鐵山公司 (IRM) 2018 Q3 法說會逐字稿

Good morning, and welcome to the Iron Mountain Third Quarter 2018 Earnings Conference Call.

(Operator Instructions) Please note this event is being recorded.

I would now like to turn the conference over to Greer Aviv, Senior Vice President of Investor Relations.

Please go ahead.

Thank you, Gary.

Hello, and welcome to our third quarter 2018 earnings conference call.

The user-controlled slides that we refer to in today's prepared remarks are available on our Investor Relations site along with the link to today's webcast.

You can find the presentation at ironmountain.com under About Us/Investors/Events & Presentations.

Alternatively, you can access today's financial highlights, press release, the presentation and the full supplemental financial information together in one PDF file by going to investors.ironmountain.com under Financial Information.

Additionally, we have filed all related documents as one 8-K, available on the IR website.

On today's call, we'll hear from Bill Meaney, Iron Mountain's President and CEO, who will discuss highlights and progress toward our strategic plan; followed by Stuart Brown, our CFO, who will cover financial results.

Referring now to Page 2 of the presentation, today's earnings call, slide presentation and supplemental financial information will contain forward-looking statements, most notably, our outlook for 2018 financial and operating performance.

All forward-looking statements are subject to risks and uncertainties.

Please refer to today's press release, earnings call presentation, supplemental financial report, the safe harbor language on this slide and our annual report on Form 10-K for discussion of the major risk factors that could cause our actual results to differ from those in our forward-looking statements.

In addition, we use several non-GAAP measures when presenting our financial results and a reconciliations to these measures, as required by Reg G, are included in this supplemental financial information.

With that, Bill, would you please begin?

Thank you, Greer, and hello, everyone.

Before I begin, I first wish to welcome Greer to Iron Mountain in her role of leading Investor Relations.

Finding someone who has the skills, experience and reputation to replace Melissa wasn't easy.

We, therefore, felt very fortunate when we found that person in Greer.

So welcome Greer.

We're very pleased you're here.

So Melissa, who will be retiring at the end of the year, I wish to take a moment to thank you, as this will be your last earnings call.

Melissa, as you know, started at Iron Mountain the same time as me.

It is impossible today to thank her appropriately.

But I do wish to mention that we will be eternally grateful for all she has done doing a superb job, leading not only our IR function, but much of our communications as well over the last 6 years.

She has done all this against a backdrop of the company executing an agenda delivering significant growth to our business, which has been transformative.

Thank you, Melissa.

I don't know how we would have done this without you.

Now moving on to the quarter.

We're pleased to report another strong quarter of financial performance coupled with marked progress in our strategic plan as articulated 4 years ago, designed to support the shift in our business mix.

Our plan revolves around 3 pillars: getting more out of our developed markets in terms of yield and cash flow; expanding our records management model in the faster growing emerging markets; and building on our strong customer relationships with 950 of the Fortune 1000, coupled with our know-how in order to expand into adjacent business areas.

To this end, we're very pleased by our progress across these 3 pillars.

A few proof points of this can be readily illustrated at a high level.

We continue to maximize yield from records management in developed markets with adjusted EBITDA margin in North America RIM now over 46% with growing internal revenue, albeit on lower volumes.

We achieved internal service revenue growth of 7%, which is a result of growth in shred in business areas such as information governance and digital solutions or IGDS.

We progressed towards our goals in making records management in the faster-growing emerging markets a bigger part of our mix where these markets represent 18% of our revenue, whilst continuing to improve EBITDA margins, which are now over 30%.

And we advanced the expansion of our data center business, which even at this early stage is now making a marked impact on our EBITDA and AFFO growth, given it is now more than 8% of our adjusted EBITDA and is already expected to contribute 100 to 200 basis points of adjusted EBITDA growth on a consolidated basis.

All told, the consistent delivery against our strategic goals has continued to drive strong growth in profitability as measured by year-over-year expansion in both gross margin and adjusted EBITDA margin, supporting healthy cash flow generation to fund our business investments, whilst also reducing leverage over time.

As a result, this morning, we announced a 4% increase in our quarterly dividend per share in-line with our 2020 plan.

This is supported by our year-to-date AFFO growth of 13.7%, which is well in excess of our 8% increase in share count.

For the full year, our AFFO payout ratio is expected to be sub-80% versus our original guidance midpoint of 81% even after increasing the dividend.

Our third quarter performance outlined on Page 3 of the presentation is highlighted by total revenue growth of 12% on a constant dollar basis, solid growth in adjusted EBITDA with an 80 basis point increase in EBITDA margins, continued durability of our storage business with total internal revenue growth of 2.3%, strong internal service revenue growth of 7.1% for the quarter, good progress on integrating our data center acquisitions illustrated by strong data center portfolio utilization of 91.1% and continued organic expansion of our global data center platform through internal development, including breaking ground on our second phase of capacity in Phoenix and entering into a development agreement in Chicago, a top 5 U.S. market.

In addition, we continue to achieve total internal revenue growth across all markets supported by internal storage revenue growth and strong internal service revenue growth.

We also continue to focus on optimizing both utilization and storage rates to maximize yield as evidenced by further increases in net operating income per square foot as shown on Slide 4.

Volume across our records management business was down 0.1% on a global basis prior to acquisitions or about 700,000 cubic feet.

This was driven by negative internal volume growth in North America and a slowdown in -- albeit continued positive -- volume growth in Europe.

