Iron Mountain Incorporated (IRM) Earnings Call Transcript & Summary

So good morning, everyone. We're continuing today at our TMT Summit. I'm Eric Luebchow, Senior Analyst of Communications Infrastructure and Telecom Services at Wells Fargo. And we're very pleased to introduce Barry Hytinen, the CFO of Iron Mountain. Barry, thank you for joining us this morning.

Thanks, Eric. Great being here. Appreciate it.

So Barry, I just wanted to kick off. So obviously, there's been some optimism, I'd say, in the general markets about COVID-19 vaccine coming in early to mid-2021, that could spur a broader economic recovery. So maybe you could just start by telling us how a broader economic recovery would impact your business, both from a document storage and from a services perspective?

Sure. Eric. And by the way, I'm joined by Greer Aviv, who's our SVP of Investor Relations.

My apologies for that.

So it's a good question again. Thanks, again, for including us. Happy to be here. It's a really good question. I think we're all heartened by the fact that there's been positive news on vaccines. It -- I heartened back to the time of our last earnings conference call and we didn't even have that positive news at that point. So a lot seems to continue to develop there. You look at our business, and I think what you see is on our storage business, it's been very durable. It's a very sticky business. We have had a very modest level of volume decline year-on-year. It's 60 basis points year-on-year in the second and the third quarters, like 1.1%, 1.2%. Well offset by our revenue management program, resulting in positive revenue growth on our storage business. Like I said, it's a very durable business. We expect continued progress on our revenue management program. And then secondly, I would say, if you look at our data center business, it's been growing very well. The team has been executing incredibly well and driving considerable conversion of our pipeline. Where we've been more impacted during the pandemic is on the service side, as you know. And so if you look back at the April-May time frame, that was -- appears to have been the real trough in our business as it relates to service trends. Global service activities at that time were off high 30s, even 40% plus. By the time we got to the third quarter, as I mentioned on the most recent call, those declines have come back materially, still down, but less bad throughout the year. We think the improvement in our service activity trends certainly outpaces return to work. And frankly, I think, is improving as compared -- relatively as compared to economic activity rebounding as well, which I think speaks to the fact that our clients really depend on our services. They -- we are a trusted partner and they need our service. So they have been coming back to us and continue to. I think when we get on the other side of COVID, whenever that is, we'll likely see our service activity trends across all of those various service lines continue to recover. And I expect, on the other side of COVID-19, we'll be right back to the levels that we were at pre-COVID because I haven't really seen anything in our business or as we talk to customers that changes our general outlook, which is that on the storage side in our more developed markets, we would expect volume to be flattish to slightly down on a longer term trend, and then we expect growth from our more emerging markets, that's both on a -- that's on a volume basis. But certainly, with our opportunity with revenue management, we would expect total revenue to be growing across our storage lines. And then I would say on the data center side, which is the key growth engine for us over the long term, we feel very well positioned. The markets that we're operating in, we've seen continuing to grow. We like the exposure we have to key markets like in Frankfurt, Amsterdam, London, Northern Virginia, among many others. And I think while I haven't seen in our business a discernible significant uptick related to COVID, I know some of the players that have more exposure to hyperscale have talked about that. I haven't seen that per se in a real demonstrable way in our business. I think it really comes down to the fact that our team is doing really well, our business is kind of got to a level where we're very much considered across all the projects that are out there in the markets we do business in. And I think that's a trend that's going to continue to -- continue over a long period of time. And we expect our data center business to become an increasingly large portion of our revenue and EBITDA.

Great. Thanks for that overview, Barry. So I guess related to some of the reopening, the economic reopening that we expect, you mentioned on your last earnings call that you had started some kind of fixed cost deleveraging had brought back a significant number of employees who had been on furlough. So should we read that as kind of a positive sign that you continue to see this gradual improvement? Potentially it gets accelerated with the COVID vaccine, we'll have to see. And then I guess are there any kind of short-term margin impacts from bringing employees on ahead of future demand that you think will improve?

