Iron Mountain Incorporated (IRM) Earnings Call Transcript & Summary

So data center renewal spreads reached 12% on a cash basis in the second quarter. How sustainable would you say the current pricing environment is? And particularly as you look at customers that are pursuing these larger AI-related deployments and given all the significant power development, how do you see the overall return and pricing environment evolving?

Okay. So I'm going to break that apart because in our business, the renewal spreads is really as it relates to our enterprise colo book, which is ballpark 1/3 of what we're operating these days. And that -- the mark-to-market and renewal spreads on that part of the business has been very strong for quite a few years now. I think like double digit to even 20% compounded for like the last 3 or so years. But that's really just a factor of what's going on in the given markets where we have space, George, because if you look at our relative churn, it's quite low. It's been running, I think last year, we were at sub-3%. And kind of like 2% or so through the first 9 months, 2.5%, quite low. And so that speaks to the fact that it's not like we're pricing beyond what's in market. The alternative for our colo clients, which renew about every year on average is what else is out there. And frankly, that's the market. As it relates to renewals on our larger format leases, the fact is we're still a very young operator. If you look at our -- we didn't get our first large single-tenant lease on the hyperscale side until about 2020, 2021, and that lease didn't even commence until 2023. And it was a decade of duration. So if you look at our lease expiration table, what you'd find is we've got a tremendous amount of megawatts that don't renew for in excess of 5, 6 years. In fact, our weighted average lease expiration across the entire portfolio is north of 10 years, and that includes the colo book, which renews every year with that low churn. So I think in the future to project out some -- all of those client contracts that I was just referring to on the hyperscale side have renewal options for them. And my guess is in light of the fact that energy continues to constrain and will likely continue to be a constraint for quite a long time. It's going to be very advantageous for those clients to renew in the future, but you're talking about 5 to 10 years from now or longer.

Right. Okay. Let's switch gears and talk a little bit about the ALM business. in the second quarter, the asset life cycle management business grew nearly 90% year-over-year you mentioned revenue scaling to basically $1 billion for the year. How much of the recent growth acceleration would you say is being driven by customer adoption compared to, say, memory prices or project timing?

Okay. So again, breaking the business into the 2 parts of the way we manage it, you've got our enterprise or corporate side and then you've got the ALM data center, hyperscale data center decommissioning. That's where in that side and hyperscale decommissioning side is where you've got a lot more exposure to memory. And in any given period, memory might be 50% or more of what we're decommissioning in terms of the value of the gear. And to be sure, memory pricing has been up year-on-year. And depending upon the grade of memory because there's many different, if you will, SKUs of memory based on the manufacture of the memory or the relative size, speed, et cetera. Pricing has been rising. Some prices have been, as I mentioned on the last call, depending upon skew to SKU, you've got some that have been up as much as 30% in recent periods. You've got others that have been down some. But what comes -- what really also needs to be in the calculus is the relative mix because as I mentioned on the last call, in the second quarter, I think some investors had expected pricing to be a really big benefit to us. And it was on some SKUs, but in total, we had relatively more DDR3 in the second quarter than we did in the first quarter when we had more DDR4 and DDR4 is at a relatively much higher price in the R3 because it's a newer generation. And so there is an element of like mix involved here. But look, I projected out going forward for this year, that memory pricing would be basically pretty stable for the remainder of the year from where we exited the second quarter and it's been probably stable to even slightly up since that period of time. But again, the mix is a big factor. On -- I will note that on the hyperscale data center decommissioning, that's generally a lower-margin business for us versus the enterprise side. On the hyperscale side, you're talking a revenue share model where we might get 20% of whatever we sell the year 4 and the rest goes back to the client. And so that's meant to cover our cost of decommissioning, fulfillment, shipping, et cetera. So that -- the margin structure on that business is more like low double digit to high teens, that kind of thing. And -- but on the enterprise side, where it's much more fee for service, and we're dealing with older gear that clients generally, if you will, sweat the assets longer it's more of a fee-for-service and the margins and there can be more like mid-20s to 30s. And that is the part of the business that we think inherently has will be the larger and longer period of growth in the ALM business for us over time. Not to say that the hyperscale business isn't growing rapidly, as you point out. It certainly is and can continue to in light of the TAM growth.