The May implementation of GDPR, or General Data Protection Regulation, is having some impact on behavior related to destructions.

Whilst the European regulation focused on protection of personal identifiable information, this regulation has global reach and covers records held by European nationals inside and outside of Europe.

Beyond regulatory changes leading to increases in destruction activity, from time to time, we have also seen a slowdown of incoming volume.

As the incoming rate of new boxes decelerates, the boxes held in inventory naturally age during this period.

As the deceleration continues, we expect the ratio of destructions to remain elevated until the rate of incoming global volume normalizes.

This interim increase in the rate of destructions is expected to flatten out over time.

However, we expect this net volume dynamic to continue for the next few years in running our business based on this expectation.

Importantly, this impact is de minimis on a bottom line financial basis and does not affect our financial plan in terms of growth in profitability and cash flow as we continue to expect to offset any volume decline through revenue management as well as growth in new services.

Stuart will walk you through some of the financial aspects of all this in a few minutes.

In addition, I mentioned earlier that our information governance and digital solutions business is growing nicely and should over time offset some of the volume declines in physical storage as our customers increasingly manage a hybrid physical and digital world in terms of how they conduct their records management operations.

IGDS provides our customers with the ability to convert physical documents into digital content through the use of migration services, supporting customers' digital transformation.

Growth has been supported by a robust pipeline of increasingly larger opportunities as well as greater customer traction.

Moreover, in terms of further growing our digitization efforts, our newly announced partnership with Google shows early signs in its potential to increase our IGDS pipeline.

With our recently announced InSights platform, we have already developed proofs of concept working with customers in oil and gas, financial services and in internal legal applications.

Additionally, within our services business, we -- our secured shredding unit experienced another strong quarter driven by a significant increase in paper prices, coupled with a 13% increase in tonnage year-over-year.

Moreover, we continue to see new opportunities in largely unvended channels, such as the federal government.

Specifically, on federal government, we were awarded a $65 million 5-year blanket purchase agreement with the Department of Homeland Security or DHS.

With this agreement, we have the opportunity to deliver significant efficiency gains for DHS, providing not only storage and retrieval services, but also accelerating their digital transformation initiatives towards a more modern information governance program.

Additionally, we had another award to help the U.S. Army Heritage and Educational Center with their digital transformation in the preservation of historical artifacts.

This is an example of what we expect to be an acceleration in U.S. government outsourcing and demonstrates that our efforts over the last few years are delivering results.

Another government win came from our fine art business where we were subcontracted to relocate the collection of the National Air and Space Museum to temporary storage as a result of extensive renovation that will take 6 years to complete.

Turning now to emerging markets for our records management business.

We continue to deliver solid internal revenue growth as well as attractive acquisition opportunities to expand our presence in faster-growing markets.

For example, we recently acquired businesses in China and South Korea, which together added more than 3 million cubic feet of storage increasing our scale and further strengthening our position in these countries.

Our data center business continues to perform well with revenue, adjusted EBITDA and investment forecast on plan for full year.

Development opportunities to provide capacity to support customer demand in high absorption markets at attractive returns remain robust.

To that point, as I mentioned earlier, in Q3, we began construction of our second phase of capacity in Phoenix, which is expected to be completed in June 2019.

This phase of capacity will be a hyperscale-ready data center for which we have entered into renewable energy commitments that offset 100% of the power.

The facility, including future phases, will add more than 530,000 square feet and 48 megawatts of capacity at full build-out.

In addition, we are entering the Chicago data center market through a development agreement with the Pritzker Realty Group to develop a 13-acre parcel in this attractive market, which has been tight on capacity for some time.

We are currently finalizing design plans and at this time have not invested any material development capital.

The site is expected to permit construction of a 36-megawatt colocation facility to support the digital transformation initiatives of global enterprises as well as meet the security and performance expectations of the largest public cloud providers.

Turning to our fine arts business.

We continue to focus on expanding our presence in this faster-growing storage-related business, leveraging our core storage expertise and customer service capabilities, whilst being accretive to our focus on maximizing yield across our range of storage offerings.

Subsequent to the end of the third quarter, we completed 2 transactions in the fine arts storage business, further strengthening the market position of Crozier Fine Arts business, though first L.A. Packing, Crating and Transport strengthens our position in the Los Angeles market.

The second transaction, we will assume operations of Christie's Park Royal warehouse in London, representing Crozier's first fine arts storage and service location outside North America.

As shown on Slide 5, we've remained firmly on track to achieve continued internal revenue growth on a global basis fueled by further yield management with ongoing expansion and development in our data center platform and continued growth in our adjacent businesses.

Moreover, given the expansion of our higher growth portfolio, which consists of emerging markets, data center and adjacent businesses, we are approaching approximately 19% of our internal revenue or 23%, including the acquisitions in the last 12 months with a goal to be 30% by the end of 2020.

Additionally, we continue to deliver improvement across the organization in terms of optimizing utilization and driving margin improvement over time.

Altogether, we are within reach to achieve a business mix delivering adjusted EBITDA growth in excess of 5% before acquisitions by the end of 2020.

On Slide 6, I want to reiterate that we remain on track with our deleveraging and payout ratio targets, which assume a 4% annual increase in dividends per share between now and 2020.

We have increased the midpoint of our constant dollar AFFO growth guidance from 9% to 14.5% for the full year 2018.

Stuart will discuss the strength of our balance sheet shortly.