Yes. So it's another important point. When we think about the way we service our customers, we want to make sure that we're there to service them day in and day out. And so our thought process was in light of the fact that we've seen the trends continue to, as we've mentioned throughout the year, improve since that kind of April low, we have been gradually bringing our team back essentially ahead of revenue. And the reason we're doing that is we want to make sure we can service demand for the customers. And it's very hard, obviously, to physically do that if you don't have the people back in advance of, if you will, the revenue improvement. And so we have brought back the vast majority of the team off furlough, and we have less folks on reduced hours at this point. And that did result in a level of fixed cost deleverage in the third quarter, and I expect that to persist as we gave in our outlook for the fourth quarter. Our view ahead of fourth quarter was, I would say, in terms of view for sequentially, was kind of cautious in that we expected -- we mentioned that we expected revenue and EBITDA to be essentially flattish on a sequential basis, which would imply that service revenue was down kind of similar levels year-on-year fourth quarter as it was in the third quarter. Our view at the time of the call was you had a lot of conjecture about winter was coming in the northern hemisphere, level of infection was continuing to rise, and even at that point, as I mentioned earlier, we didn't have any positive news on vaccines coming. I do think that we will have a level of fixed cost deleverage in the fourth quarter, as I noted on the last call. If for no other reason, then we -- as I told you, we brought people back ahead of revenue. But I would say that the longer term trends that we see as we get COVID more in the rearview mirror is we'll have more of an equilibrium as it relates to staffing and revenue, and then get back to a point where we're not having a fixed cost deleverage that we experienced in the third and in the fourth quarter. So that will help us start generating incremental levels of EBITDA as we get on the other side.

And that's very helpful. And I guess related to the cost impact, obviously, Project Summit has been a major initiative that Iron Mountain has undertaken. You've accelerated that program. I believe you're expected to reach a $375 million run rate benefit by the end of next year. So maybe you can talk about some of the areas where you've been able to accelerate that? What remains in terms of costs that you can take out of the business? And then once you get to the end of Project Summit, do you see other ways that you can improve margins within the broader Iron Mountain business beyond the full Project Summit benefit?

Sure. So Project Summit is a really big part of the story, and it's a really interesting portion of the story in that we are seeing the opportunity to deliver, call it, $375 million of EBITDA benefit from the program in total. This year, in light of our strong performance from the team, we think we'll generate about $165 million of benefit. We generated about $48 million of benefit year-on-year in the third quarter. Those levels are all ahead of what we were thinking at the outset of the program, when at that time, we conjectured that the full program would generate about $200 million of benefit. The significant increase was driven by elements related to cost of sales improvements. At the beginning of the pandemic, we mentioned we have been looking at and, frankly, testing the idea of some levels of service level agreement changes in terms of how quickly, for example, we'll return a box or how frequently we will visit a customer. And with those SLA changes, we've been able to think of drive better routing. So think about metropolitan area where you might have us visiting one -- the northeast quadrant on one day, the southeast quadrant on another day, as opposed to all quadrants all every day of the week. And with that, that generates a considerable amount of improvement in terms of our relative cost of sales. It also unlocks the opportunity to use some level of third-party logistics where we have relatively better scale going that direction as opposed to using our own resources. And that's something that we've been continuing to mix in over time. Those SLA changes, among other adjustments in cost of sales, have driven the significant increase that we talked about this year in terms of Project Summit, both for the current year as well as going forward. I look out to next year, we expect to have the full benefit of the program on a run rate basis exiting the year. So while I haven't given any guidance per se for next year, if you assume, say, $150 million, $160 million of incremental benefit from Summit next year, that would -- with the run rate being the exit of the year that would put maybe $50 million or $60 million of incremental benefit year-on-year in 2022 for the full $375 million. I feel very good about where we're trending in terms of Summit. As you know, Eric, as you follow company very closely, we've increased our expectations this year for Summit really throughout the year. And obviously, earlier in the year, we stepped up the total program benefit. We feel very good about where we're headed. And I -- that's a sort of -- by the way, those are all net of investment kind of levels. So that's what we ought to see. Now sometimes I get the question, well, if you have $48 million of benefit this most recent quarter year-on-year, the EBITDA was slightly down year-on-year, where -- what washed it out? And that's what you were just asking about principally. So our service revenues were down, obviously, and we didn't have that EBITDA from those service revenues. We also had a fair amount of fixed cost deleverage in the third quarter. I personally think as we get on the other side of COVID, those sorts of things go away and we get to a better -- much better place as it relates to service trends. In addition, we have incremental levels of bonus compensation in the quarter, which were nontrivial because last year, as you know, the business had a tough year and was well off its budget. So throughout the year, but particularly in the third quarter, bonus levels were well below target. And this year, because -- thanks to the fact that our team, especially on the front line, but really the vast majority of the team is doing great work and working through the pandemic in a very business-like way and frankly, taking risk for their own family and their own health, and we've been doing everything we can to make sure that they have all the PPE needed and every precaution necessary. We're going to continue to pay bonuses to that -- to those -- to the team. And so that's another year-on-year headwind, which that together with FX has really been a factor. So the way I think about that, the reason I call it all those items is, I think as you get into a more of a steady state situation on the other side of COVID, all of those become neutralized and you get into a situation where Summit can really come through in the numbers, all of the things equal. So feel very, very good about where Summit is, Eric, and that's really just on the cost and the EBITDA side. The other thing I really want to highlight is Summit is about transforming the way we work such that we're much more customer-focused that we are getting to our customers and servicing their needs, whether that be in the storage side, whether that be in digitizing records for them and just speeding up the way we do work as well as some substantial technology changes, which enable the company to be that much more customer-centric in the form of reducing the number of billing systems from literally dozens to just a relatively few, having one full view of the customer, reducing the number of CRM systems such that we have one, and therefore, everyone on our sales team can see what's going on in customer activity. So Summit is a big part of the story. It's driving a tremendous amount of EBITDA benefit. And it really, I think, helping transform the company.

