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Equinix (NASDAQ:EQIX)

Q2 2011 Earnings Call

July 27, 2011 5:30 pm ET

Executives

Jarrett Appleby - Chief Marketing Officer

Stephen Smith - Chief Executive Officer, President, Director and Member of Stock Award Committee

Jason Starr -

Keith Taylor - Chief Financial Officer and Principal Accounting Officer

Analysts

Christopher Larsen - Piper Jaffray Companies

Colby Synesael - Cowen and Company, LLC

Gray Powell - Wells Fargo Securities, LLC

Chad Bartley - Pacific Crest Securities, Inc.

Simon Flannery - Morgan Stanley

Michael Rollins - Citigroup Inc

David Barden

Frank Louthan - Raymond James & Associates, Inc.

Operator

Good afternoon, and welcome to Equinix Conference Call. [Operator Instructions] Also, today's conference is being recorded. If you have any objections, please disconnect at this time.

I'd like to turn the call over to Mr. Jason Starr, Equinix Senior Director of Investor Relations. Sir, you may begin.

Jason Starr

Good afternoon, and welcome to today's conference call. Before we get started, I would 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 as identified in our filings with the SEC, including our Form 10-K filed on February 25, 2011, and Form 10-Q filed on April 29, 2011.

Equinix assumes 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 the financial guidance during the quarter, unless it's done through an exquisite 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 would also like to remind you that we post important information about Equinix on our 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 Jarrett Appleby, Chief Marketing Officer. Katrina Rymill is out this quarter on maternal leave and will return next call. Following our prepared remarks, we'll be taking questions from sell-side analysts. In the interest of wrapping this call within one hour, we'd like to ask these analysts to limit any follow-on question to just one.

At this time, I'll turn the call over to Steve.

Stephen Smith

Thank you, Jason. Good afternoon, and welcome to our second quarter earnings call. I'm pleased to report that Equinix delivered strong financial results in Q2, driven by strong global demand with a good mix of opportunity across all of our industry verticals.

Revenue was $394.9 million, which included $11.7 million from our controlling interest in ALOG in Brazil, up 9% quarter-over-quarter and 33% over the same quarter last year. Adjusted EBITDA was $181.3 million for the quarter, or a 46% adjusted EBITDA margin, above our expectations. This result also included $3.1 million in adjusted EBITDA from ALOG.

Net income was $30.7 million for the quarter, up from a net loss of $2.3 million in the prior year. Equinix's business and the current market opportunity remain strong, and we feel that we are extremely well positioned to achieve our objectives for 2011 and beyond.

The strength of our model is attributed to several important market and business trends. We continue to find ourselves well positioned at the intersection of mobile, video, IP and cloud growth. Our go-to-market strategy around ecosystems is a strong driver of our growth as evidenced by the approximately 90,000 cross-connects deployed globally.

Platform Equinix continues to deliver significant value to customers operating worldwide. CIOs are increasingly locating critical infrastructure closer to their end users, deploying a decentralized architecture across multiple markets to achieve better application performance while reducing their operating costs.

Our global footprint gives us the opportunity to serve these needs and is a key competitive advantage for Equinix. More than 73% of our recurring revenues comes from customers deployed in multiple markets and more than 54% from customers deployed in multiple regions. We have seen this accelerate over the past several quarters.

As global demand for our services grow, we are experiencing record quarterly bookings, while pricing remains stable as reflected in our increased Monthly Recurring Revenue per cabinet. Meanwhile, churn has decreased on a global basis. This is all underpinned by the strength of our global operations as evidenced by our near 100% operational availability.

Careful fill rate analysis and our just-in-time approach to expanding Platform Equinix has resulted in a very efficient use of our capital. We'll touch on this more later, but suffice it to say, all of these factors give us great confidence that we will continue to achieve our targeted returns.

Before I turn it over to Keith, a couple of quick updates. First, you probably saw that we had a very successful financing event this month, raising $750 million in high-yield debt at attractive terms. This opportunistic transaction demonstrates the strength of our position and provides the company with added strategic and operational flexibility.

We expect to use a portion of the proceeds from this offering to repay our 2012 convertible debt, which avoids equity dilution of 2.2 million shares. The remaining use of proceeds may include continued investment in expansion projects or strategic and organic activity such as bolt-on acquisitions. Any remaining proceeds will be held on the balance sheet.

As you may have seen in our release today, we are excited to announce our 10th IBX in the D.C. metro area, which is available for preordering and should open in the first quarter of 2012. This will be a specialized retail offering to meet the needs of customers who want all or most of their infrastructure requirements met by a single strategic partner. Digital Realty is collaborating with Equinix to build this IBX facility based on a customized set of Equinix specifications. The DC10 facility will be very similar to our business services suites that we have built in Asia and Europe and complementary to our current offering.

We also announced the availability of our business continuity services in Milan, Italy, to address existing customer demand in this new market. This service is already available in Frankfurt, Düsseldorf, Hong Kong, Munich and New York.

Now I'd like to turn it over to Keith to review the financials.

Keith Taylor

Great. Thanks, Steve, and good afternoon to everyone on the call. I'm pleased to provide you with a review of our second quarter results, including an update of our regional performance. Where appropriate, I'll highlight the impact of the ALOG acquisition, which effective April 25, was wholly consolidated into our financial results. This is effectively our stub period. Other than financial results, all other metrics today will exclude the impact of ALOG.