Overall, we expect revenue growth in 2018 to be between 9% and 11% versus our original guidance of 7% to 9%.

We continue to be unique within the S&P 500, in that we are a top yielding company with durable cash flow, delivering low to mid-single-digit internal revenue growth, expanding margins, a solid balance sheet and great long-term growth potential supported by acceleration in contribution from our faster-growing portfolio.

These factors are driving consistent growth in both the top line and in cash flow that ultimately supports our ability to continue to grow dividends per share at an attractive rate, whilst funding investments and delevering over time.

This dividend growth model has been further underscored by our announced 4% dividend increase and solid balance sheet.

With that, I'd like to turn the call over to Stuart.

Thank you, Bill, and thank you all for joining us this morning.

In the third quarter, we delivered strong cash flow growth with solid progress towards our strategic objectives.

Our leading records management business performed well with steady internal revenue growth and strong margin expansion.

Our faster-growing emerging markets data center and adjacent businesses are gaining scale and expanding margins, and our disciplined capital allocation supports strong cash flow to fund our multiyear plan.

We continue to deliver attractive returns for our shareholders through maintaining healthy performance in our durable records and information management businesses, while investing in data centers and other adjacent businesses for further long-term value creation.

This is all underpinned by a substantial high-quality portfolio of owned industrial and data center properties.

I'll start off with the performance highlights, which you can see on Slide 7 and 8 of the presentation.

We're trending at or above all of our key financial metrics from our original 2018 cost and currency outlook and have increased our guidance for both revenue and AFFO.

For the quarter, revenue exceeded our expectations approaching $1.1 billion, growing about 10% on a reported basis, but more than 12% on a constant dollar basis, driven by contributions from our data center acquisitions and strong service revenue growth.

Total internal revenue grew by 4.1% compared to the prior year, and we grew internal storage revenue by 2.3% for the quarter or by $14 million and 2.6% year-to-date.

We're pleased with the results from revenue management, but these are partially offset by slower volume growth, which I will discuss in more detail later.

Internal service revenue grew by 7.1% in the third quarter and by 5.2% year-to-date, primarily due to increased contributions from our shred business, which Bill discussed, as well as additional digitalization and special projects.

Our adjusted EBITDA grew almost 15% on a constant dollar basis for the quarter to $364 million, with margins expanding 80 basis points year-over-year to 34.3%.

The margin improvement resulted primarily from the flow-through of revenue management, the impact of the adoption of the new revenue recognition standard and labor productivity, including ongoing synergies from the Recall acquisition.

I'll provide more color on performance by segment in just a moment.

SG&A as a percentage of revenue, excluding Recall and related costs, increased about 30 basis points year-over-year to mainly to investing in new growth initiatives and other technology.

The adjusted EBITDA margin improvement came even while making these investments.

Adjusted EPS for the quarter was $0.28 per share, down slightly compared to last year, due mainly to the increased depreciation and amortization associated with acquisitions as well as an 8% increase in shares outstanding following our December offering to fund the acquisition of IO Data Centers.

This is all in line with our guidance at the time of the announcement.

AFFO was $680 million year-to-date, up about $80 million or nearly 14% over the prior year, reflecting the strong operating performance, expansion of our data center business and a very disciplined approach to capital allocation, while increasing investments in new businesses.

We increased the midpoint of our full year AFFO guidance by $40 million, of which $30 million was from business performance and $10 million was from the adoption of the revenue recognition standard.

Year-over-year, AFFO growth is expected to exceed 13%.

To touch on operating performance in a little more detail, on Slide 9, you can see developed markets internal storage revenue growth came in at 0.7% for the quarter, despite the negative volume growth, reflecting the impact of revenue management.

Internal service revenue in developed markets increased 7.1% for the quarter, due mainly to growth in our shred business, project revenue and digitization, as mentioned earlier.

In other international, we continue to see steady internal storage revenue growth of 5.1 -- 5.9% for the quarter on 3.6% growth in internal volume for the trailing 12 months, with internal service revenue growth at 6.6%.

In other reporting segments, the details of which are in the supplemental, the data center business delivered strong internal revenue growth of 27% for the quarter, though off a small base of pre-acquisitions.

Turning to Slide 10, you can see the detail of our 80 basis point adjusted EBITDA margin expansion, with growth in most of the segments.

We did experience a margin decline in North America data management or tape business driven by lower volumes as well as customer mix.

In the tape storage business, the amount of digital data being stored continues to grow.

However, greater density on data protection tapes is resulting in lower physical volumes.

In Western Europe, margins in the quarter were lower than last year as we experienced higher bad debt in France where we're now integrating Recall's business.

Note though that Western Europe margins were up 190 basis points year-to-date, reflecting our focus on continuous improvement.

In the global data center segment, adjusted EBITDA margins have improved over 44% year-to-date, reflecting increased scale of the business and progress on integration activity.

We expect data center margins over time to move closer to a mid- to high 50% range as we fully integrate recent acquisitions and add more scale to this business.

Year-to-date, we've executed 6.3 megawatts of new and expansion leases, primarily with enterprise customers and the federal government.

Our churn in the quarter was less than 1%.

We remain on track to achieve 2018 revenue of more than $220 million and adjusted EBITDA of approximately $100 million, which includes integration costs of $7 million to $10 million.

We continue also to expect leasing around 10 megawatts for the year of new and expansion space.

