Iron Mountain Incorporated (IRM) Earnings Call Transcript & Summary

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Good afternoon, everybody. Thanks for joining us again at our 5th Annual Wells Fargo TMT Summit. I'm Eric Luebchow, Senior Analyst covering telecom services and communications infrastructure, and very pleased today to be joined by Barry Hytinen, the CFO of Iron Mountain. Barry, thanks for joining us.

Thanks, Eric. I always appreciate being invited and taking part in the conference. Thanks, again.

Of course, happy to have you. So Barry, I wanted to start on just some broader economic trends that you see within the business around return to office and the economic recovery. So your core RIM storage and services business, I'd say, has been very resilient in the face of the pandemic. So as you look out into 2022, and we'll see what happens with this newest COVID variant, but if return to office does pick up, as many still expect, what changes would you expect overall in terms of new boxes inbounded, destructions and then some of the related services activities that are tied to those businesses?

Yes. It's a good question, Eric. On the storage side, in our core, we have been performing very much in line with what we've been expecting for some time. If you even look back at last year, we did a little better than we expected. And this year, we said that on our core -- on an organic basis, we would expect something like flat to slightly down. We're running, kind of, of that order, less than 1% down. And then we expect that our total volume on an organic basis to be flat to slightly up. And as you've seen through the first 9 months, we've been performing quite well in that regard, and I fully expect to be in that level. Going forward, I think in the absence of other specific guidance, that's not a bad way to look at it. When we look at what occurred during the pandemic, our new boxes inbounded did come down some, but also did -- so did the permit withdrawals and other destructions and generally in very similar order. And so as it comes back, while notwithstanding some elements of potential backlog, which I'll speak to in a moment, I think it's probably reasonable to expect that as people return to office, probably get a little bit more on the new box inbounded and probably a little bit more on the permit withdrawal. We have seen some specific backlog on new boxes inbounded of wins we've had on clients. Specifically, that backlog has been running at a higher level than what we normally see, and we generally attribute that to some markets, particularly in Asia. We've talked about this on the last couple of calls, where there's been more extensive lockdowns and just moving of boxes has been a little bit more sluggish. But we think over time that, that will be a net positive for us. And then you asked about services. Here, I think we may see an incremental benefit as there's more return to office. We have been seeing our traditional services continue to recover generally quarter-by-quarter, and obviously, they've recovered far faster than return to office as clients have figured out how to use our services, which are very important to their overall business, regardless of where their employees are working. But if you look at our traditional services, we've commented on this on the last couple of earnings calls, they are still on a traditional side below where we were pre-pandemic. And we have seen them continue to recover. So I think as return to office occurs, we'll see more refiles, more activity on those traditional service lines. Some people have asked me then, if that's the case, how have our service revenues rebounded so nicely and been up over the last few quarters? And that's a testament to the fact that the team has developed some great new products and services around digital solutions, our InSight platform, secure IT asset disposal that are, I think, long-term secular growing markets, which we can easily -- relatively easily cross-sell into our large client base on the core side. So that's -- I expect that trend to continue to happen in any environment.

And that's a good segue, Barry. I was just going to ask a question about that. Obviously, your services business in total is actually now ahead of the pre-pandemic comp. As you mentioned, that's largely attributable to some of those newer areas. So maybe you could give us a little more detail into kind of the growth rates or the addressable markets or the potential for you to maybe grow in a more sustainable way now that you're a little more exposed on the services side to digital solutions, InSight platform, IT asset disposal? It seems to me like your services business is now actually more durable than it was pre-pandemic as we look out over the next few years.

Yes. So I think our team has done a really great job during the pandemic, working with our clients to offer them solutions that the clients need. So whether that be in the sorts of things where we've done some level of claims processing or helped clients on the -- with digital solutions, helped them put content into our InSight platform and let them make it that much more user -- usable by their user base, whether that be in the form of scanning and then having the tags, so that it could be used in AI-type solutions and otherwise. And when we look at the trajectory for that kind of service and those sorts of products, it's -- I think we're still in the early days. And then there's a lot of incremental opportunity. We don't find too many clients that have -- don't have a significant need for that sort of digital solution. And then as you mentioned on the IT asset disposal side, that's another example where I think it goes along very, very well with our existing client base and the kind of trust they have in us because, as you know, they've -- most of our clients have been working with us for literally years, if not decades, entrusting to us valuable assets for us to store. When you think about the other side of that, when they're looking at IT assets that need to be disposed, it's similar trust issue, right? The CIOs, they want to make sure that they know exactly what's going to happen with those assets on an end of life when they leave their four walls. And while both of those businesses, Digital Solutions and SITAD, for us are still relatively small, they're growing at a very fast rate, relatively speaking. I think they can grow at those relatively higher rates for an extended period of time as the market that we're addressing there is quite large and growing quite rapidly.