So starting with Slide 4 from our presentation posted today. Our financial results for Q2 exceeded our expectations across each of our key financial metrics. Global Q2 revenues were $394.9 million, including approximately $11.7 million of revenues attributed to ALOG, a 9% quarter-over-quarter and up 33% over the same quarter last year. Q2 revenue were normalized with the ALOG acquisition and Q1 one-offs grew 7% over the prior quarter, above the top end of our guidance range.

Similar to prior quarters, foreign currencies were again volatile and impacted revenue with a benefit of $5 million when compared to the average rates used in Q1 and a $500,000 benefit when compared to our FX guidance range. Our backlog continues to be healthy. On a regional basis, each of our operating units performed better than expected, with particular strength in the Americas.

Banking [ph] remains firm across each of our markets. Our global MRR churn, including Switch and Data but excluding ALOG, approximated 1.6%, a strong improvement over the past 4 quarters. Global MRR churn should continue to remain at or below our 2% per quarter for the rest of the year. As a reminder, from our Q4 call, we define MRR churn as a reduction in MRR attributed to customer termination agreements and net pricing actions in the quarter, divided by the total MRR at the beginning of the quarter.

Global cash gross profit was $257.3 million for the quarter, or cash gross margins of 65%. With a strong quarter, we're on target for our cash gross profit to surpass the $1 billion level for this year. Excluding the impact of ALOG, our cash gross margins would have been 66%. During the quarter, we benefited from lower-than-expected repairs and maintenance expense, lower-than-planned utility costs as well as lower-than-planned salaries and benefits expense.

Global cash SG&A expenses were on target at $76 million for the quarter. As we look forward to Q3, we expect to feel the full quarterly impact of the recent headcount investment in our sales and marketing organization as well as higher seasonal utility prices.

Global adjusted EBITDA was $181.3 million for the quarter, including about $3.1 million of adjusted EBITDA attributed to the ALOG assets. Our adjusted EBITDA margin was 46% or 47% when excluding the impact of ALOG on the quarterly results. This was better than expected -- our expectations and included only a modest FX benefit of $200,000 in the quarter when compared to our guidance range.

On a sequential basis, adjusted EBITDA experienced a favorable FX benefit of $2.1 million. Our global net income was $30.7 million or $0.64 per share on a diluted basis, which included a higher share count related to the current treatment of our 3% convertible debentures due in 2014, as these shares attributed to this debt are no longer considered antidilutive to our EPS calculation.

And to be clear, this is an accounting determination and does not reflect our intent one way or the other on how we plan to settle this obligation in 2014. Our 2012 and 2016 convertibles are still considered to be antidilutive and therefore, the shares attributed to these instruments are not included in our diluted share count.

Finally, looking forward, the U.S. dollar exchange rates used for our Q3 and Q4 guidance are $1.42 to the euro, $1.61 to the pound, SGD $1.22 to the U.S. dollar. Our updated global revenue breakdown by currency for the euro and pound is 14% and 8%, respectively. And the Singapore dollar represents about 6% of our global revenues.

Now I'd like to review the regional results in the quarter, including a bit of color on our nonfinancial metrics. So please turn to Slide 5.

Americas revenues, including $11.7 million of ALOG revenues, grew 9% quarter-over-quarter to $253.9 million. Cash gross margins dropped to 68%, down over the prior quarter, primarily the result of the ALOG acquisition. Adjusted EBITDA was $122.5 million, including $3.1 million of adjusted EBITDA attributed to ALOG, a quarter-over-quarter increase of 8%, driven by strong revenues and more than expected SG&A spending in the quarter.

Our Americas sales hiring plan progress well in the quarter and for all intents and purposes, is complete. We expect to incur the full expense impact of the sales hiring plan by the end of this quarter.

Americas net billing count has increased by approximately 500 in the quarter, lower than the prior quarter primarily due to timing of cabinet installations. We expect the net cabinets billing to increase in Q3 as our level of preassigned cabinets increased by 17% at the end of Q2 relative to the prior quarter. This expectation is reflected in our Q3 guidance issued today.

Our Q2 bookings increased over the prior quarter consistent with our expectations, and we expect our booking activity to increase throughout the rest of the year. As noted previously, a portion of the booking activity remains in backlog and will be converted into revenues over the next few quarters. Equally important, our pricing remains firm in the Americas and within our targeted average range, though it does vary by market.

During the quarter, our Americas cross-connect increased by over 2,000, our strongest regional result ever, and interconnection services remained at 20% of our recurring revenues. Our financial vertical experienced meaningful growth in the quarter, a reflection of the strength of our financial ecosystems, particularly in Chicago, New York and our Toronto market.

Looking at EMEA, please turn to Slide 6. EMEA had a strong quarter, with revenues up 8% sequentially or 4% on a constant currency basis. As a reminder, EMEA Q1 revenues included a $1.8 million customer termination fee. Therefore, normalized EMEA revenue was actually up 6% on a constant currency basis.

Adjusted EBITDA increased to $34.8 million or an increased EBITDA margin of 39%, a 14% improvement over the prior quarter. EMEA region's net billing count has increased by about 620, reflecting strong bookings performance across many of our markets and verticals. EMEA's average price per sellable cabinet equivalent increased $1,232, a 6% improvement quarter-over-quarter driven by strong interconnection activity as well as stronger operating currencies relative to the U.S. dollar.

The EMEA region continues to win key strategic customer deployments over many of our markets and our verticals. Interconnection revenues increased 14% quarter-over-quarter and remained at 4% of the region's recurring revenue. We added over 990 cross-connects in the quarter, a healthy improvement over the last quarter. We remain very pleased with the level of interconnection and exchange port activity in this region.