Turning to Slide 11, you can see that lease adjusted leverage ratio was 5.6x at the end of the third quarter, very much in-line with our original outlook, while having debt funded the acquisition of EvoSwitch data centers in Amsterdam.

Our current leverage ratio was comfortably in line with other REITs, especially when considering that our business is more durable than many other REIT sectors.

As of September 30, our borrowings were 72% fixed rate, our weighted average borrowing rate was 4.8% and our well-laddered maturity is an average of 6.3 years with no significant maturities until 2023.

Our strong balance sheet and capital structure is supported by our significant real estate portfolio and long-term nature of our customer relationships.

Turning to our revised outlook for 2018.

We now expect total revenue growth of 9% to 11%, with total internal revenue growth between 3.5% and 3.75%, up from 2% to 3% initially.

Our outlook for internal storage rental revenue growth is revised downward to 2.5% to 2.75% with total volumes expected to be slightly down for the year 2008 (sic) [2018] prior to acquisitions.

We've also increased our outlook for AFFO growth, while narrowing our EBITDA -- adjusted EBITDA guidance, the details of which can be found on Page 6 of the supplemental.

We would also like to remind you about the exchange rate impact on our reported results that we communicated on the Q2 earnings call.

Exchange rate headwinds have strengthened since then and we've added reported dollar ranges reflective of the headwind to our guidance page in the supplemental.

In addition, we've refined our cash available for dividends and discretionary investments schedule on Slide 12 to reflect our expectation of lower cash taxes and interest expense as well as the lower level of acquisitions in records management and slightly higher proceeds from real estate dispositions generating more internal cash to fund investments.

While we plan to provide comprehensive 2019 guidance on our February earnings call, at this time, we're basing our business plan on an expectation that internal volume will continue to be negative in North America and total internal revenue growth to be in the low single digits.

As in this quarter, we continue to expect revenue management to more than offset any global volume decline and to continue growing our internal storage rental revenue in 2019.

While we continue to see good progress on our IGDS business, we do recognize that paper prices in our shred business are at all-time highs, which we do not expect to repeat in 2019.

We remain confident in our ability to grow adjusted EBITDA, cash flows, and ultimately, our dividend in line with our 2020 plan.

To further underscore our confidence, I would like to provide some perspective around the volume moderation.

For illustrative purposes, what, for example, might be the impact if we had a global volume net decline as large as 1% of total volume or 7 million cubic feet, which is 10x larger than anything we've experienced.

If you assume the volume decrease comes from a combination of fewer incoming boxes and increased destructions, the revenue loss from the fewer incoming boxes would be largely offset by an increase in destruction-related fees even before any paper revenue.

So in the first year, the EBITDA impact would be de minimis.

In second year, the lost revenue would be about $20 million or $3 per cubic foot.

So even if the global level of decline was 10x greater than what we're currently saying, we could absorb the impact through faster growth in our other businesses, better revenue management or cost-saving initiatives and continue to achieve our 2020 plan.

In summary, we remain on track to continue strengthening our balance sheet, while funding our targeted dividend increases, such as that announced this morning.

We can -- we expect our strong cash flow generation to enable us to fund dividend increases, while improving our AFFO payout ratio.

We are pleased with our third quarter business performance and results year-to-date.

Our revenue management is working well, driving steady growth and strong margin expansion in records management business.

Further, we remain intently focused on integrating and scaling our data center platform.

We look forward to updating you on our progress and providing more detailed 2019 guidance on the Q4 earnings call.

With that, I'll turn the call over to Bill for closing remarks before we'd open it up for Q&A.

Thank you, Stuart.

To summarize, we've had a strong quarter both in terms of financial results as well as progress on our strategic plans.

Key financial highlights include: Upping our AFFO and revenue guidance for the year, increase dividend by 4%, whilst improving dividend coverage.

In terms of key strategic highlights, with continued margin improvement, build-out of our faster-growing adjacent and emerging business areas, they now represent almost 19% of sales mix or 23% post acquisition.

This mix is already delivering 4% organic EBITDA growth, some 200 basis points better than 3 years ago and in line with our 5% organic EBITDA growth goal for 2020.

So we're well on track for our 2020 objectives given our successful shift in business mix.

Now operator, we would like to open up for questions.

(Operator Instructions) The first question will come from George Tong of Goldman Sachs.

You've indicated that you're largely done with implementing your revenue management initiatives in the U.S. Can you discuss your progress in rolling out your initiatives in Europe and Asia?

And frame how continued rollout will alter your internal growth rates going forward in storage?

Okay.

No, it's a good question, George.

So let me answer it in 2 parts.

So first is that, when we say we've completed rollout, we've rolled out the infrastructure, but we continue to expect similar levels in absolute terms of revenue management benefit in developed markets next year as we did this year.

So continuing to get that kind of benefit that we've seen in this past year from revenue management for North America and Europe.

In terms of how we're rolling that out, you can even start seeing that in this quarter in terms of -- historically you'll recall that, if you've looked at our internal revenue growth in the emerging markets, you would see that, that was almost all driven by volume and you can now start seeing that we're actually getting positive traction.

I know one is on a sequential basis and one is on a year-over-year -- or trailing 12 months basis.

But if you look -- see, the numbers aren't "directly comparable," but you can start seeing that they're starting to actually get a positive spread.

So we've rolled out -- doing this top off my head -- we have a center now, I think it's in São Paulo, we have one, I think, in Hong Kong, we have one in Budapest and there's one in Sydney, or Melbourne, I should say.