That makes a lot of sense, Barry. So I guess given your learnings from the pandemic, do you think some of these newer growth adjacencies and services -- should we expect that there might be new products or services you might add to your portfolio to expand the addressable market further? Or do you have enough growth runway that's really not necessary, you can just keep executing against that addressable market of which you have a very small market share today? And do you think that's something that you can sustain for several years or beyond?

Well, the short answer is there's plenty of opportunity in our existing addressable market, right? In terms of the last -- if you look at this business over, say, the last 5 or 6 years, we've taken our addressable market from something like $10 billion total addressable market growing at a low single-digit percentage to something on the order of $80-plus billion growing at a double-digit rate. Now that said, the team is still working on incremental products and solutions that can address even larger portions of our customers' needs. So I certainly think that while we've got a lot of growth in front of us with the products and solutions we're already offering, there's more to come. We've got some very nice work underway in our innovation teams on working with specifically around industry-oriented solutions and solutions that really make a difference for our global customers.

Okay. Great. We'll stay tuned for that. So sitting in the CFO seat, Barry, I wanted to ask about Project Summit and kind of the margin trajectory for the business. You're wrapping up Project Summit next year, and so I guess the inevitable question is, well, what additional cost efficiency initiatives or levers you have to pull once you get past Project Summit so that you can continue to expand profitability? And I know some of that will happen in your data center business as that scales, perhaps in some of your international markets as those scale. But maybe you can just walk us through how to think about margin progression once we get past the positive cost impact from Summit.

Sure. So first up, just a summary, Project Summit is about $375 million of benefit for the full program. And next year, we'll have another round number, $50 million of year-on-year benefit from the activities that we're finishing up this year and the run rate thereof as we anniversary those going forward. When I look at the business, and it's something I've found in other businesses that I've been that, I think there's always more. The businesses -- we have -- still have a relatively large cost structure, an SG&A structure. There's opportunity for additional productivity. You know from the activities that we've been doing in Project Summit, whether it'd be service level delivery changes that we've made earlier last year, those resulted in considerable incremental productivity and benefit on our cost of sales. You've seen our margins, particularly on service, being very positive over -- on a year-over-year basis in the last couple of quarters. I think that's a trend that can continue. And I think that their -- our COO and I have been meeting regularly on additional opportunities to drive productivity over the long term. So I think there's more there. In addition, we've been driving profitability through incremental pricing. This business has been one that has had a revenue management program for some time, and it's averaging 2% to 3% kind of realized benefit for a while. And I think the macro environment is such that, going forward, we'll be able to at least price at the same level, if not potentially even realize more in light of what I think some of the other companies out there are having to do. And when you look at our cost structure, while we've got a component of labor and we're not immune to wage inflation, you've seen us be able to drive improved cost of sales and thereby drive those service margins through those productivity efforts together with opportunities on pricing. So where a large portion of our cost base and our revenue and profit is driven off of the storage side, which has relatively less escalation from things like general inflation. So I do feel very confident in our ability to continue to price going forward, Eric, in light of the just the services and products that we offer, the client trust that we have and what else is going on in the macro environment. Beyond that, I'll just point out one other headwind that we've intentionally kind of created for ourselves over the last couple of years is we have been doing a level of sale leaseback and -- on the industrial asset side. And that's for good reasons, right? We're very -- we find the cap rates that we can actualize as being very attractive for those industrial assets. And over the last couple of years, we've been at above average levels, in the last year, a few hundred million, this year, my guidance was $250 million of industrial asset recycling. Now of course, the other side of that is it comes along with some level of incremental rent, which we've been putting through the EBITDA. Without specific guidance, I think the reasonable way to think about it is, over the long term, we'll probably be at that $100 million to $150 million a year kind of level, which just from a -- if you work through the map, that creates less of a headwind than what we've been experiencing with the larger transaction. I'm not saying that we wouldn't do a larger transaction going forward, but we have a very well-funded plan as it relates to supporting our growth capital. And with our leverage now back inside our leverage target range, we feel very good about our ability to both internally fund our growth while growing earnings.