That's very comprehensive. So thank you. And I guess that's a good transition into -- obviously, the COVID pandemic has had some negative impacts on your business, but you've also mentioned that you've used this opportunity to come up with some kind of new unique customer solutions that you can architect, that involve more digitization, more cloud storage. So maybe you could provide a couple of examples of what you've done to kind of help your customers navigate through a rather uncertain time? And how do you think that's going to benefit the business longer term?

Yes. So there's a few areas. One is, what we found is, naturally, like all of us today, it seems are working from home, there's a level of desire for digitization and be able to work with the records that we store for them, which are incredibly important assets to our clients wherever they are. So our digitization services have been more in demand. That's been an area, frankly, that's been growing for us for some time. But particularly so, it's really the only service line that we've had during the pandemic that's been actually on a large service line that's been growing year-on-year and continue to. So it's strength to strength. And I think that speaks to the fact that our clients really count on us. They want -- they need access to the records that we're storing for them. And they appreciate about what we're doing for them. And that also enables us to do -- help them with things like taking unstructured data and creating metadata, being able to help them search the information and be that much more efficient with that, which we're storing. You asked about other ancillary services during the pandemic -- there are a couple of other examples of where clients have come to us in new ways, whether that be in terms of helping them with unemployment claims, in terms of state governments, whether it be in the form of even stockpile -- storing stockpiles of PPE for quick fulfillment into client sites, we've done that for quite a few medical facilities as well as other clients. So it speaks to the fact that we are a trusted partner to our clients. We have incredibly high retention rates in our business from a customer standpoint. And they know that we're a trusted vendor they can count on.

Okay. No, that's helpful. Thank you. So I'm going to pivot to the data center business, an industry I've covered closely for years. You've had, obviously, a really strong year, kind of a record leasing year by any -- even excluding the Frankfurt JV that you recently announced. So -- and obviously, some of that has been hyperscale. You've had some federal wins. Maybe you can talk about to what degree since you acquired some of the data center assets a few years ago, you're seeing real cross-selling benefits from your kind of traditional global RIM business and the data center business because I think that's maybe an underappreciated part of the synergies that you see probably even more so on the enterprise customer base that you have.

Yes. It's a good question. It's one of the areas where, Eric, early on in the company's exploration into data center, viewed it as an element of another area where it gives us permission to win, particularly on the enterprise side because we have such long trusted relationships in the core, literally hundreds of thousands of customer relationships around the world. And in many cases, we're servicing, for example, data management, where we're going in and rotating their tape. So it's not just core record storage. And so we have those deep relationships, which then can translate over into cross-sell and warm leads into our data center business. On average, quarter-to-quarter, we might see 35% to 40-plus percent of the enterprise pipeline is coming out of -- directly out of our core business, where it's actually a warmed up lead. And that helps us win. We get selected into processes much more than probably punching above our weight essentially as it relates within the data center segment on those. And I would say -- look, in the last year, I think our data center business has really come on the scene, and that's really getting us into almost any project where a client has a need in one of the markets we're doing business in. And also, we have clients that are coming to us and asking us about opportunities to work with them in geographies where -- long term, where we aren't currently. So -- but you're right that we tend to focus a fairly balanced approach in terms of both enterprise colo together with hyperscale. You mentioned how we're doing this year. Year-to-date, through the first 9 months, we had leased up about 51 megawatts of new and expansion leases. Now that did include the big hyperscale opportunity you referenced, which was a 27-megawatt deal in Frankfurt to 1 hyperscaler. If you had excluded that and just looked at the balance, I think we're running about 55% of that was enterprise colo and 45% of that is hyperscale. We like having a more blended approach because it allows us to get scale off the hyperscale players and be able to build out the facilities faster with really strong clients that are going to be there for a very long period of time who don't want to kind of jump around. And albeit with, as you know, generally lower returns, I think, high single-digit type of returns. And then we balance that with the enterprise colo players where we've got those warm leads that you mentioned coming out of our core together with the opportunity to get a better returns to low double-digit kind of returns to a blended kind of return that we think is very attractive in the 11%, 12% kind of range.