So we've got 4 new pricing clusters, if you will, or we've actually invested in pricing expertise.

And you're now starting to see that spread where we're getting even more in the emerging markets.

And we expect that to accelerate.

So if you say -- if we go forward into 2019, just to underscore it, we expect to get a similar level of absolute dollar benefit or uplift from Western Europe and North America as we did in 2018 and we expect to get further increases next year.

So we'll do even better on revenue management that will be coming from the emerging markets.

Got it.

That's helpful.

And then as a follow-up, shifting to look at your services business, you talked a little bit about paper price trends for next year.

Can you talk about on a underlying basis how service activity is currently evolving?

How conversations with customers are changing there?

And how retrieval in new business activity will alter or not alter the growth trends in services?

So let me answer it at a first cut and then Stuart may want to talk a little bit more about paper prices because paper prices are a big driver in terms of the results that you've seen in service because we're benefiting from quite strong paper prices right now.

So if you think about it kind of in roughly 3 buckets of service, is we have the shred, we would have what I would call the normal transportation and activity service level around RIM and then we have new business service areas around IGDS.

So on the shred, there's 2 aspects and I'll ask Stuart to comment again about the paper pricing.

But if you see that, our volumes are up by 13%.

So in other words, we are actually -- so there is an activity aspect about shred, which we expect to continue through in 2019.

The other part is the benefit that we get on service revenue from selling the paper.

If we look at the transportation, our transportation activities continues to slow down, but I think in the -- as we've said before on previous calls, if we look at the box business, that's starting to hit a more steady-state level.

On the tape business, we still see a drop in terms of transportation on terms as the tape business is becoming more archival as well.

But where the real improvement has been in service, so the story evolves and going to positive service is not so much a change in the transportation.

It's more about these new digital services or information governance and digital services that we're operating.

And over the last 2 or 3 years, we've seen a doubling in that size of that business.

So it's really -- we're quite encouraged that as our customers are trying to manage this hybrid digital physical world, the relationships that we have developed with them on information management over the decades where it was historically more in the physical realm is really giving us the opportunities to help them manage that transition.

And we think partnerships such as the Google partnership will continue to add products in that pipeline that can only accelerate that.

So we feel really good in terms of our setup for 2019 to continue to build out and grow the information governance and digital services, and we've had a great last couple of years in terms of growth, and we expect that type of growth to continue.

I think the transportation, to me now, is still waning a little bit, but it's not -- it's being more than offset by our growth in shred and in IGDS.

And then the -- going into the 2019, I'll turn it over to Stuart, is that the paper prices are an impact in terms of what 2019 will look like.

Yes, so just to quantify the impact of paper prices, so if paper prices reverted back to the historical 3-year average from where they are today, that would be about 100 basis point impact on service internal growth.

The next question will come from Sheila McGrath of Evercore.

I was wondering if you could comment on your revenue management approach.

Do you believe some of the elevated destructions are a result of customers revisiting these boxes under a higher pricing scheme?

It's a good question, Sheila.

And we continue to monitor it.

We don't see -- it could on the margin, but we don't see a major link in terms of what we're doing on pricing in terms of increasing destruction.

The major increase in destruction, I would say, was in part by the GDP -- GDPR coming into effect at the end of May.

So that was forcing people to relook at the way that they retain personal identifiable information.

By the way, it also leads to more opportunities on the IGDS, I should say.

And then the other part is that, we have seen a deceleration in terms of incoming volume from verticals that are from customer segments.

I should emphasize that virtually every customer segment is still sending us new boxes, but as that rate has reduced over the last months, is what happens is that you get a deceleration of incoming.

The boxes that they've already sent us are not being replaced at the same rate.

And generally, what we find is in the 0 to 7-year mark is when people more -- it's usually around the 7 to 10-year mark is when people do the destructions.

If they keep things over 10 years, it tends to be kept for very long periods of time.

So it's in that 7 to 10 year -- the number of boxes that are in the 7 to 10-year mark is the one where we see the destructions happen.

And if incoming boxes are coming in at a slower rate, then you get an imbalance between what's being destroyed at year 7 or 10 versus what's coming in.

So we just have to kind of go through this process, albeit still positive incoming volume, but get that into balance and then we expect it to even out over time.

The only thing I'll add, Sheila, is just to remember -- so if you look at implied price in North America records management, it's about 3%.

So it's nothing really extreme.

It's just higher than what it was historically.

And you also have to remember this is a pretty small part of people's cost base in terms of where they're trying to save money.

Okay, fair enough.

Just one follow-up question on margin.

It was positive to see EBITDA margin increase 80 basis points in the quarter.

Just wondering when you look at your mix adding the -- increasing the data center percentage, just the outlook of margin trends, bigger picture over the next few years.

Yes.

One thing, if you look at the margin trends in the quarter, we're impacted also by the increase in service revenue, which is a lower-margin business.

Over time, as the data center business continues to grow, that will be at a higher average margin than the rest of the business, so you'll get some positive mix impact from that.

So if you go out and you look at our 2020 guidance, that implies basically from where we are in 2018 a 200 to 250 basis point margin expansion over time.

So a lot of that will come from the continuous improvement initiatives that we have around cost of sales, SG&A.

Obviously, the pricing flow-through on the revenue management that we were talking about a little while ago as well as we'll continue to get margin expansion in emerging markets as we lever up with -- continue to grow those businesses and get the leverage of higher revenue on a fixed cost base.