Great. That's a good overview, Barry. So just diving into the cost inflation, which has become a pretty hot topic around a lot of industries. You mentioned, obviously, your revenue management program. Typically, you're seeing price bumps of 2% to 3% for the year. And to the extent that this inflationary environment that we're starting to see ourselves in now is more permanent and not transitory, how do you think you're positioned in terms of your ability to raise that -- take that revenue management program and raise pricing even further so you can keep margins steady, you can keep return steady? Maybe just talk about the various puts and takes into inflationary environment and how it impacts you?

Okay. Sure. So when you look at our cost structure, right, there's wage inflation for those folks that -- we employ about 25,000 people around the world supporting our client base. And naturally, there has been and will continue to be a level of wage inflation. You've seen that in our P&L, albeit we've kept, I think, our total labor costs very well in check in light of the productivity initiatives I mentioned, there's more of that going forward, in my opinion. And so -- then you naturally have some level of -- for those leased facilities, rent escalators, but we -- those are very predictable because those are built into our leases. And on the other hand, from a pricing standpoint, I would say that the macro environment is such that it probably bodes for a little bit more price for us going forward. Because when you look at the sorts of businesses that we would benchmark off of under analogs for the sorts of activities that we're doing, whether it be couriers and other logistics companies, they've got a much larger -- generally speaking, they've got a much larger wage content in their cost structure. And so they've got to, I think, price more relatively speaking than they've historically priced. And that macro kind of umbrella likely creates incremental opportunity for -- I think, for anybody in these broader business lines. So without giving specific guidance for next year or the year after, I do think that the pricing opportunity continues to be a good one for us. And our new products and services are obviously quite compelling to our customers, and they're continuing to uptake those. So I feel very good about the organic opportunity in the business, Eric.

That's fair, Barry. And what about the inflation conversation specific to your data center business? So we've heard about some component costs that are going up. This kind of ties into the whole supply chain conversation with lead times for items like generators elongating somewhat. There's been some consensus that data center pricing may be able to increase in the next couple of years. But have we really seen that yet? Is that something that you expect? And have you noticed any higher development costs in your data center business to date? Or has it mostly been insulated from repurchased inventory you have?

Yes. So we would generally say I haven't seen much inflation that we didn't plan for. If you look at my guidance earlier in the year, I mentioned that we had planned for a fair amount of inflation. I didn't have a crystal ball, but that's kind of the way we prudently planned it. And in fact, one of the reasons that our total margin for the company has been better than we initially planned is that inflation generally has been underneath what we had planned for in the initial guide. Specifically around data center, I've been really seeing too much there that we didn't expect. I wouldn't say that there is nothing happening there. There is a level of inflation. But from your point about prepurchases as well as just being very good about sourcing, we've been quite pleased with the way that's been trending for us. Now our margin on data center has been, on a transitory basis, impacted a little bit here. And we had projected this at the beginning of the year that it would happen because we were going to be doing a level of almost pass-through services on our Frankfurt asset for the client that is taking that entire facility. We'd be doing some fit-out services that we would traditionally do at a relatively thin margin, but happy to do that in light of the strength of that lease. And so -- but that's transitory. That would -- we mentioned that, that would be an impact during the third quarter and the fourth quarter. And as we move forward, I think the EBITDA margins on our data center business have a very positive trajectory over the long term as we get more towards a stabilized position. The other thing about our data center business is obviously we're continuing to develop, and we'll be developing for some period of time. As I look at what projected margins are on the stabilized assets, they're quite good. And as it relates to your question about pricing, I do think that from everything I'm seeing out there together with hearing from other peers in the industry, that pricing is likely to be more positive going forward. What we've been generally been planning for is something like flat to slightly up. And I think market by market, generally speaking, where we play, it's been at least that good.

Okay. That's -- understood. I guess continuing on with the data center theme. You're well on track, as you've mentioned, to lease 30 megawatts this year of capacity. And as you look into your pipeline, where are you seeing more opportunities over the next 12 months, for instance? Is it -- are they more on the hyperscale side? Are you seeing enterprise demand that may have been impacted by COVID-19 last year start to return? Maybe you could just kind of give us a highlight of where you're seeing the most demand and the mix between those 2 big segments?

