鐵山公司 (IRM) 2008 Q2 法說會逐字稿

Good morning, I will be your conference operator today.

At this time, I would like to welcome everyone to the Iron Mountain second quarter 2008 earnings webcast conference call.

All lines have and placed on mute to prevent background noise.

After the speaker's remarks, there will be a Q&A session.

(OPERATOR INSTRUCTIONS) Thank you.

Mr.

Golden, you may begin your conference.

Thank you.

And welcome, everyone, to our 2008 second quarter earnings conference call.

After my announcement this morning, Bob Brennan will give his state of the company remarks followed by Brian McKeon, who will deliver the financial review.

When Brian is finished we will open the phone for Q&A.

Per our customer, we have a user controlled slide presentation on the investor relations page of our website at www.ironmountain.com.

Referring now to slide two, today's earnings call and slide presentation will contain a number of look forward-looking statements, most notably our outlook for our 2008 financial performance.

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

Please refer to today's press release or the safe harbor language on this slide for a discussion of major risk factors that could cause actual results to be materially different from those contemplated in our forward-looking statements.

As you know, operating income before D&A or OIBDA and free cash flow before acquisitions and investments are metrics we speak to frequently and ones we believe to be important in evaluating our overall financial performance.

We provide additional information and the reconciliations of these non-GAAP measures to the appropriate GAAP measures as required by reg G at the investor relations page of our website as well as in today's press release.

Before I turn the call over to Bob, I would like you to know that our 11th annual investor day will be held on Wednesday, October 8, 2008 at the Grand Hyatt Hotel in New York city.

Stay tuned, we will be releasing more information as it becomes available.

And the best way to stay informed is to sign up for email alerts at the investor relations page.

And with that, I would like to introduce Bob Brennan, our President and CEO.

Thank you, Stephen.

Good morning, everyone, and thank you for taking the time to join us for our second quarter earnings release call.

The format we will use today is similar to our past calls.

This is my first call as CEO and I will start by giving you my report on how the business is doing and reference our strategy as we go through that.

Afterwards Brian will take you through quarterly results and provide an update our full-year outlook, followed of course by Q&A.

Let's get started.

Here are the key messages I want you to hear today.

First, Iron Mountain is performing well and we're on track to delivering against our full-year financial goals.

Next, we are continuing to advance the growth strategy we have been delivering on for years, a strategy that's driven by solid expansion of our core business, which is of course supported by continuing strong growth in services that leverage the investments that we've made in storage, by expanding our international presence in markets where we see strong economics and in building scale for our digital business to meet large, expanding market requirements.

The last message that I would like to drive home is that the team at Iron Mountain is taking a very disciplined approach to growing our business and that that discipline is producing the desired results.

I will now provide a quick summary of our Q2 financial performance, which Brian will review in detail after I am done.

Overall, we delivered strong revenue and OIBDA growth in the second quarter with each up 15% compared to the same period last year.

Both numbers were at the high end of our guidance range.

And we also continue to drive strong growth across our major business segments, with all segments performing well across the board.

More specifically, there are three key areas I want to highlight that supported our strong Q2 financial performance.

First, service revenues continue as a key driver of our overall growth.

Second, our digital business is performing very, very well.

And third, we are really getting clear benefits from having a broad portfolio of businesses.

But let's go to the service component first.

Consistent with our long-term strategy, we are building off a strong storage revenue base, which continues to generate solid growth rates so that we can introduce new services that help our customers solve their information protection and storage problems.

In the second quarter, overall revenue growth was led by service revenues, which were up 18% on a reported basis, including benefits from acquisitions, and 9% in terms of internal growth.

We are seeing positive benefits from our strategy to invest in services that leverage our strong storage relationships.

Our international segment reported strong service growth supported by continued momentum in Latin America, where our document management solutions continue to be a key growth driver, as well as in Europe where we are seeing significant benefit this year from special projects, specifically within the U.K.

North America also posted solid gains despite pressures impacting many of our customers.

As you might expect we are seeing some impact from a worsening economy on our complementary service revenue, particularly with respect to more discretionary projects.