So every part of the business should contribute, including data center growing as well as the margin there, expanding from where we're today.

The next question will come from Andy Wittmann of Robert W. Baird & Company.

I'll just keep going with the margins here.

We've heard a lot of kind of outsourced business service companies talking about the impact of the tight labor market as well as fuel costs.

Stuart, probably for you, can you just comment on how that affected the quarter and how that's impacting your outlook as you move into '19?

Yes.

If you look at what's going on in the -- actually, labor in the third quarter actually was one of our biggest margin improvement drivers, and that's continuing synergies from Recall.

So actually, if you look at our current results, actually our labor was favorable.

Some of that also driven by the health and welfare costs as we've changed our provider and continue to manage those costs well.

The other side of it, if you look forward, we are seeing labor pressure, and there is lots of demand for warehouse workers and for drivers.

There is a -- somewhat of a pass-through to our customers in terms of the revenue management, right?

It's one of the things when we're talking to our customers, they understand that there's labor inflation going on out there.

So it's one of the reasons that we're able to get the pricing flow that we do.

In fuel, which you mentioned, fuel, there is a -- we do have a fuel surcharge that we can pass-through to our customers as well when prices move up.

Yes, just one thing I'd just add, Andy, to Stuart's comments is that the fuel is, I would say, for most logistics companies positive, but the other thing is that we still have a long way to run in terms of the productivity that we think we can drive.

So whilst at one level you're right, the competition for warehouse workers and drivers is keen.

On the other side, if you look at this year, we consolidated 30 facilities and we expect to consolidate another 19 next year.

So we are looking for ways to continue to streamline our back-end that allows us to get more labor productivity.

Helpful perspective.

Just on the data center strategy next kind of finish up on this one, at least for me.

Previously, I guess, you reiterated greater than $200 million of revenue.

I think previously you guys talked about a little bit more EBITDA than you signaled on this call.

Just curious as to what the differential is on that.

Is it timing of when some of these kick in?

Is it the rates that you're able to achieve?

Maybe just kind of an update on kind of how that lease-up and the profit margins that you expect here?

I'm glad that you asked the clarifying question.

The numbers in my script was -- included integration costs.

So we've talked previously about exit run-rate and we're right on track with those numbers.

About $10 million of EBITDA.

Yes, about $10 million more of EBITDA over what the 2018 number is when you look at the exit run-rate.

The next question will come from Nathan Crossett of Berenberg.

Just a kind of follow-up on the data centers.

I believe you said it's around 8% of EBITDA in your prepared remarks.

When we think out kind of long-term, maybe 5 years plus, how should we think about where that percentage can migrate to?

Can we get to a level that could be 30%, 40% data centers for you guys?

So Nathan, I think, at this point, we've only guided out to 2020.

So I'd love to give you longer-term guidance, but -- so a good try.

But anyways, in 2020, we've guided that it'll be about 10% of our EBITDA, but if you -- you can even see at 10% given the growth rates that we're getting.

That's why we're saying this is driving 1% to 2% of the consolidated EBITDA growth just in and of itself.

So it's already becoming an important driver towards our march to 5% EBITDA growth in 2020.

And just to reset because I know that you've come on to our story recently.

When we started this journey before, we were only at about 2% organic -- even a little bit less than 2% EBITDA organic growth.

So we're actually making good progress, and data center is already proving to be a large component.

But we'll keep you updated as we start extending our horizon beyond 2020 in terms of how we see that shaping up.

But you can expect it to continue to be a major driver in terms of our EBITDA growth.

Sure.

And maybe you can comment just on potentially converting some of your storage facilities to data centers.

I remember you guys saying when you did the EvoSwitch transaction, there was, I think, a few facilities nearby that were storage facilities that you could convert.

So I'm just wondering if you did an analysis kind of across the rest of your portfolio, I'm just wondering, how many centers could maybe be converted over time.

So it's a very good question.

So you're right.

There is -- I'll be specific in Amsterdam, there is a facility that we're looking at in Amsterdam to do exactly that.

And there's 2 other facilities in North America, one, which we've gone to a fair amount of detail and it's associated with a potential customer and then another case is because of the advantageous power rates that we can get because of our historical footprint.

So there's 2 facilities in the U.S. that we're actively, look -- 2 locations in the U.S. we're actively looking at and then obviously, you just highlighted the Amsterdam one, which we've talked about before.

So those are 3 areas where we continue to develop our thinking.

Okay.

And then, just quick one final question.

Can you talk a little bit about the China storage acquisition and kind of how you view the long-term opportunity in China?

Is that a large untapped market for you guys?

Yes, it's a really good question.

So China is growing low double digits in terms of organic volume growth.

So it is an important market for us.

And we are now the leading international player -- we were before, but now we're firmly the leading international player in that market after this recent acquisition.

There are 2 parts of the Chinese market.

So I feel really good about our ability to serve multinationals in the China market and the way we approach the market, the types of services we provide is very familiar with them because they expect that kind of service everywhere they go in the world.

The other part of the market is the state-owned enterprise in China.

And we do have some state-owned enterprise customers, but that's an area which is more difficult to penetrate quite frankly as a multinational.

So our business case and business plans associated with China are more around serving multinationals or Chinese companies that are looking for that kind of service.

And over time, we think we will be able to access more fully state-owned enterprise channel.

