacent to us in the wholesale phase, 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-à-vis a more raw wholesale offering. But I think when you look at it, the real value, and in terms of the amount of time that it takes to build a global reach and scale and scope of network density that we have, is simply not something that happens quickly. And so I think there are ways that they might, vis-à-vis their own offers relative to other wholesale players, be able to differentiate themselves and 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 [indiscernible].

Jonathan, I'd add on the rest of world, the way to think about the business suite question is that we'll take the learning 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'll be focused on magnetic ecosystem pull-through-type deployments that have pull-through effects throughout the ecosystem and the interconnection business.

And then just real quick. On Germany, if I understood the commentary and some of the challenges there, that all relate to the legacy operations, it's 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 differentiating force in Europe. We're attracting networks and content because of the network density 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 or if I heard that correctly.

Yes. I think what we mean by that is we're seeing uptick in the hybrid cloud deployment as the public cloud players continue to deploy across Equinix. And 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 I think as enterprises mature, the type of workload they want to put in to source and to data centers like colo models, they're 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's taking time.

Our next question comes from Frank Louthan with Raymond James. Frank G. Louthan - Raymond James & Associates, Inc., Research Division: With the lengthening of the contract periods, what sort of implication does that have sort of for your pricing power? I mean, in the past, if you'd had shorter contract lengths to see if it effectively could be raising pricing a little more quickly, does this imply that things are getting more competitive or you're trying to lock in customers for longer periods? Any change in the pricing power in your model currently?

Frank, this is Charles. No, I would say, in fact, those multi-year deals, many of them, we really had a very focused effort on sort of long-term renewals, particularly with our core strategic customers. And many of those continue to include PIs, annual PIs, which is consistent with the model and something that, I think, people have -- they understand the reasons for that, and it's typically baked into those. So no, there is -- our overall pricing remains firm. I think we look at each of those renewals. And sometimes we do, for example, say we're willing to make some concessions to get even longer durability and term in the contract, and we're willing to make those trade-offs as appropriate. But 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're central to our developing ecosystem. Frank G. Louthan - Raymond James & Associates, Inc., Research Division: Okay. And are there any meaningful wholesale leases that you have currently on the cost side that are coming in? What's your expectation for rent increases where you do have leased space relative to what it's been the last couple of years?

Yes, Frank. Certainly, we have a number of leases. Obviously, we have almost 100 data centers around the world in different sort of -- in different incarnations, as you can appreciate. So there's certainly some that will be forthcoming over the next few years. There's no sort of sea wave of renewals that are forthcoming, and 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's been some level of increase that's anticipated, that we've anticipated and, certainly, the landlords anticipated. But that's just baked into our operating plan and our operating model. It goes back a little bit to the comment that Charles made. There's an understanding of PI growth from the customer side. But when you look at it from our side, there's an expectation that there'll be some level of PI in our lease arrangement, and that's just a given. So we continue to work very hard in renewing them. Again, recognizing our lease costs are a relatively a small piece of our overall cost bucket and recognizing most of our leases are on a very long-term lease arrangement with multiple renewal period, we feel very good about, if you will, lease position at this stage.

And our last question comes from Sterling Auty with JPMorgan. Sterling P. Auty - JP Morgan Chase & Co, Research Division: I just want to make sure I understand. In terms of the large deal dynamics that you're 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 decisions on which way they want to take their compute architecture?

Sure. So I think 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 of the deal flow. And so -- and 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 rates that we have become accustomed to. However, I think there is also a portion of the deal flow that is in part due to the competitive intensity of the wholesale space and market clearing prices dropping to a level that we simply view as unattractive. And 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 one that I think now you're saying we're unwilling to go to the price points there and are therefore not closing this." So I think that's the general dynamic. It's slightly -- and that's causing a slight shift towards our sort of 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 colo, what portion of that is well-positioned to move into a public cloud setting, perhaps due to the need for reversible workloads, and what does it mean to implement a hybrid cloud. And oftentimes, as they come to grips with that, they realize that the network density that Equinix provides is a very compelling reason to sort of center their hybrid cloud infrastructure around Equinix. But that is a nontrivial sort of assessment on the part of an enterprise CIO. And anybody who's holding an 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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