Yes. Okay. Let's talk a little bit about the records management business, both the physical and the digital solutions part. So the physical part has seen volumes be relatively stable for a long time now, flat to up. And you're seeing customer consolidation, you're seeing outsourcing opportunities, how durable would you say that volume growth profile is in that legacy physical records management business. And what could cause the growth to move above or below the current range, which is somewhere between 0 to 50 bps of growth.

Yes. For people who have heard me over the years, I've been with the company now almost 7 years. I kind of keep saying the same thing about that part of the business, George. We love that business because it's very cash generative and it's super durable. We have been growing the volume, the physical volume in that business on an organic basis for many, many quarters now in a row. And really, it's years at this point, together with strong pricing. So the last -- this year, last year, we were actualizing around 6% pricing benefit. And the volume is growing, albeit very slowly, like we've always said, we expect it to be slightly up, I think, like 20, 30, 40 basis points a year. And with that model, that business generates a tremendous amount of cash. And it speaks to the fact that how are we doing all that, how we're doing the pricing, the revenue management actions together with incremental volumes because we're giving our clients a really good value. We continue to bring out services that they can't get from any other vendor in this place. There's plenty of competition. But we offer a worldwide solution for large corporates and we've got a very consistent track record of doing this in a highly secure and effective way -- and we make it very easy for them to do business with us. And so we expect that business to continue to be stable to slightly up on a volume basis for the foreseeable future together with strong pricing. And as you know, there are some markets. India is the one I talk about the most frequently because it is the largest opportunity for us where outsourcing is just really starting as it relates to records management. And there's a huge opportunity for additional growth there. And the margins in India are very good as they are around our records business across the globe. So we think that can continue to grow at a mid-single-digit plus clip rate for a long period of time. And then you started to ask a little bit about the digital solutions business. That's a business that is actualizing on an annual basis today at north of $600 million of revenue. You don't have to go back many years where it was like sub-$200 million. back 5 or 6 years ago, it was principally a scanning business and very project-oriented, meaning we had to win business each year to keep going. But now the team has successfully been winning more and more business that's recurring and that is multiyear in nature. So we start each year with a larger base of revenue generation. And we're getting into many more software-as-a-service deployments utilizing our DXP technology, which enables us to help clients with content that they have historically not been able to use essentially dark data. And so with the various new AI tools together with our DXP platform, we think our digital business has got a lot of opportunity for additional growth, George.

Sticking with digital, how much opportunity do you think the new contract with the treasury department will contribute to revenues this year and next year and after the growth will be driven by that versus traditional DXP deployments.

Yes. So that's a good size contract. And as many people have probably heard me talk about in the past, it was a complicated procurement situation over the prior year. But this year, now that we're kind of doing the work for the government -- we expected to do -- at the beginning of the year, I said we'd probably do about $45 million of revenue. We were a touch ahead of our expectations in the first quarter on revenue, and we were a couple of $2 million, $3 million ahead in the second quarter. And so we will probably exceed that level that was initially expecting. And we have noted multiple times that next year and for the years beyond, we expect to do at least $100 million of revenue on that business. Now -- the government did award the contract to potential partners for that. We were the largest player, and I think we're doing much more business than any of the other players as our service level agreements that we have with the government, we are doing in a very diligent way in meeting all of the requirements and then some that are under that contract because as you would imagine, the government is very sensitive to the confidentiality of that sort of work and the chain of custody and frankly, speed and quality and efficacy of the work, and our teams are doing a great job there. If we got 100% of the theoretical volume that the government put out to bid, we would probably generate about $150 million of revenue in a given year, George. But our expectation was in light of just having multiple vendors, et cetera, we think we'll get the majority of the market share. The -- one of the things that is a factor is, of course, both how many returns are coming in, how much correspondence there are with taxpayers, but of course, also how quickly the government outsources the business. And so that's one of the reasons why this year we anticipated like $45 million. As I mentioned, we're in a little ahead of that. And then ramping over the next year plus as the government continues to essentially learn how to outsource what is something that they've always done internally.