But right now, I would say, our state-owned enterprise -- and as you know, is a big part of the Chinese economy -- is relatively limited.

The next question will come from Andrew Steinerman of JPMorgan.

This is Michael Cho in for Andrew.

I just had a follow-up on the margin discussion that we just had.

I guess, first the clarifying question was, the change in the margin guide for '18 is just a difference in business mix.

And two, just more longer term, Stuart, I know you gave some color on it, but historically, we've thought about Iron Mountain's margin expansion from really 2 buckets of Recall and transformation or efficiencies.

And then I realized there is pricing and other efficiencies in data centers that you talked of.

Can you just help us frame a little bit better the magnitude of contribution from some of those pieces that you mentioned as we go from 34.0% margins to 36.8% at the midpoint in 2020?

Yes, Michael.

So Firstly, 2000 -- in terms of taking the revenue guidance up and keeping the EBITDA guidance largely the same, it is primary mix and really in the service business and you can see that obviously in the internal growth on the service side.

So then, if you take that and look forward to the sort of the 250 basis point margin improvement and that sort of is implied from the current midpoint of guidance in 2018 to sort of the midpoint of 2020 in terms of what that plan is, the 250 basis points, I think you can think about it in the sense that about half of that will come from continuous improvement and cost reductions.

Bill touched briefly on productivity improvements we think we can keep making.

And then on top of that then you'll get some mix benefit from data center as the data center margins itself grows, as we get those businesses integrated as well as that business growing.

And then you'll get leverage in emerging markets from M&A primarily as well as organic growth as we've over time built up the infrastructure to support a larger business and you continue to see the margins in emerging markets expand quite nicely and then margin expansion in developed markets in addition from the continuous improvement also coming from revenue management.

The next question will come from Eric Compton of Morningstar.

I guess, I wanted to kind of switch back to the volume growth kind of discussion.

So I guess, first, as people are changing, not bringing as much physical paper storage or whatever and they're switching to digital, do you guys disclose any numbers on what percentage of the business is being replaced kind of with these digital initiatives?

I mean, other than the segments we already report, no, but also, let me just kind of put it back into context.

So if you look at Stuart -- the math that Stuart took you through -- and let's take the year 2 because the year 2 is after you don't get the benefit for the onetime charges when people actually pull things out for destruction -- is that we're talking about at the rates that we're seeing around a $2 million EBITDA impact.

Because remember, he gave you an example that's 10x anything that we see or expect to happen in what we can see going forward.

So this is really a very small impact.

I mean, on a 1 point -- the business is approaching $1.5 billion for that matter in EBITDA, over $1.4 billion as we sit here today.

A couple of million in EBITDA associated with this trend is de minimis.

So it's not a major thing.

If you -- we don't break out the segments more fine than you want, but on the other side, as we're -- if you ask me the question in a different way, are we getting more than $2 million of EBITDA from our uplift in IGDS services, our information governance and digital services, absolutely.

So we're more than getting -- we're getting -- as we're helping our customers on this digital transformation journey going from the, in this hybrid world, is we're more than picking up what we're losing on the volume side.

So it's a -- it's not one versus the other.

Got you.

That's super helpful.

And then, my last one is, you said you kind of expect some of the change in customer behavior with this volume to potentially reverse over time.

Is that just related to kind of, if I understood your first example correctly, kind of a silly example, you might have a client that was previously bringing maybe 5 boxes a year and now they've changed to 4, so you'll kind of get that onetime downdraft then as long as they stay at 4, kind of that initial decrease will sort of reverse, so to speak.

Is that kind of the main driver there?

Or are there any kind of longer-term reasons you would expect this kind of acceleration in declining volumes to reverse?

You've got it absolutely.

That's exactly the dynamic that's going on.

And then the wildcard, so to speak, on the upside, is that if some of the unvended market or less vended markets that we've talked about before, if those things start coming in and those things can kind of offset that while you're going through that process.

But that process alone is the thing that's the key driver at this point.

Your next question will come from Karin Ford of MUFG Securities.

Stuart, I think you said in your comments that there was about $30 million of business changes that drove the AFFO guidance increase.

Can you just detail what contributed to that $30 million?

Karin, probably easiest thing is to refer you to the year-to-date calculation in the supplemental of the reconciliation of AFFO.

But a couple of things that I've talked about is, you've got taxes coming in lower than we originally expected.

Interest expense is favorable.

From a capital standpoint, continuing to focus.

I'll also refer you back to the guidance page as well where you'll see some of the detail.

But some of the efficiencies that we're getting around maintenance capital as well as then just sort of the underlying business performance, those are the key drivers.

And I did mention that of the total $40 million increase in AFFO at the midpoint, about $10 million of that is from better flow through to AFFO of revenue recognition change.

So I didn't want to call that out because that is different than our previous guidance as well.

Got it.

Okay.

And I wanted to go back to that volume loss example that you described.

You're expecting continuing volume pressure next year on top of what we've seen this year.

So if you think you'll see a bigger impact in year 2 versus year 1, given the fact that you no longer have the fees offsetting, should we expect more pressure on revenue next year given that sort of pattern there?

I think as Bill discussed, the trends that you see are really incredibly small, right?

So even if it was the same global volume declines we saw, now it's been almost around $2 million.

So the example I gave is what I would probably classify almost as an extreme scenario, right, 10x of what we're seeing today and which Bill talked about is easily offset by digitization services, but there's lots of other things we can use to offset that as well.

Got it.