And now looking at Asia-Pacific, please refer to Slide 7. In Asia-Pacific, revenues improved 8% sequentially and 5% on a constant currency basis. Adjusted EBITDA was $24 million, a slight increase over the prior quarter, reflecting strong revenue growth but offset by higher SG&A cost in the quarter. This was partly due to an increase in headcount and partly due to higher training costs associated with the scaling of our sales organization.

Cabinets billing increased by 690 over the prior quarter and overall, unit pricing remains steady. MRR per cabinet increased 2% over the quarter compared to prior quarter and up 17% year-over-year, largely due to increase in interconnection revenues and favorable currency trend. Interconnection revenues in the region increased 9% quarter-over-quarter and represented 12% of recurring revenues. During the quarter, Asia-Pacific added 670 cross-connects.

Now looking at the balance sheet data, refer to Slide 8. Our unrestricted cash and investment balance approximates $423 million, a decrease over the prior quarter largely due to cash used to fund the acquisition of ALOG and our construction projects. Our DSO remains low at 33 days, a slight increase over the prior quarter due to timing of certain customer payments.

Also, higher balance sheet exchange rates relative to the U.S. dollar increased the value of many of our non-U.S. dollar denominated assets. We've recorded a year-to-date $71 million benefit into our shareholders' equity section on the balance sheet.

Looking at the liability side of the balance sheet, our quarter-end gross debt approximates $2.3 billion, or pro forma debt of about $3.1 billion when you take into consideration the high-yield debt raised in early July. Our Q2 net debt leverage ratio was approximately 2.5x our Q2 annualized adjusted EBITDA. Looking forward, we expect our annual cash interest expense to approximate $170 million.

As Steve mentioned, the completion of the high-yield financing provides the company with additional strategic and operational flexibility. As we set out to best allocate our capital, our clear priority is to continue to invest in profitable growth, whether be through organic or inorganic means, with an overriding objective of creating shareholder value.

Finally, as part of our accounting for the ALOG acquisition, you'll note a new balance sheet item reported between the liability and equity sections of our balance sheet referred to as redeemable noncontrolling interest. Effectively, given that we've only consolidated the ALOG business into our books, this account represents the liability for the portion of the ALOG asset that we do not own.

Moving on to Slide 9. The cash flow attributes of the business continue to be strong and track nicely to our adjusted EBITDA metric. This quarter, our operating cash flow increased to greater than $140 million, a 19% quarterly improvement, partly due to stronger operating results as well as more cash interest cost in the quarter.

Our Q2 discretionary free cash flow was approximately $112 million, a 26% increase over the prior quarter and better than expected. We expect our 2011 discretionary free cash flow to now range between $420 million and $440 million.

And finally, looking at Slide 10. For the quarter, our Q2 capital expenditures was $188.9 million. Also, we invested $9 million for the purchase of our Frankfurt 3 land, building and equipment asset, a distressed asset investment that we believe will provide a strong future return for the German business.

Our Q2 expansion capital expenditures were below our guidance expectations, primarily due to the timing of vendor payments. Ongoing capital expenditures were consistent with our expectations at $28 million.

And I'm now going to turn the call back to Steve.

Stephen Smith

Thanks a lot, Keith. As outlined last quarter, we are seeing increased demand from our new ecosystems, including both cloud and mobility. Two of our more established ecosystems, network and financial services, are also driving significant upside for Equinix. I'd like to dive deeper into the fundamentals of these 2 segments.

At the heart of our business model, as depicted on Slide 11, is the access to a wide variety of network service providers in our IBX data centers. The original network ecosystem started with traffic exchanges built around Internet peering and carrier connectivity points. Today, although this business model still exists, our network customers also view Equinix IBX as revenue centers because they are very attractive place to sell and scale their services to customers within our IBX marketplace.

We now have more than 675 network service providers deployed in our IBXs around the world. This provides our more than 4,000 customers a tremendous choice and flexibility when purchasing network services. We believe this marketplace is a multi-billion market opportunity for network service providers today, which makes these customers a very sticky part of our broader ecosystems. Our increased investment in sales and greater focus on the network ecosystem are paying off as we go deeper into the needs of our more strategic customer base, as depicted on Slide 12.

Over the past several quarters, we have seen carriers transition from leveraging Equinix primarily as an IP peering point to establishing next-generation telecom hubs in order to meet the increasingly more sophisticated demands of digital businesses. Also, as legacy voice, transmission and IP equipment located in central offices is upgraded, much of this next generation of technology is being consolidated and deployed at Equinix sites.

In addition to locating their own infrastructure and exchange traffic inside of Equinix, the carriers are also selling new services such as managed and cloud services, which require a larger footprint. As an example, to offer Infrastructure-as-a-Service, the carriers need additional data center space and multiple interconnections often across many markets, similar to what is required by pure play cloud providers.

Slide 13 depicts the increase we've seen in the scale of Platform Equinix since Q1 2010. Over the last year, global revenue for the network vertical has increased by 23%, with growth nearly 40% in Asia and Europe. Our Q2 network bookings doubled, primarily due to technology refresh cycles, wireless growth and explosive video demand. Equinix is the one provider who can satisfy the location, the power, the network density and the growth capacity to successfully deploy next-generation network services across multiple markets and regions.

In fact, each of our 3 largest network customers are deployed in at least 50 of our IBXs. Despite the maturity of our network vertical, we see a great deal of growth potential in this ecosystem, with our team adding approximately 25 new network customers per quarter.

The 4 other verticals that we support today -- financial, cloud and IT services, digital media and content and enterprise -- leverage this dense carrier connectivity and also take advantage of each other's presence by interconnecting within Platform Equinix. A good example of this is in the financial services vertical, where we host a number of exchanges, asset managers, broker-dealers and technology service providers, shown on Slide 14.