I would say our team is doing a great job on the data center side, continuing to both execute leases as well as build our pipeline. And on the enterprise side, it's been good and building. And on the hyperscale side, we, over the last couple of years, have been growing a lot, and I think we've now gotten to a point -- really a year or 2 years ago, got to a point where the business was large enough that we're on the radar screen of all of the largest hyperscale players. So we -- whenever they need capacity in a given market where we're playing, or frankly even in markets where we're not playing, we're hearing from them about those and seeing a request for proposal and quote. And where -- we've been winning and we've been having a very good year with -- on the hyperscale side, in fact, being a little bit more hyperscale than our traditional expectation. Our expectation is to be, over time, more like 50-50 enterprise, hyperscale. And so we felt very good about where things are. We've got great capacity and additional build-outs happening in Virginia and in London. Obviously, we just bought an asset in Frankfurt. Those are some of -- in Amsterdam, we have a nice facility there. We -- those are some of the key markets for us, and we feel very good about the pipeline we have to continue to lease up.

And as we think about you expanding further in the data center business, Barry, I guess, is the primary goal for new markets potentially to do some type of new development, greenfield, brownfield, potentially pre-leased with an existing customer? Are there M&A opportunities out there that might be interesting? Obviously, there's been pretty material M&A in the space recently, although multiples are certainly very elevated. How would you think about that balance of doing development versus M&A and data centers, particularly as you look at new markets that might be attractive for you to enter over time?

Sure. So we've got quite a few megawatts that we've held for development, and we feel very good about the markets we have those in. So while I'd never say never to anything, you shouldn't really expect us to do a large platform-oriented data center deal for a few reasons. One, we feel like we've already got a very nice global footprint. Two, we've got a lot of megawatts to develop. And as I mentioned, that pipeline is building to lease those up. And we're more interested probably, Eric, in sort of surgical deals where we can pick up an asset, to your point, like our Frankfurt 2 asset that we just purchased, where it was one that we could purchase at a relatively reasonable price, almost equivalent to building it out, get into the market that much faster and where we have a pipeline that we can lease it up relatively quickly. You'll note that within just weeks literally of closing that transaction, we signed up a couple of megawatts into the facility, thanks to the fact that the team has done a great job building out pipeline and developing a client base. So you should expect us to -- and then that deal was of the order of $90 million. So reasonably nice tuck-in deals are something that we would have our eye out there for and together with that, continuing to aggregate land bank for future development. And you should be expecting us to dedicate something on the order of a few hundred million a year at least into our data center development CapEx.

Okay. That makes sense. Obviously, you're well aware of some of the large data center deals we've seen in the space. There are 2 take privates and 1 strategic acquisition. A question we often get is, particularly when companies go private, do you know -- see any notable differences in their competitive intensity in terms of their willingness to maybe bid more aggressively on price in a private context versus some of the public peers? And I've realized there aren't that many public peers left now. But just wondering if that's something that you've noticed over time. And whether you think a lot of the hyperscale-focused data center companies going private changes the competitive dynamics within the industry at all?

Yes. So we've been -- naturally, we've been following that as well. And I would say, certainly, for the private players that have been -- that we've been competing with over time, we haven't seen a discernible difference. And we found them to be quite disciplined in terms of the way they price. I don't have a crystal ball for the future, but I would say that these larger assets that are being taken private by very well-run private equity organizations are likely, I think, to want to be quite disciplined. Because to your point, they are being taken out at very high multiples. And my guess is that lowering pricing is not part of the return algorithm. Frankly, I view these acquisitions as another testament for why -- an example of why we really like the space, which is that it's a long-term secular growing portion of the economy where there is going to be that much more client need over time. So it furthers some of the reasons why we're very bullish on the data center space.

And one of the concerns, specifically related to more wholesale or hyperscale deployments, was on renewal spreads and mark-to-markets being negative from some vintage leases that were signed 5 or 7 years ago as they renew. Can you kind of just remind us whether you have any material above-market leases that are left to come out, whether that's from the IO -- I guess it would be from the IO transaction? Or should we kind of expect pricing to be relatively stable to potentially even increasing at some point on renewal?