At the same time we're generating solid growth in our shredding business, supported by strong paper prices and service volume growth.

It's worth mentioning that Iron Mountain Digital also delivered a strong service revenue in Q2.

In advancing our growth agenda, you should expect service revenues will continue to expand as a percentage of total revenues, which will in turn drives high returns.

This builds on our foundational storage relationships with our customers, maximizes our potential to service them and does so with less capital intensity and therefore higher returns.

In summary, we see the expansion of service revenues as central to maximizing our opportunity and our value as a company.

With regards to Iron Mountain Digital, Iron Mountain Digital continues to perform quite well, with 16% internal growth in Q2.

Our eDiscovery, archival and intellectual property management businesses were all very strong contributors in this quarter.

Iron Mountain Digital is the leader in providing digital storage as a service, with annual run rate revenues approaching $250 million this year accompanied by solid returns.

Our early vision as a storage as service provider is being validated as the market continues to expand at a rapid pace and continues to attract more competition.

We believe we are particularly well positioned against the competition to capture our share of growth because of two primary factors.

First is the Iron Mountain brand.

Iron Mountain is a brand built on trust because customers have really relied on us to protect their data for decades.

We have no agenda in using their data, in selling them equipment, in doing anything other than providing them strong SLAs around the long-term preservation, protection and storage of their data.

The second is our business model.

Storage as a service is something that we started a long time ago.

It's a flywheel business that you are familiar with, and in digital just as in our physical business, it has the same recurring properties.

It has taken us some time to get to $250 million in annualized run rate revenues for Iron Mountain Digital.

If you think about our early entries through the Connected and LiveVault acquisitions, both those companies were started their revenue in the mid 1990s.

So it takes time to build a business, but it is a very sticky business.

And it will take time and a very different mindset from our competitors to successfully drive this type of approach.

I think it's worth just settling on a point.

Our primary competition for Iron Mountain Digital is customers who seek to solve these problems themselves by purchasing hardware and software from traditional technology companies and running it in-house.

We see that moving towards us as companies become increasingly frustrated with the explosion of data that they are facing and the complexity of doing it themselves, not to mention the cost.

So we are pleased with our progress in Iron Mountain Digital and remain optimistic about our potential going forward.

The third theme underlying our strong results is the strength of our business portfolio.

We have evolved many businesses over the last decade.

all building off of our strong storage foundation and expanding our geographic reach and adding our service capability and providing a broader and broader range of customer solutions.

All of our businesses are contributing, whether you look at them by product or geography across the board.

We will continue to invest against this strategy, balanced of course with a disciplined focus on driving return improvements.

The strategy has been working and we expect to continue to advance it.

So those are the three underlying themes to Q2 performance.

So as we go forward and drive our growth goals, we will remain focused on managing costs, especially given the softer economic environment we are all operating in.

We are seeing some impact from the economy in certain areas of our business.

So in this context, we are being particularly disciplined about prioritizing and concentrating our investments.

In terms of managing cost, we are still working through a higher cost growth effects from acquisitions and overhead investments that we initiated in 2007.

At the same time, we're targeting and expect moderated overhead growth as we work through the second half of this year.

I want you to know that we are committed to investing to advance our growth strategy.

At the same time, we are committing and committed to delivering against our annual financial objectives.

I believe we can manage this balance effectively.

Overall our solid start to the year puts us on track to deliver our full-year goals.

We made some positive revisions to our guidance this morning, which Brian will discuss in more detail.

I'll ask that you not get too excited about that.

Our business remains solid but as Richard has said many times, nothing changes fast in this business and I promise you we will remain very disciplined to manage against our targets.

There are couple of important happenings in the past quarter that we reported on that I would like to inform you more about.

And it is really again as it relates to service development and these are two new services that we rolled out during the quarter.

One with Accutrac, which was a small records management acquisition that we did last year, where in the past in Q2, we announced a partnership with the FileNet group within IBM to provide prescriptive records management solutions that enable an integrated approach for managing either paper or electronic documents.

IBM is a burgeoning partner with us and also provides part of our image-on-demand solution into our digital record center.