Electronic trading firms come to our sites for the network density, low latency and proximity to our rich financial ecosystem, where they can interconnect with unlimited bandwidth in a very timely and cost-efficient manner. This continues to be a high-growth opportunity for Equinix.

The key measure of the growth in electronic trading is peak message per second rate, now 5.1 million messages per second in the U.S., as shown on Slide 15. This is nearly twice the volume that occurred during the flash crash in May of 2010, which at the time, was an unprecedented number.

Today, financial services firms are adding significant infrastructure to support this increase in volume and ensure they have the capacity and throughput to absorb future market events, which does drive additional cross-connects.

On Slide 16, which illustrates how financial services companies are drawn to our dense interconnection points to connect with vendors, counterparties and customers, they heavily utilize our network customers to interconnect their infrastructure in key global markets, such as Frankfurt, Hong Kong, London and New York. We're also seeing incremental interconnection activity of financial firms linked to cloud service providers and digital media companies in addition to the networks.

This incremental interconnection grew 67% year-over-year. All of our ecosystems have a strong dependence on the critical mass of networks that we've assembled since our inception, and it's exciting to see this interdependence begin to take place between other ecosystems.

The value that these customers extract from our IBX environment is rooted in the benefits gained by being in close proximity to one another, enabled by our innovative business in traffic exchange. This reinforces the value of Platform Equinix and is a key reason for the strength in our pricing and returns, which is in stark contrast to the value proposition offered by wholesale or a non-neutral data center provider. Our core strategy is to deepen and expand our ecosystems to facilitate more electronic trading, IP and Ethernet traffic and ultimately, help accelerate the commercial growth of cloud, digital media and the mobile traffic explosion.

Now I'd like to update you on how this translates into our thinking about capital allocation and why we expect to be able to sustain our return objectives over time. As a reminder, we target 10-year IRRs of 30% to 40% on a pretax basis when we approve any of our expansion projects. Let me begin with a quick update of our same IBX performance on Slide 17.

As previously presented, this chart breaks out our revenues, cash profits and returns for IBXs in North America that have been opened for at least a year and demonstrates our success to date. This chart also provides a solid proof point of the attractive unit economics of our expansion, which highlights that for every $2 of expansion CapEx invested, we will generate about $1 of revenue and this dollar revenue will generate greater than 65% cash gross margins at capacity.

Next, I'd like to walk you through the 3 recently announced data center builds to illustrate how we make expansion decisions across each of our regions. Let me first begin with New York 5. Prior to approving our New York 5 build, we compare the fill rates and pricing at New York 4 to our original business plan from 2006. We evaluated our pipeline, the current pricing environment and input from customers on their expected growth plans in the market.

On Slide 18, you'll see Q2 performance for the New York 4 asset, which outlines revenue, cash profit, cash on cash returns and utilization in a similar fashion to the same IBX view. And at 80% utilization, there's still plenty of headroom for growth and incremental returns from this asset. These results, which validated our original assumptions, also show we were ahead of our profit and return targets and has validated our decision to build New York 5.

Despite the success in New York 4, we continue to apply significant discipline on our capital allocation plans by designing and building in multiple phases. We expect to build the New York 5 data center in 6 phases. This approach derisks expansion projects and enables a just-in-time delivery of capacity.

We turn to Slide 19, and let's look at the second example. We originally entered the Amsterdam market in 2008 through the acquisition of Virtu. This is a great example of Equinix moving quickly into a new market by acquiring an existing asset to extend our platform into a key growth area. Following the acquisition, we completed an in-progress expansion, which ultimately became our Amsterdam 1 IBX.

Moving to Amsterdam has proven to be a great decision as we quickly achieve high utilization levels by attracting a diverse customer base across all 5 of our industry verticals. This led to decisions to build out Amsterdam 2 and Amsterdam 3, where we apply the same discipline of a thorough analysis of fill rates and targeted returns as depicted on this slide.

One final example comes from Sydney, which is a market that has had strong GDP growth and good network density but was relatively supply-constrained. We originally entered the Sydney market in 2002 to the acquisition of Pihana Pacific, which included our Sydney 1 IBX. Similar to other markets, this was the initial site for what has now become our Sydney campus.

In Q1 of 2009, we opened our Sydney 2 IBX, which was 90% sold within the first year. This success led to the decision to build the first phase of Sydney 3, which opened last month. On Slide 20, you will see the specific results of our disciplined approach applied to this market based on strong returns we achieved with Sydney 2.

Using these examples, we've attempted to convey the discipline we apply to our expansion decisions and the results we expect to achieve, which we measure and manage over time. We understand that managing 10-year IRRs requires us to hit specified performance markers consistently over this time horizon, and you can expect us to continue to do this as we make future capital allocation decisions.

Now let's move to Slide 21 for our third quarter and 2011 guidance. For the third quarter of 2011, we expect revenues to be in the range of $412 million to $417 million, which includes between $18 million to $20 million in revenue from ALOG. Cash gross margins are expected to be approximately 65%. Cash SG&A expenses are expected to be approximately $86 million.

Adjusted EBITDA is expected to be between $180 million and $185 million and includes approximately $4 million from ALOG. Capital expenditures are expected to be between $160 million and $180 million, comprised of approximately $30 million of ongoing capital expenditures and $130 million to $150 million of expansion capital expenditures and excludes ALOG.

For the full year 2011, we expect total revenues to be greater than $1.59 billion, a greater than 30% year-over-year growth rate and includes $40 million to $50 million in revenues from ALOG. Total year cash gross margins are expected to range between 65% and 66%. Cash SG&A expenses are expected to approximate $320 million.