Yes. It's a good question, Eric, and you put your finger on where we have had some level of roll down, which was on the IO acquisition. Now we knew that when we priced that deal and built it into our return expectations. And this is -- and we said this publicly before, this is likely to be the last year when we look at the lease profile of what was to be renewed, where we have any level of kind of significant mark-to-market in terms of renewals. And so as you get out beyond this year, I do think that pricing will be flat to slightly up, if not better, going forward. And you shouldn't be expecting us to be dealing with the mark-to-market adjustments of that sort going forward.

Okay. That is helpful. So I wanted to touch on kind of the balance sheet leverage uses of capital. So you're now within your longer-term leverage target. And which seems like it should continue to come down, particularly as growth picks up in the business. So maybe you, at a higher level, could give us your thoughts on the leverage trajectory of the business here over the next few years? And then as you look at reinvesting how do you think about uses of capital going forward between growing the dividend, investing in more organic CapEx and data centers or other businesses, additional M&A and/or share repurchases?

Okay. Thanks, Eric. When I joined the company a couple of years ago, we were a little beyond our target leverage range for some good reasons, inclusive of the acquisitions that we were just speaking about. And -- but our leverage range target was 4.5 to 5.5x, and the team has done a phenomenal job growing earnings and driving cash generation all through the cycle here and now got the leverage range back into -- got the leverage back into our target range for the first time in several years. And our expectation is to operate inside that range. Again, I'd never say never about operating outside it again, but I -- you should really be planning for us to be inside the range generally speaking going forward. Now as we're inside it, that enables us to have more flexibility for funding additional development of our data center and other growth avenues. In particular, you asked about allocation of capital going forward. So on the dividend, the way we think about it is we are targeting a payout ratio as a percentage of AFFO at something like the mid-60s. Now if you work through my guidance for this year, you'd find that, that's around 72%, 73% this year. So as we grow earnings and therefore, grow AFFO, we'll work down over the next 1.5 years, 2 years, without giving specific guidance into that payout ratio. And at that point, you should be expecting the dividend to grow in alignment with the growth in AFFO, just to maintain the payout ratio. And then as it really turns -- as it relates to other capital needs, we would certainly be continuing to fund the data center development that I mentioned, something on the order of a few hundred million a year. And then in addition, we are looking and we will continue to look for tuck-in acquisitions of the sort that I was mentioning earlier. Those would be the principal uses of capital.

Makes sense. And I think you mentioned earlier, Barry, on the capital recycling front, somewhere to the tune of maybe $100 million to $150 million per year. I mean maybe you can talk about where kind of industrial cap rates are today? It's not a market that we follow closely. I know that they're very, very attractive from a cap rate perspective in the maybe 4%-ish range. But just wondering what you see in the market? And it sounds like you have at least a few years left of potential industrial capital recycling to work through as another funding lever?

Yes. So if you look at the company's historic industrial recycling and not counting this year and last year, we'd be in that $100 million to $150 million kind of range annually that you were mentioning, Eric. And I think that's not a bad place to pencil for the go-forward few years. I'm not suggesting that we wouldn't take advantage of the market, again and potentially strategically continue to recycle. But one of the reasons we've been recycling a little bit more over the last couple of years is it's helped us fund our data center development capital while maintaining and bringing our leverage down. And as you point out, it's at very attractive rates. In terms of the -- in the industrial cap rates -- of course, it's all facts and circumstances driven over the specific asset or portfolio of assets. But a lot of the deals we've been doing are certainly well sub 5, in fact, some sub 4. And so those are at levels that are we think, very attractive to then take that capital and redeploy it into our development pipeline where we can get much higher expected returns. And I'll note that in light of the market dynamics for industrial assets right now, it really is a situation where we can put out to offer what assets we want to recycle, together with a sort of form lease on our terms, in terms of the escalators and renewal options, such that we really have ownership like -- we play as an owner essentially without having it on our balance sheet and then monetizing that and then putting it back into the data center development CapEx. So we have found the industrial asset recycling to be a very strategic portion of our capital allocation model the last few years, and you should expect us to continue to do it going forward.

Okay. Great. Well, I think we are out of time. So Barry, thanks again for your time today. Always good to see you virtually and looking forward to 1 day doing this in person.

Some day. Thank you, Eric.

Thank you.