The second is our most recent acquisition of Animus.

Animus provides document workflow solutions that help our customers reengineer workflow processes that have become cumbersome without them losing control of the existing process.

So for example, if you take documents associated with what can typically be bad workflow, say, invoices into accounts payable or contracts within the legal department, we can help them take over the process by scanning those documents, indexing the documents, presenting them back to our customers through a web interface and either preserving the original physical document or destroying it as the business requires.

This gives us advantage both in software as a service and storage as a service in driving recurring revenue and, while Animus just joined the Iron Mountain family, we are encouraged by their potential.

In general, acquisitions of new service capability is key to our strategy.

And we did tell you acquisition activity would be modest this year and we're following through on that, in part because we had a relatively fast-paced year in 2007.

And I do want to update you that the integration of our three biggest acquisitions, ArchivesOne, RMS and Stratify are all going particularly well.

And we are particularly excited about some of the potential that we are seeing out of the eDiscovery space with our Stratify acquisition.

You should look for more news to come, as they acquire a larger and larger footprint in that very fast-growing space.

During the quarter, we also announced the tactical divestiture of one of our businesses.

As we add to our service portfolio, we also want to ensure that we are sharply focused on performance management and strategic fit.

And in the context of both actually, we made a decision to divest our commodity data sales business in Q2.

This is a small business comprising about 1% of our revenues that is focused on the sale of commodity products to our customers where there was limited contribution to our profits.

So we really saw this and evaluated it as a non-core business and entered into an agreement with another company for them to manage this business, where we will receive a royalty on future sales.

That is my report on Q2.

I want you to know that Iron Mountain is doing well and that the team is committed to a disciplined growth strategy that maximizes our long-term potential while delivering consistently strong annual financial results.

I am very pleased with our performance year-to-date and believe that we are on track to delivering against our stated objectives for the remainder of the year.

With that, I will turn the call over to Brian for today's financial review.

Brian?

Thanks, Bob.

Q2 was another solid quarter for Iron Mountain, keeping us on track to meet full-year financial goals.

We posted strong revenue and OIBDA gains, slightly ahead of forecasts.

These results reflect solid underlying business performance across our business segments.

We will begin today with a review of our Q2 results.

We will also review our year-to-date cash flow performance, capital spending trends and dispositions and put these results in the context of a full-year outlook.

We will conclude with an update of 2008 full-year guidance, which has been positively revised today, reflecting our solid first half results.

We will also share outlook for the third quarter.

Slide four highlights the key messages from today's reviewed.

Iron Mountain delivered strong financial results in Q2 with revenue and OIBDA each growing 15%.

We continue to drive strong business performance in a challenging economic environment.

This reflects the strength of our business model as well as benefits from a disciplined approach to managing our operations.

We posted high revenue gains across all major business units supported by 9% internal growth, the benefits of our major acquisitions, and favorable year-over-year foreign currency improvements.

OIBDA was supported by solid gains in gross profits, which offset some dilutive impacts from acquisitions completed last year and some carryover impacts from investments initiated in 2007.

We also strengthened our balance sheet, increasing flexibility and liquidity with a successful refinancing transaction including the sale of $300 million of 8% bonds due 2020 and the redemption of $72 million of 8.75% bonds due 2011.

The redemption was completed in early July.

As a result of our first half performance, we announced positive revisions to our 2008 outlook.

We now expect 12 to 13% revenue growth and 11 to 14% comparable OIBDA growth for the year.

We remain confident that we're on track towards achieving these full-year financial goals.

One item of note before we continue.

As mentioned in our press release this morning, we divested ourselves of our commodity product sales business as of June 1st.

Accordingly we are removing the revenues associated with this business from our internal growth calculations for both 2007 and 2008.

The impact of this divestiture is reflected in our updated guidance.

Now, let's move on to looking at the details of our performance on slide five.

Slide five compares results for this quarter to Q2 of 2007.

Overall we had another strong revenue quarter, supported by balanced growth across our key business segments which drove the overall increase of 15%.

Our largest segment, North American physical, posted 11% growth overall.