Adjusted EBITDA is expected to be greater than $720 million and includes approximately $10 million in contribution from ALOG. We are maintaining our expected total CapEx guidance for 2011 at a range of $645 million to $665 million, and this excludes any CapEx allocated to ALOG. This is split between expansion capital in the range of $530 million to $550 million and expected ongoing CapEx of approximately $115 million.

In closing, I believe we have demonstrated through our results and guidance that Equinix is in a very strong position

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a disciplined manner. The solid market fundamentals combined with our global leadership position provides us a very unique opportunity to build a historically significant company.

We firmly believe that continued execution on our core initiatives around ecosystems, consistency of service, vertical go-to-market strategy and extending our scale and reach into new growth markets will serve us well and ensure that Platform Equinix will remain something that very few, if any, companies can replicate.

So let me stop there and turn it back to you, Brandon, to open it up for some questions.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question is from Gray Powell.

Gray Powell - Wells Fargo Securities, LLC

Can you discuss the potential impact of Google taking over 111 8th Avenue on the New York data center market? And do you see that benefiting your facilities in Secaucus and Weehawken?

Stephen Smith

Let me start, and Jarrett and Keith could add in. We have a total of 3 leases at that facility. I think 1 has already been renegotiated, and there's 2 that are still outstanding. On the surface, we don't see, based on the intelligence we gathered, any issues with extending those leases. Jarrett, I don't know if there's anything...

Jarrett Appleby

Yes, I think there is a need. I think there is an additional capability to build out there, so we're seeing demand pick up in Secaucus and some in downtown New York as an alternative. So we are seeing an opportunity to leverage Secaucus and the campus there. That also is feeding in, I think, in some of the decisions in N.Y. 5, but there isn't room to grow. And particularly, it's important to the financial electronic trading community. They're going to be looking more and more at Secaucus at us. That's some of the traction in backing for N.Y. 5.

Gray Powell - Wells Fargo Securities, LLC

Okay. And then just kind of like along those lines, utilization in the U.S. is now about 81%. It looks like about 2/3 of your future expansion is coming internationally. Just curious how you're feeling about demand trends in the U.S. and need for additional expansion there.

Stephen Smith

Well, generally, Gray, the demand has remained very steady across all of our industry verticals, as I said in the prepared comments. It's a more mature market as you well know. So there's a different level of focus in terms of extending deeper into our existing customers, which is what we're doing. We've got much more focus on our big global accounts. So we're going wider -- we're getting deeper and wider into these accounts. And as I mentioned, the networks, we're seeing a lot of growth because we're getting better coverage with some of these strategic accounts. So our goal is to continue to grow the existing base. We still have a good focus on new logos coming in, in the U.S. market. I think in all these industry verticals, we see a lot of upside in terms of new logos and opportunity to continue to grow. So we're very optimistic about growth in the North American market.

Keith Taylor

And Gray, let me just add one other thing. From our perspective, I think it's important to note that certainly, if you look at it as a percentage of revenue, we're investing more in Asia-Pacific than we are in North America. Likewise, Europe's investing quite heavily. But part of this is really about signage. As you know, we recently introduced

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over the last sort of 12 months into North America and through the U.S. And when you think about some of the announcements that were made, such as New York 5 and we're investing in Chicago, the DC10, we're going to continue to make investments. This will be very much present on what Steve said in his remarks, which is we're going to be very disciplined. We're going to look at that, the pipeline, the fill rates and all the opportunities that we have in front of us, and then make that decision. So I hope that's sort of clear -- sort of gives you a little bit more information on how we think about our expansion strategies.

Operator

Our next question is from David Barden.

David Barden

I guess first, Keith, or maybe just on the churn improvement in the quarter. Obviously, you guys have talked about bringing the churn that was kind of more like 2.5% down into 2% for the year, the 1.6% is a big improvement. Should we be expecting that to kind of maybe tick back up a little bit for the rest of the year? Just so kind of expectations are in the right ZIP code. And then the second question and again, this is kind of a follow-up from last quarter's question. But if we take the first quarter number for EBITDA and we take the second quarter number for EBITDA and we take the third quarter guidance number for EBITDA and we kind of make adjustments for the ALOG business -- and you've given us some margin information on that, thank you for that -- it really looks like you're kind of making some assumptions that the EBITDA growth is going to really slow down in the fourth quarter. That doesn't seem to have been the historical trend. But I just want to make sure we're not missing anything in terms of seasonal forces or other things that might be impacting kind of the implied fourth quarter numbers.