Yes. Makes sense. We've got a couple of more questions, but I'm going to pause here to see if there are any questions from the group here. No. Okay. Let's move on to margins and in cash flows. So the AL business is a bit margin dilutive to overall company EBITDA margins. Can you talk a little bit about what your outlook is for consolidated margins over the next couple of years? And what factors could drive reported margins to expand? .

Yes. So -- the way I usually explain this is a couple of things. If you look at our business, we have 5 or 6 distinct businesses that are that make up our amount. So there's the record management box business, which is our highest margin business, and it's doing very well. Then you've got a services that those are professional services that go along with the box. You've got our digital business, we were just talking about our data center business and the 2 different ALM businesses, the hyperscale and the enterprise. The enterprise margin, therefore, is the amalgamation of all of those together. And if, as you pointed out earlier, the ALM business is lower margin. the enterprise business, as I mentioned earlier, is more like 20 to 30s whereas the hyperscale is lower than that. If those businesses are growing faster than the rest, then naturally, that's just an obvious headwind to the actual enterprise margin. But the thing that's really important to note is in each 1 of those businesses I just highlighted, they are all increasing their margin within their businesses. And they have the opportunity, and we see the ability over the next few years to continue to increase the margin across each 1 of those businesses. So then it just is a relative growth rate. And when I think about our 2 biggest growth businesses in the growth portfolio you mentioning earlier. In one case, you got data center and you have the other, which is ALM. And they're both this year going to be a little -- right around $1 billion of revenue -- they've both got huge opportunities for growth. And data center is an accretive margin for us. So we're doing like low 50s EBITDA margins in data center today. So as that continues to grow and lift its margin, -- and as ALM grows and we lift the margin within ALM, there's a lot of opportunity here, George. And the other thing is, while you point out ALM is kind of a dilutive margin to the total, I'll just say it's all incremental to the company. It's not like it's taking from any other part of the business. That is a truly incremental business for us, and it's a franchise, which we think can be measured, as I said earlier, in billions with an increasing margin -- and so we're feeling really good. And furthermore, the ROIC on that business is actually quite high relative because there's just not a lot of capital required to grow it.

On the topic of capital requirements, a lot of the CapEx spend today is being deployed to data centers. As you think about future growth investments, including data centers and other areas of the business, how -- what are your expectations for cash flow generation, cash flow conversion? How should that evolve from where it is today?

Yes. So we -- we're kind of an operating company inside of a REIT structure, as you know. And unlike a lot of REITs, we generated a tremendous amount of cash off of our core businesses, which we then can use to fund a portion of our growth. So if you look at it, George, I would say our Cash after discretionary -- cash available for discretionary items is growing appreciably. I think like hundreds of millions each year over the next few -- and so that means that we can continue to build out our data center portfolio with relatively less debt each year. And we have a dividend in our framework for our dividend is that we're going to pay out at a low 60s percent of AFFO. And if you look at that as a result of how fast we've been growing AFFO over the last few years, we've grown the dividend, call it, 10% each of the last few years. And with continued very positive outlooks for AFFO, you should anticipate the dividend will continue to rise. But -- that works very well with the growth of the free cash flow off the core, together with the fact that while we've got a lot of megawatts to build out. As I said, we're not a speculative builder. So we're going to build those as they energize with -- hopefully with pre-leased contracts. And as a result, the incremental call on the capital is pretty consistent in here as it relates to how much we're spending on data centers over the next couple of years, subject to additional land purchases. So -- we think we can continue to run the business at leverage levels right in here, say, we're a little below 5x, which is our target midpoint of our range and generate increasing levels of free cash flow. -- to invest in the growth.

Wonderful. We're just about of time. Barry, thank you for the great discussion.

Thanks, George.