Internal revenue growth was 8%.

We saw solid growth in secure shredding, supported by continued strength in recycled paper prices and in our data protection business.

These gains offset some softness in project-based revenues.

Despite these impacts, the internal growth in North America is tracking solidly within our target growth range for the year.

Our international physical business was up 21% overall.

Internal growth was 9%, supported by continued strength in our Latin America business and gains in complementary service revenues in our European business.

International growth also benefited from select acquisitions that are strengthening our global footprint and from favorable foreign exchange changes, which together added about 12% to revenue gains.

Finally, our digital segment drove strong revenue gains, growing 37% overall supported by 16% internal growth.

We saw consistent growth in storage revenues and better-than-expected performance in data restoration projects, which had been relatively weak since the end of 2005.

Revenue gains helped drive a solid 17% year-over-year improvement in gross profit.

Gross margins were up about 100 basis points for the quarter compared to the same prior year period, supported by improved storage margins reflecting labor and real-estate efficiencies as well as benefits from growth in high margin services and sustained high recycled paper pricing.

SG&A growth was 20% in the quarter compared to prior-year levels.

Higher rates of overhead growth were impacted by two primary factors highlighted in our last conference call.

The first involves the integration of recent technology acquisitions including Stratify, which have a relatively higher overhead cost basis percentage of revenues.

SG&A growth also reflects carryover impact from investments in security, international sales resources and infrastructure initiated in 2007, as well as additional stock-option expense related to higher than normal grant activity last year.

We expect SG&A growth to continue at higher rates through Q3 and to moderate in the fourth quarter this year, as most of the rampant acquisition and overhead investment took place in Q4 of 2007.

Despite these effects, OIBDA was up 15% for the quarter to $197 million.

Depreciation was $64 million and amortization was $9 million for the quarter.

The increase in amortization was driven primarily by technology acquisitions completed in the second half of 2007.

Operating income was $124 million for Q2 2008, up 11% versus the prior year as OIBDA gains were partially offset by increased depreciation and amortization driven by 2007 capital spending and acquisitions.

Slide six breaks down our overall revenue growth.

It shows internal growth by major service line as well as the impact of acquisitions and foreign exchange, which added about 4% and 3% respectively to our growth rates for the second quarter.

Internal revenue growth was -- for the quarter was 9%, in range of our full-year growth goals.

As a reminder, we group removed the 2007 and 2008 revenues associated with divested product sales business from our internal growth calculations.

This had no impact on the internal growth rates through the quarter for Q1.

Internal growth was comprised of 8% storage growth and 9% service growth, reflecting continued benefits from expansion of less capital intensive, more project based offerings.

Core service internal growth improved to 9% in Q2, supported by benefits from higher fuel surcharges.

The internal growth rate for complementary services moderated in Q2 as expected.

Gross of recycled paper revenues across geographies remained strong, supported by a year-on-year increases on recycled paper pricing.

Offsetting these gains was a slowdown in project activity in the Americas and lower growth in fulfillment services, which are areas more likely to be impacted by economic conditions.

Complementary service revenue, which represents nearly 15% of overall revenues, can fluctuate over time given fluctuations in demand and timing for special project activity and variation of factors such as recycled paper pricing.

As noted in our last call, we do expect growth in complementary services to moderate as we work through this year, due to comparisons to some large European public sector projects that are either completed or winding down.

We also expect some continued pressure on more discretionary spending areas in the Americas given the current economic slowdown.

Despite these anticipated impacts, we expect that our overall growth rates will remain solid through the year and believe that we are on track to deliver against full-year internal growth goals.

Moving on with our review of Q2 P&L performance, slide seven bridges our Q2 operating income to net income and EPS results.

Q2 results on these fronts were basically as expected, although we did experience some discrete impacts which pressured our reported net income and EPS results for the quarter.

As discussed, operating income for the quarter was up 11% to $124 million as OIBDA gains were partially offset by a year-on-year increases in depreciation and amortization.

G&A grew $13 million versus prior-year levels in Q2, reflecting increased CapEx spending and the impact of our 2007 acquisitions, most notably ArchivesOne and Stratify which were completed in May and December 2007 respectively.