Keith Taylor

Great. Two very good questions. First, let me deal with churn. This quarter was a vast improvement relative to our original expectations. I will tell you, David, that part of the reason there's a lot of focus going on from the company into working with our customers to eliminate or at least reduce the level of churn, so we're certainly enjoying the benefits of our efforts. So that'd be the #1 thing. I would tell you, as we go forward, the comment I made at least in my prepared remarks were that we'd be at or below 2% the next -- for the rest of the year, for the next 2 quarters. I feel pretty comfortable with that. And so I think it would be fair to say we're going to be in that ZIP code of 2% or less. I don't know if I can -- I don't want to sort of commit today that it would be 1.6% again. But certainly, as we look forward, we're aware if those accounts could potentially could churn, and we're working hard to try and avoid that churn. But certainly, there will be some level of churn. I just -- I'm not sure we'll tick back above 2% over the next 2 quarters, unless something catches us by surprise and we'll certainly share that with you on the next call, if that does happen. When it comes to the EBITDA, for the full angle effect, part of what we've done this year, as you realize, is we're giving you greater than. And certainly, if you look to Q3 relative to Q2, you go, that's not really a meaningful uptick in EBITDA, partly because we have had a very successful sales force acquisition strategy in Q2. And the team's done a very good job with getting a lot of those teammates on board. Because of that, of course, our salary and benefits costs are going to go up, plus all of the ancillary cost cut that come with the sales head. So that cost is going to creep into our Q3 numbers. And probably, there will be some elements of that increase also taking place in Q4. The second piece in Q3, of course, is our repair [ph] cost go up quite dramatically. We've seen it for the last 8, 10 years. We're expecting that again. But what that does is it gives you a relatively flat Q3, but we expect to accelerate again in Q4 as we have historically. And as you know, we're giving you a greater than $720 million number right now. And so it gives us at least the latitude to figure out in the quarter -- over the next 2 quarters where we're going to put the spending. And if we certainly have discretionary, the discretionary diluted for cost in one quarter or the other, we'll look at that very carefully as we sort of exit the year. One of the comments I did make on the last call, though. I said if you really -- you sort of look at the numbers, we're starting to feel really good about that sort of -- that exit rate at or around the $800 million level from an EBITDA perspective. So we are feeling pretty good about the direction that we're taking the business. I think it's just a little bit early to sort of give you an exit rate in the Q4 number. But I think we're setting ourselves up for a good part of the remaining year.

Operator

Our next question is from Colby Synesael.

Colby Synesael - Cowen and Company, LLC

I have just 2 questions. The first one, I just wanted to talk about potential acquisitions going forward. It's been about a year now. Actually, a little over a year since you made your acquisition of Switch and Data. Just curious if the company is at a point where you feel comfortable potentially looking to make another sizable acquisition if that was to be provided or presented in front of you? And then the second question is more just a housekeeping item. I noticed in the U.S. that your managed infrastructure revenue popped up to about $7 million. And I think in the previous quarter, it was less than $1 million, obviously, being in the recurring revenue component of the business. Just trying to get a better understanding of what happened there.

Stephen Smith

Yes, Colby. This is Steve. Let me just start off with that, and maybe Keith can find [indiscernible] update at that and we'll give you some color on that. But on the acquisition front, I think the recent acquisition that we did in Brazil is going to be indicative of what you should expect from Equinix as you think about going forward. We have consolidated all the systems and operation at Switch and Data, so we successfully have that behind us. We completed that in May. We did a full reconciliation of the installed base. So all that is done and fully integrated, and the asset is performing well. We're covering those markets. So everything with Switch and Data is exactly where we wanted to have it. But in terms of go forward in acquisitions, I would tell you, we're mostly focused in the markets that I've mentioned in the past, where we try to find an asset that does exactly what I described in my prepared remarks in Amsterdam and similar to what we did in Brazil. That's the focus. We want to find something that's more of a bolt-on that gives us a start in the high-growth market, and there's a handful of those high-growth markets that our business development team is active in today. So that's the priority focus for us.

Keith Taylor

And then, so Colby, on the second question, just on the sort of dynamics around our managed infrastructure. And certainly, with the acquisition of ALOG, there's an element of their business that is managed infrastructure. And that's basically what -- that's the impact of what you're seeing in that particular line. Clearly, with the recent announcement of the opening of their incremental data center in São Paulo, they're going to continue to focus on that piece of the business, similar to what we experienced in Virtu when we bought the Virtu business. But the emphasis on the team going forward, certainly, is going to look for a much more interconnection-oriented business, not just the managed infrastructure business. So what you're seeing is a full sort of the impact of the ALOG acquisition in this quarter.

Operator

Our next question is from Michael Rollins.

Michael Rollins - Citigroup Inc

Just want to talk on a couple of areas. First, on ALOG. Can you give us some more thoughts on how to look at cabinets and the economics of that business just given it has a significantly higher managed service component than what your typical IBX might have? And then secondly, if you could talk a little bit more on the discretionary free cash flow revision. Does that include the higher interest expense from the recent debt offering?

Keith Taylor

Yes. Good questions, Mike. So cabinets, to be honest, would be quite limited in the amount of data provided thus far on ALOG because we're working real hard to close the acquisition. As you know, it closed on April 25, but there's a lot of work to get done to close it for the quarter from an SEC perspective. And so having said that, we're not at a point where we can probably provide you good cabinet data, but that's something you should continue to expect from us as we go forward. We certainly gave you the number of units that we have available, but the pricing per cabinet and the services provided, we're not there yet and we'll certainly spend more time in that going forward. And then when it comes to the interest, this is what I think is going to happen at least from an interest perspective. But certainly, there's more interest associated with the high-yield instrument that we drew down on effectively in July. That has been anticipated in our guidance. There is a movement up in discretionary free cash flow, primarily because when you think about how we sort of analyze it, it really is about operating performance and operating cash flow. And we're comfortable that the performance in the first half of the year should allow us to increase it for the last -- for the total year. And so that's why we've got confident in sort of moving that number up a little bit about 10%, anywhere 5% to 10% depending on how you want to look at it. But it has been contemplated. And again, for everybody in the call, this is -- cash flow is an interesting number when you look at it. We have to be very careful that as we message it, we want to make sure we're doing the right things, and cash flow is very period-specific. And so as we think about that, we'll continue to update you on our Q3 call and our Q4 call on the movements of cash flow. But I feel pretty good about giving you that guidance at this stage, including new high-yield instruments.