But understanding that the numbers are in the $2 million range, just trend-wise, we should expect to see a little bigger impact if volumes continue to come down next year versus what we saw this year, right?

It's not -- we expect it to maintain around this level, Karin.

So we're not seeing a compounding effect, if that's what you're getting at, in other words.

What we're saying -- that we're not talking about next year would be compounded on top of that.

We would see it at a similar level as what we have now.

That's what we're planning for and we'll issue guidance in February.

Okay.

Just a question on pricing.

So developed market internal revenue growth was 70 basis points, that was a 60 basis point deceleration from the 2Q level.

The volume deceleration was only 30 basis points.

So should we read into that you're getting less benefit from pricing in revenue management from 2Q to 3Q?

I know it's always hard to put together because we do it on 2 different basis.

But if you're just kind of trying to do the rough mathematics, it's still that we're getting kind of high 2% range for North America and on a blended basis, you're getting the mid-2s across the globe.

So it's still in the same range.

Okay.

And then last question just on data center.

So it looked like in the supp there were a few changes to your investment volume and timing on a few of the different projects, Arizona being the biggest you talked about that one.

It also looked like Northern Virginia and then in the Boyers and other category, there were some investments.

You showed in 2Q that are no longer there.

Can you just talk about what those changes were?

Yes.

In the supplemental -- in the development activity, we actually added more detail to clarify sort of what's actually under construction today versus what's future construction.

So we broke those pieces out because there were some things that are held for future development and are able to be built out, but not currently under construction.

So we just broke those pieces out for you.

So the data is still there.

It's just in separate columns.

Got it.

And can you just talk about the size, the potential size on your return expectation on the new Chicago development?

It's still early days in terms of what the -- what it's going to be.

We're in the process right now.

As Bill talked about in his script, this is -- Pritzker Realty Group has got land in the Chicago market that is currently being prepared.

They're doing site preparation work now.

We will develop about 36 megawatts on that site, what the plan is.

It won't actually start construction probably until, could be late Q4, probably in the first quarter.

And so we're mentioning this today.

We'll put out a formal announcement to the broker community soon, so we can start pre-leasing on that.

And you'll buy the land and provide the capital for the project?

The land will actually be contributed.

So it'll be -- it's not a legal joint venture.

It's structured as a land lease, but it'll basically operate like a joint venture where the Pritzker Realty Group can participate in the upside as they help us with -- in the Chicago market with local companies and things like that.

So they've got some skin in the game as well and get part of the upside.

The next question will come from Kevin McVeigh of Crédit Suisse.

Just one thing I wanted to -- it feels like the business is a little less predictable just kind of looking at kind of the pure storage versus service components over the course of this year.

So what I want to do, is there any way to frame out what the delta is between kind of the step-up in the service because it looks like the service has been over kind of 7%, which is a great outcome for you folks, but how much of that is kind of sorted office paper?

How much is the pickup in destructions and then how much of that is the new TMBS initiative?

And that was actually my first question.

And then just what percentage of the EBITDA today is sorted office paper?

If you go back, if you look at total shred business, Kevin, you've got about 1/3 of that is from the sale of paper.

So you can go back and sort of do the math on that.

If you look at sort of third quarter, total shredding revenue was up about 15% or $15 million year-over-year.

And if you remember, from a paper pricing standpoint, last year was actually a little bit of a dip compared to where we are this year.

So of the $15 million increase, about $6 million to $7 million of that increase is paper price and the rest really has to do with volume in bin tips as that business continues to grow.

We've done some tuck-ins as well in that business, and so you've seen good margin expansion and business is performing really, really well.

But I think, Kevin, just to pick up on your predictability as you've been following the story for a long time, so I kind of go back is when you first started, we were 2% organic EBITDA growth.

We're seeing here 4% EBITDA growth.

The company was -- it was struggling to maintain $900 million of EBITDA.

We're now approaching $1.5 billion of EBITDA.

So when we talk about $6 million or $7 million coming from paper, this is -- quite frankly, I'm not complacent, I chase every million dollars, but this is noise in the way we run the system.

So if you sit there and say we're approaching 5% EBITDA growth organically before we do an acquisition, whereas when you started following us, we were less than 2% is the business is a lot easier.

It can take a lot more noise in the system than it used to.

So I actually think that predictability and the robustness of the business is really strong.

Got it.

That's helpful.

And then just, Stuart, the delta -- because it looks like the storage revenue, the guide for the full year came down to 2.5% to 2.75% versus 3% to 3.5%.

Does that imply the back half deceleration -- and was that primarily all volume driven?

Did it kind of -- took those numbers down?

Yes.

I mean, you see it in the year-to-date numbers.

So it is primarily volume driven on the storage side as well as the offset that -- looking forward, right, some of the other storage businesses as companies get more digital, we continue to invest in Iron Cloud, in Iron Mountain in the InSight product that we're offering.

So we're continuing to talk to our customers about what needs they have.

And so going back to sort of Bill's point on the predictability, these are numbers despite us actually increasing investments in some of those new businesses.

And this concludes our question-and-answer session and today's conference call.

The digital replay of the conference will be available approximately 1 hour after the conclusion of this call.

You may access the digital replay by dialing (877) 344-7529 in the U.S. and 1 (412) 317-0088 internationally.

You'll be prompted to enter the replay access code, which will be 10123998.

Please record your name and company when joining.

Thank you for attending today's presentation.

You may now disconnect.