Our Q2 interest expense was $60 million, as expected and in line with Q1.

We now expect interest for the full year to be in range of $240 million to $245 million, including impact of the recent refinancing activities I spoke of earlier.

Other expense was $4 million or $0.01 per share in Q2, primarily reflecting losses related to foreign exchange rate fluctuations as we mark our in-company and third-party debt to market.

We also recorded approximately $350,000 of debt extinguishment charges in Q2 related to our June 2008 debt offering.

The second quarter of 2007 we reported other income of $3 million or $0.01 per share, related primarily to foreign currency exchange rate gains and insurance gains.

Net income and EPS were $36 million and $0.18 per diluted share respectively, down slightly from the 2007 levels due primarily to a higher effective tax rate in the second quarter compared to the same period last year.

As a reminder we will recorded significant tax benefits on net gains associated with foreign currency rate changes in the second quarter of 2007.

This year our second quarter tax rate before the impact of discrete items was 38% as forecasted.

The impact of discrete items, including the interest on our tax reserves, added three points to our effective tax rate and reduced diluted EPS by about $0.01 per share.

We are still estimated our tax rate before discrete items for 2008 to be approximately 38%.

After 2008, we expect our tax rate, excluding the impact of discrete items, to decrease over time to approximately 36%.

Turning to slide eight, let's look at our year-to-date performance.

You can see that our Q2 results build on the solid performance we posted in Q1.

Overall balanced growth across our key business and service lines and supporting solid revenue and OIBDA gains and reinforcing our confidence that we are on track towards delivering against our strategic and financial goals this year.

Net income for the first half of 2008 was $69 million, compared to $74 million for the same period in 2007.

The key factors impacting the 2008 results are other income, which was $3 million or $0.01 per diluted share, versus $11 million or $0.04 per share in 2007, and a higher effective tax rate which was 38% versus 33% in 2007.

Let's now shift to reviewing drivers of our cash flow performance.

Slide nine summarizes our capital spending for the quarter.

It highlights our year-to-date results compared to the full year 2007 amounts and our current 2008 outlook, which we are reiterating today.

Our CapEx for the first half of 2008 was $137 million including $11 million for real estate.

Traditionally the first half of the year is later with respect to CapEx, as some projects are scheduled for later in the year and many require time to plan and source before the significant expenditures are eventually made.

We are currently spending to our plan and expect to finish in the forecast range.

Let's now move on to slide 10 and look at free cash flow for the quarter.

Slide 10 highlights our year-to-date cash flow performance compared to the same period in 2007.

For the first half of 2008, free cash flow before acquisitions and discretionary investments in real estate was $20 million.

The year-on-year decrease in cash flow reflects the payment in Q1 2008 of the unusually large 2007 year-end CapEx accrual balance of $60 million and a $30 million increase in working capital usage.

The working capital increase was due primarily to increased AR, increased incentive compensation payments in 2008 and the timing of the payroll check run.

Keep in mind that free cash flow is best looked at on a full-year basis, as the timing of certain cash events is not consistent through the year.

For example the first quarter, historically our lowest cash flow quarter, was impacted by the 2007 CapEx accrual and the payment of annual bonuses.

For 2008, we expect free cash flow before acquisitions and discretionary investments in real estate to be approximately $25 million to $75 million.

As noted in our last call, 2008 free cash flow is impacted by the 2007 CapEx accrual I just spoke of being paid in Q1.

Let's turn to slide 11 to review our debt statistics.

In terms of our debt portfolio we ended Q2 2008 in a strong position, as you can see in the slide.

Our weighted average interest rate is 7% and we are 81% fixed.

Consolidated leverage is now 4.4 times, within our target range of 4 to 5 times OIBDA.

Maturity is now at 7.8 years with no meaningful repayment obligations until 2012.

As you know, we successfully issued $300 million of 8% senior subordinated notes through 2020.

We used the net proceeds to pay down our senior credit facility.

We also redeemed the remaining $72 million of outstanding 8.25% notes due in 2007 in a transaction that was completed in early July.