Michael Rollins - Citigroup Inc

If I could just follow up with one other question on the interconnection side. Can you give us an update as to where we are in the process of increasing Europe and Asia with respect to the contribution from interconnection? And is there going to be some period where that could potentially accelerate? Or should it just be a steady climb to some level relative to where the U.S. is?

Keith Taylor

Well, interconnection -- I mean, you saw the performance data, and again, albeit off a small base in Europe, was up 14% quarter-over-quarter. But it only represents 4% of their total revenue. They're growing the business quite rapidly, as you know, Mike. And interconnection is always a little bit of a lagger, but there's a lot of energy in the business, not only in the European side here, but across the organization as we push more and more focused on development of ecosystems and development of customer opportunity. But I think going forward, you're going to continue to hear us talk about it. Whether or not it can move the needle dramatically, I can't tell you that today. But what I can tell you it's becoming more and more relevant every quarter that goes by, whether it's Europe or whether it's Asia-Pacific or even for that matter, this quarter when you saw North America. I mean, that was a sizable step up in interconnection revenues this quarter. And so for all those reasons, we were enjoying the benefit of that. But also, the tangential benefit, which is basically when you have increased interconnection, you've got stickier revenue, but you also have customers who are wanting to come in and procure colocation of services or perhaps managed services, managed infrastructure services from us. So it sort of pulls along a lot of our values, so it's not just about that one particular line.

Stephen Smith

Mike, the one thing I'd add to what Keith is saying is our whole go-to-market, as you've heard us talk about, is squarely aimed at ecosystems. So the byproduct pull-through is going to be more cross-connects and ports and our switches as we continue to focus on that. All of our product development, all of our focus in the company is completely aimed at ecosystems and interconnection. That's the type of applications we're focused on in these IBXs.

Operator

Our next question is from Chris Larsen.

Christopher Larsen - Piper Jaffray Companies

So a quick question -- 2 questions for you really. On the services that you're introducing in Milan, Steve, you talked a little bit about that. What specifically are your providing in disaster recovery? Is it more on the power side, or are you beginning to provide data storage and backup? And is this -- can we read this as a foray at getting in some more managed services? And then secondly, for Keith, can you just give us an update? I know you want to lever up the balance sheet. One of the ways you said that you might do that was potentially through buying some of your buildings and/or the ground leases underneath. Where do you stand on that, and any more opportunities there?

Stephen Smith

Let me start on that and have Jarrett jump. Jarrett -- we've asked Jarrett to really grab ahold of this whole business continuity around trading rooms, where it started in several markets. We have in Frankfurt, Munich, Hong Kong, New York. We had a customer that access out of Frankfurt to go help them in Milan and that's what initiated the opportunity. But it's going to -- Jarrett is going to take the business and his team from a business continuity around trading rooms, which is where historically we've been for several years and think about expanding that a little bit further to other markets because there's quite a bit of demand for this. And Jarrett, you want to add...

Jarrett Appleby

Yes, just building a space and desktop infrastructure in the local market, and we're really seeing demand where we can support both the primary site and the secondary site that's really pretty close, that they're leveraging it through. And it's a low cost to get into these markets. It's really a low-cost built out for us. So we're in the process of productizing it, not just for financials, but for some of the other verticals.

Stephen Smith

So just to size that for you, Chris. The Milan decision, the initial investment is less than EUR 1 million. But a very good client, big client, it gets us started in their market like that. So we see a business continuity around trading rooms, possibly extending into business continuity services in a little bit broader perspective and that's what we're studying.

Keith Taylor

So Chris, on the second question, obviously, from a gross debt perspective with this transaction that we just announced, we've levered up the balance sheet a little bit. So the opportunity that we talked about or Steve referred to is that we want to continue to grow smartly by looking at these opportunities both inside the U.S. and certainly outside the U.S. As you know, over the last little while, there's been a much larger investment going outside of the U.S. and into AP and EU. And then there's other markets. And so we want to continue to make sure that we have the ability to do that as and when we choose. The second piece of the opportunity, really, is in organic, and Steve alluded to that. But from a balance sheet perspective where we also see the opportunities, we want to make sure that we can maximize the value for our shareholders. And so when you think about ALOG acquisition, it was an all-cash deal. When that thing gets -- certainly gets cooking and gets to a larger scale, I mean, it's going to be a great return for us from our perspective. And so using capital to deploy what we can those cash that sort of puts value into the shareholders' pocket, that's one way. Another other way is looking at ways to limit the amount of dilution that could occur. And so we're talking about the $250 million convertible that will come due on April 15 of next year. So there's $1 billion-plus debt on our balance sheet that's convert oriented. And so we have to look at what opportunities could that present to ourselves -- that would present to us, that we could take some of the capital that we have or the unrestricted cash that we have and use that to find ways to create more and more shareholder value. But part of it also might be purchasing properties where we can, and so we recently announced a small purchase. It's only $9 million in Frankfurt 2. I think of it as a distressed asset, it was buildings, it was land, it was equipment, that's the type of thing that we want to do. But if there's other opportunities, we'll look at that. And we want to make sure to make strategic sense and that it can create value for the shareholders as move forward. So hopefully that gives you a sense that we're -- sorry, I said Frankfurt 3 -- I said Frankfurt 2. It should be in Frankfurt 3. That's a mistake. So that's a small discrete investment. And so hopefully, that gives you a pretty good idea of how we wanted to deploy the capital and continue to use the balance sheet leverage to our advantage for the shareholder.

Operator

Our next question is from Frank Louthan.

Frank Louthan - Raymond James & Associates, Inc.

Can you give us a little more color on looking at the exchange business, Ethernet exchange and having the carriers in there from that slide. Are you indicating that there are more revenue opportunities you can get from the various carriers in the data center? And then, any other Latin American expansion opportunities you see in the next couple of years?