Great. Yes. That's helpful. And it kind of led into my next question on the returns on the data center business, which you kind of just referenced the difference there. So obviously, one of the -- I guess, investor concerns on hyperscale and that returns now are maybe 8% to 10%, but used to be higher, and that pricing has come under pressure, particularly in markets like Northern Virginia for some of these larger deals. So what do you see? I guess you haven't been in the data center business as long, so you may not have seen the evolution of pricing. But have you seen deals continue to be competitive? Do you see any risk to that high single-digit yield compressing further? And do you think we've kind of reached hopefully a level of stabilization on the hyperscale side in terms of the pricing? Or do you think that given the number of players, private players, public players chasing these deals that could come under further pressure?

So it's a good question, Eric. It's one that we get from investors all the time, as you'd imagine. I think first thing I would say is in terms of what we've seen in our pricing in our markets, it's been stable to actually slightly positive. And that's absent any one-off items with respect to like a mark-to-market, et cetera. I do think you're right that in light of the fact that we are -- we've been in the data center market for some time now, but we're not -- we weren't one of the first early entrants, we haven't had to deal with things like a lot of roll downs. And to your point, we are less exposed, as I was mentioning the prior answer to hyperscale. I can't speak to what others are seeing, but I would say in our pricing, it's been good and we've been pleased. It's been fairly stable. I think as you look at the opportunity for our customers to continue to look for third-party data center and as they move some load to the cloud and some load into third-party, it's a very good place for us to be in light of those long relationships we have. And you mentioned about just generally speaking, competition. Look, it's a competitive market, but I would say that data center tends to be one of those businesses where it's market by market in terms of -- particularly on the hyperscale side, where you get a situation where a hyperscaler might need a specific amount of service in one specific market. And if you're there and you have the ability to service it in a relatively short order, in a lot of markets, it's market-by-market in that sense. So we feel very good about the markets we're exposed to. In Europe, we're exposed to 3 of the 4 largest markets, in London, in Amsterdam and Frankfurt. We'd like to have -- we have more exposure here recently to London. We have very good exposure in Amsterdam and a very nice business. We'd like to have more exposure in Frankfurt, in light of the very strong business we've already booked there. And over time, we said publicly that we would like to have exposure in Paris. In Northern Virginia, and as you know, we have a good amount of exposure there, and we have a nice land bank. Same with Arizona. We feel very good about both markets. And we like Singapore as well as a market we've been in just to name some of the key markets that we have exposure to. Eric, you're on mute.

My apologies. Helpful overview. So the other aspect I wanted to talk about, obviously, as the CFO of the balance sheet. So another perhaps underappreciated part of the story is the sizable industrial real estate portfolio you have. And from talking to you recently at some conferences, you had talked about how cap rates have really compressed recently for high-quality industrial real estate. So maybe you can talk about how you're going to use capital recycling going forward as a source of funding? And then what flavor that could take? Will it be more dispositions of assets where you can move, consolidate into one facility in a market? Will it be more sale-leasebacks, which you've done recently? And how should we think about that?