This is the regular term-out of our short-term debt consistent with past practice.

Rates had come down considerably over the preceding several months and were reasonable compared to our long-term average.

Based on our ability to execute transaction at attractive rates and our expectations of continued uncertainty in the credit markets, we felt it was the right time for this refinancing.

Our ability to issue debt at attractive rates in an uncertain credit market demonstrates the strength of the Iron Mountain business model.

As a result of these activities, our liquidity in the position remains strong.

As of June 30th, 2008, we had nearly $750 million of cash and availability under our revolving credit facility.

Now, let's move ahead so slide 12 to discuss our 2008 guidance.

Turning to slide 12, based on our solid start to the year, we're announcing positive revisions to our full-year outlook.

Our full-year revenue outlook is now $3.05 billion to $3.09 million, for growth of 12 to 13%.

We are now targeting full-year operating income of $478 million to $498 million.

This would imply and OIBDA range of $773 million to $793 million for the year, or growth of 11 to 14% on a comparable basis, excluding gains and losses on asset write-downs.

We're maintaining our full-year CapEx forecast of $440 million to $480 million.

At midpoint performance, this would equate to a modest reduction in capital spending as a percent of sales in 2008, building on our 2007 progress.

Our expectations for Q3 performance are shown here as well, which implies revenue growth of 8 to 10% and 4 to 9% comparable OIBDA growth.

Note that our prior-year Q2 results benefited from high levels of service growth, which resulted in 12% internal growth and strong OIBDA margin flow through.

Our growth outlook for Q3 of this year reflects comparisons to these strong results.

We will continue to work through higher levels of cost growth in Q3 as well, driven by acquisition integration and carryover impacts from investments initiated in 2007.

As noted, we expect these impacts to moderate in the fourth quarter.

In summary, we had a solid first half of the year, we're driving solid growth across our business and we are confident that we are on track towards delivering our full-year financial objectives.

Thanks, we will now open the phones to take your questions.

(OPERATOR INSTRUCTIONS) We will pause for just a moment to compile the Q&A roster.

Your first question comes from a line of Kevin McCarthy with Credit Suisse.

Thank you.

Hi.

I wonder if you could give us the sense -- very nice job on gross margins in the second quarter, how you see the gross margins playing out in the second half of the year relative to OIBDA overall.

We are continuing to target solid gross margins in 2008.

We are seeing factors such as real estate and productivity gains helping us, these are things we expected when we build our plans this year.

And we are also currently seeing benefits from paper and higher margin service growth, though those are factors that will moderate later this year, but our outlook includes sustaining solid gross margins.

Great.

And if you could give us a sense of -- in terms of recycled paper prices, where they are currently and what you have in the second half of the year?

The recycled paper market has flattened in recent months, it is actually down a bit from the peaks we saw in February and March.

It would still -- can be up year-on-year at current rates through the back half of the year.

We think the underlying factors that have supported the higher levels of paper pricing, which are really driven by international demand, are still there.

This isn't an easy market to forecast, but we think we will see sustained solid paper rates.

But if you want to reinforce that, this is a factor we have highlighted several times in the past, these things can fluctuate, it can have an impact on our results with the margin.

And we are basically -- embedded in our outlook is an expectation that they will sustain in the similar range.

But this is something we will keep an eye on.

And we are being careful to moderate overhead growth as we go through the balance of the year, something that we are just very careful about.

One more question if you don't mind, the services really sequentially came up nicely internally, can you each talk about destructions a little bit and how the surcharges impacted that.

Two different topics that you raised there.

We highlighted in our last call, where we saw a little softness in core service activity, that was down a bit in areas like destructions because we had higher activities late last year.

And that is pretty much sustained.

I'd say our overall service activity is a little below what we would see normally.

And that is not unexpected, given some of the things that we did last year.

There is a cost associated with destructions, people are pausing on now, because they face their own overhead pressure.

And while they saw the usefulness of doing that, maybe even just a matter of months ago, they are now holding on that project.