Stephen Smith

Jarrett, you want to handle these things?

Jarrett Appleby

Yes. So Frank, yes. We wanted to really -- we've been talking about this for a little bit and talk about the importance of the stack, the foundation, the IP, the transit and peering infrastructure. It's actually expanded into private network, enabling Ethernet and NDLS. And that's really a key enabler for the cloud providers, financial services and the network community to come together. So it's still early days. We're up right now 48 participants. We're in 16 markets. Actually, our competition is backing off in the global markets. We don't really see competition outside the U.S., and most of the competition in the U.S. has moved to secondary markets. And so we're getting traction in the core markets, working up the staff. And that enables cloud, managed services, CDN and mobility. And so we're still at the early days on the new services, but it's all in one location, very unique asset that we have. And again, it builds on the ecosystem and the traffic exchanges at our core DNA.

Frank Louthan - Raymond James & Associates, Inc.

Yes, just curious, any other thoughts -- if you could comment on any other thoughts, desires for other markets in Latin America to expand to.

Stephen Smith

Well, Brazil was at the top of the list that we've been staring at for the last couple of years, and I think we want to go and be really successful in Brazil first. We did look at a couple of ancillary markets in that region. But our complete focus in that region is to get very stable on Brazil and make this thing highly successful and that's where all our energy is today.

Operator

Our next question is from Chad Bartley.

Chad Bartley - Pacific Crest Securities, Inc.

I was hoping to get a little more color if possible on the revenue mix for ALOG across colo interconnect and managed infrastructure. And then how are you thinking about managing EBITDA margins there and can we see expansion from the low 20% level any time in the near future?

Keith Taylor

Yes, Chad. Again, I sort of said on one of the other -- sort of one of the other question. I think you're going to see us come back to a little bit more of the detail around, certainly, the revenue and the breakdown and the margin profile. But clearly, as you can see, it's roughly at a 25% EBITDA margin primarily because of managed infrastructure costs and the like. And the company -- as we look to this opportunity and the size and scale of the incremental asset that was recently opened up in Brazil, certainly, we're going to continue to do a little bit of the managed services because that's what the market needs, quite frankly, similar to some of our other markets. But when you look at Equinix, our focus is really about colocation and leveraging off the investment and getting to scale. And so I think over time, you're going to see margins continue to improve like you had in some of our other markets that we service around the world. But I think it just takes time, and recognizing that although we have a controlling interest in this asset, we have partners that we're working with and we want to make sure we do things in a very sort of methodical fashion. And so it's a little bit early to tell you any direction of where it's going to go, but we're very optimistic that we can scale and expand margins over time.

Stephen Smith

And the one thing I'd add Keith -- Chad, is as Keith said, and we've experienced this in other markets, multinational clients going down to that part of the world want more handholding for total service. So it is not going to be uncommon for us to have up to 1/3 of this business being managed type of services because the clients are going to want more help in that part of the world around hardware and software and different things. And so a part of this mix will probably remain in the managed bucket for some time. As Keith said, we'll evolve this thing and really make the colo part of it get Equinix-ized over time.

Chad Bartley - Pacific Crest Securities, Inc.

Okay. That's helpful. And then just one quick follow-up. Should we think about the business as primarily colocation and managed infrastructure? Or do they actually have some interconnect as well today?

Stephen Smith

Well, there's -- the network destiny is not as dense as it is in the U.S. but they've got several carriers that are connected into both of those markets. And yes, over time, we will push the interconnection agenda. And with multinational traffic heading in that direction, we expect to have that part of the mix. So it's all part of the agenda.

Operator

Our final question is from Simon Flannery.

Simon Flannery - Morgan Stanley

I wanted to talk about 2012 for a minute, if I could. We've obviously had a strong set of results, strong guidance. When I look at your forecast for 2012, you're increasing your sellable cabinet equivalence is slowing to about 6% growth from the rate compared to half the rate of this year. In particular, there doesn't seem to be a whole lot of space coming on in Asia. And I just -- I know it's early days, but I just wanted to understand how you are thinking about 2012 and how you're evaluating the potential to be more aggressive in terms of adding space to take advantage of some of the trends you've been outlining today.

Stephen Smith

Let me start, and Keith, won't you add. Simon, in terms of Asia, as you know, we've opened up capacity in a pretty rigorous fashion here during this first half of this year in all markets in Asia. The only thing that's announced that's out there later this year is another phase in Hong Kong, which you're right, there isn't anything that's projected because we brought on a lot of capacity in the first half of this year that's going to carry us through the back of this year and early 2012. So I don't know what else you can add to -- I mean, there's not much we can really point to in 2012 at this point.

Keith Taylor

Other than to say, Simon, we have -- we do not have any guidance of there vis-a-vis our financial results. We certainly have a good idea from an expansion tracking perspective of where we're planning on building right now. But as you can appreciate, there's a lot of other projects that we're looking at. As Steve alluded to in the last call, we have stuff on our whiteboard that we look at all the time, and we've been very methodical and analytical around: What does the pipeline look like? Where are the customers going? What do they need? And that gives us a pretty good indication of when our next build is going to be. We map out our construction activity effective through 2015. And what you see on the expansion page today is what we feel comfortable announcing and putting energy towards. And certainly, as we past through time, you're going to -- and if the model and the market continues to perform well, you'll see us make incremental investment provided we can get the returns that we need.

Jason Starr

This concludes our conference call today. Thank you for joining us.

Operator

This now concludes today's conference. You may disconnect at this time.

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