Certainly, where we see the opportunity to do levels of consolidation, we would take those, and we have taken those over time. But the principal point that we speak to when we're talking about our capital recycling program is in the form of sale leasebacks. As you know, Eric, the company has been doing a level of capital recycling, principally in the form of those leasebacks, I mentioned, for some time now, somewhere in the vicinity of $100 million to $150 million kind of proceeds a year. Through the first 3 quarters this year, we had recycled about not quite $120 million, with the vast majority of that in the third quarter. We -- the team executed 2 great transactions for us, 1 in Washington State and 1 in Southern California that brought in about $110 million -- in the cap rates we were seeing -- when I joined the business at the very start of the year, we were frequently seeing cap rates on industrial real estate in the 5, 5.5 kind of the zone. But if anything, I would say the market has continued to strengthen, and that's probably somewhat -- with real estate investors wanting to have more relative exposure to industrials and data center as compared to some other sectors within real estate broadly and drove -- driven cap rates down, and we think it's a highly attractive situation for us. So we'll continue to recycle and monetize a portion of our industrial real estate asset base because to give you a sense, I mean, on those 2 transactions, I was just mentioning, there were like 4 -- just under 4 cap rates. And so those are particularly compelling types of opportunities where we think we can monetize those facilities, make it leverage neutral. So obviously, we'll have rent going forward. So we put enough down against our debt to keep it leverage neutral, and then take the remainder of the proceeds and go invest it in high-return projects that principally will be on the data center side. And that by -- that way, further our strategic imperative of driving data center to be, over time, a larger and larger portion of our business. And the other thing I'll note is the reason -- one of the reasons why we feel this is a particularly attractive situation is in light of the terms we can get on leases, which is to say that we'll effectively have control of the facility, whether we own it or lease it, if you think about long-term leases, with multiple renewal options at our option with relatively low escalators. So we think that the opportunity to continue to monetize, albeit a small portion of our industrial real estate over time in comparison to the total, will be a way to continue to boost our data center and other growth initiatives, and you'll see us continue to do that, Eric.

Great. That's helpful. So maybe you could just remind us kind of your leverage targets. I think you've talked about wanting to get to the midpoint or even lower of your leverage range. I think you're toward the higher end today. What you need to do to get there? Obviously, you want to continue investing in data centers. Capital recycling is a tool you can use. You have a JV partner on the data center side, which you could potentially leverage again. So how do we think about that? Obviously, EBITDA growth will be a large component of it, capital recycling. What are your kind of your targets? And how long do you think it will take you to get there?

Okay. It's a good point. And maybe I can broaden it out. From a capital allocation standpoint, specifically on a target range, we target our net lease adjusted leverage to be between 4.5 and 5.5x. Now at the end of the third quarter, we were 5.3x on that metric with a kind of a cautious view for EBITDA in the fourth quarter in light of the trends that we mentioned earlier. I suggested that it might round look 5.5x at year-end. But over time, over the next few years, as Summit becomes a larger and larger portion of our EBITDA and expand our EBITDA, together with the fact that we -- hopefully, in light of the vaccines and things get COVID in the rearview mirror, I expect considerable growth in EBITDA over the next few years, that will help us delever over time. Capital recycling, to your point, is also additive to our story. I want to note, though, we have a large but very sustainable dividend, we're very committed to it, as we've said multiple times. And then we're going to continue to build out our land bank and drive our data center business. So I think $200 million, $300-plus million a year at least into data center over time is a reasonable number as we build out what is a relatively large land bank for us. And the other thing I'll note is as we grow AFFO, we expect to bring toward our AFFO target payout ratio for dividends of kind of mid to low 60s. And as we get to that level, or until we get to that level, you should expect the dividend to be essentially flat in the year. And as we grow into that through the expansion of EBITDA from things that I mentioned a moment ago, we'll then get to a place where we would expect dividends to start growing because, frankly, we'd be almost at the REIT minimum at that stage as we approach that kind of low 60s to mid 60s payout ratio. I expect that if you model it out in light of assumption on COVID, maybe being -- this will be the last year for COVID in '21, being a factor together with Summit that you get out into '22, '23, you get in a situation where you might even be seeing the dividend start to expand again together while having a balanced approach of growing data center. You mentioned also the JV we did on data center here recently. I'll -- we're very pleased with that. That's a unique situation because that asset being a fully leased up hyperscale facility, 27 megawatts in Frankfurt, gave us the opportunity to recycle a portion of -- well, basically all of our investment in the facility and maintain an interest in it on the equity side, together with servicing it from a standpoint of property management, asset management, construction fees. And -- but I would say that's a unique situation that isn't like plan A. Plan A for our data center business is to continue to have it grow as a percentage of total, growing the revenue and EBITDA coming out of data center. Where we might have those unique situations like that, we continue to look at it, but we're going to continue -- where our expectation is to be able to fund the vast majority of our data center growth on our own terms.

Okay. Great. Well, that's a very helpful overview. I believe we are out of time. So Barry and Greer, thank you so much for joining us today. Hope you stay safe and healthy, and we look forward to chatting soon.

Appreciate it, Eric. Thanks very much. Everyone, have a great day.

Thank you.