But the second topic which you picked up on, we did highlight in the call, is the improvement quarter-on-quarter, because the growth rate went up 200 basis points, it was helped by higher fuel surcharges.

Obviously, that is offsetting some of the higher energy costs that we see.

So net add it really helps us to manage energy impacts and keep that effect at a minimal level.

It is not intended to be a profit driver for the Company but it does benefit us in terms of our core service growth rate.

Thank you very much.

Your next question comes from Andrew Steinerman with JPMorgan.

Hi, gentlemen.

I would like to look at EBITDA margins sequentially.

They went from 239 to 255 in the quarter -- first quarter versus second quarter this year, 160 basis point increase.

If you could break out for us, what do you think the drivers are there, into three buckets?

One, what is a normal seasonal pick-up -- I know first quarter is the low quarter of the year usually on margin?

Two, kind of less drag from past acquisitions, and three, less incremental investment in infrastructure.

If I could just start, we have tried to be very careful about the fact that this is not how we manage the business.

So with that in mind, we can get into the specific answers.

I think one of the things, trying to get at the gist of your question, I mean I do think we look at our business more year-on-year rather than quarter-to-quarter.

I would say year-on-year we've made improved progress on gross margin enhancement, which was driven by several things actually.

It included the solid productivity gains on the storage front, we had higher levels of service margin growth, so high growth in areas where we have high service margins, areas like Stratify, like our digital business.

And we've -- those factors -- and continue to benefit from recycled paper pricing, but I think those factors were probably sequentially a bit better for us.

I think we're seeing some moderation in the overhead cost impacts.

We've continued to see that as we've worked through the year.

It's going to be more a Q4 benefit than a Q3 benefit.

Those are really the two key -- two kind of key drivers.

And I think both of those factors are things that we hope to sustain.

So if you look at our outlook for the back half of the year, it implies that we will have improvement in year-on-year margins, assuming that our mix comes in as we expect and that reflects sustaining a good gross margin performance and maintaining good discipline over overhead cost growth.

So we look forward to continuing to post progress on that front.

The one thing I would caution you on is, and this was something Richard reinforced in the last call, is taking the ruler out and looking at a quarter and drawing a line off of that.

I mean, we do have seasonality impacts in this business, we do manage this business on an annual basis and are discussion today has just focused on the year, we haven't given any outlook or insight into next year.

Right.

That is why I ask the question originally, sequentially, to account for seasonality.

But it sounds like, when you answer it year-over-year, it probably was some help seasonally, sequentially, plus the other factors that you just attributed year-over-year also helping the sequential progress as well.

That's right.

And Q1 historically is our a lower margin quarter, just given the higher relative energy costs.

That is right.

Take you very much.

Thanks, Andrew.

Your next question comes from the line of Scott Schneeberger with Oppenheimer.

Thanks.

Good morning.

Just following up right there on energy, and some question on pricing.

Obviously, you're getting the fuel surcharges and that's contributing to the growth.

The impact of higher energy costs, is that -- I would assume that's hitting more on the gross margin than it is on SG&A.

Could you just confirm that and also discuss how your fuel surcharges work, how much of your client base is on that, for what term of a contract and are you hedging through it all?

The net of it all is a limited impact on financial results.

We don't hedge on fuel.

It is about 3% of our total costs that are energy related -- 3% of revenue, sorry, thank you, 1.5% of which are transportation related.

We are able to pass most of that through, if not all of it through, but in some cases -- we have contracts where it doesn't go through, other cases we do.

Our buildings are very energy efficient and relatively quiet from an energy consumption perspective, but the net of it is that -- we hear a lot of questions on this front and it doesn't have a material impact on our financial results.

That is the point we want to get across.

Okay, thanks.

Shifting gears a bit.

I think you had alluded when you were discussing Stratify,and I got the sense that you may be looking to expand or potentially do acquisitions in that space to pad.

Was my inference correct?

And are you going to be thinking about doing large things or more tuck-in in nature?

I have great confidence in the team at Stratify and in the business that they've built.

To the extent that -- you will find that we generally partner with folks before we acquire them so that you can, generally speaking, see those things coming.

We partnered with Connected and Live Vault long before we bought them.

And I think fundamentally we have great faith in that team.

Nothing big coming, but we are always looking for potential candidates to partner with and that can act as a precursor to acquisitions.

Scott, I think in Bob's comment he was alluding more to -- we feel really good about the team and have some pending customer wins that we look forward to talking about.

It wasn't intended to be a reference to acquisitions.

You will see them expand their market presence.

We love the platform we have got in eDiscovery and the Stratify team.

It is a great team.

Excellent.

Thanks.

Jumping back real quick.

As far as what I meant to follow up with on the surcharges as well was, I think pricing you had alluded this year that you are looking to get a 2% increase, any update there and how do you look at that in combination with the surcharge?

We don't look at the surcharges, what we would think of, as pricing.

I think that's a relationship we have with our customers where we're trying to mitigate to offset costs.

And I think our ongoing service relationships, looking at our pricing, we had talked about improving our trend on that front and we're making good progress, we think we are on track to achieve -- the metric we typically talk to is the U.S.

hard copies, storage price and how that's increased over time.

And we are on track towards that 2% level which we think is consistent with the value that we're delivering to our customers and we feel good about the progress we are making.

Great, thanks.

And then finally, announced recently the collaboration with IBM and the partnership with HP, is this something -- are we seeing the start of a trend here of something you're going to be doing a lot more just partnerships?

And could you give us an update on how those are going?

Sure.

So we feel very good about our relationship with HP for medical image archiving and the one that we just announced was Accutrac.

I think you should expect to see more of it.

We have a great opportunity to move technology through other's P&Ls and to move their technology integrated with ours through ours.

It is a validation of the brand that we have in the market, the trust that we've created with our customers and the technology that we've acquired through our internal bills as well as through teams and technology we've acquired at Stratify, Connected, LiveVault.

These are technologies that are unique and differentiated in the market where there's a sustainable competitive advantage and interest from some of the largest players in technology today.

So I would expect the amount of business that we're driving through alternate channels to increase slowly over time.

These things take -- these partnerships take longer than everybody expects.

Because we do it from a recurring revenue perspective, they have a much slower build but a much longer duration.

Thanks so much.

Your next question comes from the line of David Gold with Sidoti.

I wanted to follow up a little bit on your comment about SG&A moderating in the fourth quarter.

Should I understand that as a function of basically some of the more discretionary items like security spending pullback or spending tailing off on that?

Or are you more saying we anniversary the increase in expense last year so it is going to be more a function of that?

It does.

Going back to what some of the drivers have been year-to-date, the bigger driver was the actually the impact of some of the technology acquisitions that we did last year and layering that into our cost base.

And Stratify was completed in December last year, and we will start to see moderating impact from that factor.

We did step up the investment in the areas that we highlighted in terms of security and international sales resources.

We are still investing in those areas, we just don't have the step-up.

We've been, as Bob mentioned, being very mindful about prioritizing our investments in the current climate.

And we are balancing investments against our strategy with making sure they are calibrated against our top line growth.

So those are factors that are contributing.

One thing I would highlight is, if you recall on our fourth quarter call last year, we had -- every year we have a level of kind of true-ups on accruals and things of that nature at year-end time and last year we had a number of things that kind of went in one direction that impacted negatively to the tune of about $5 million.

Keep in mind, we are not expecting that, we always could have some variation, but we are kind of expecting normal activity this year.

So that is a $5 million kind of lasting benefit in terms of cost growth that's built into our Q4 expectations.

So it's all of those factors combined.

And on some of the -- discretionary is probably a bad word, but the more discretionary items there like let's say security and some of the ones that you have marked out, were those more front end loaded or are they fairly evenly spread out?

It's a pretty even spread, it's something that we plan over a long period of time.

if you are going to be fortifying transportation fleet or training an employee base or facility infrastructure, it is planned over a long period of time.

So it's pretty smooth and, from our perspective, we have series of core values inside of Iron Mountain and we consider security to be job one, so that is not a discretionary from our perspective.

We don't view ourselves vis-a-vis our competition.

We view ourselves vis-a-vis our value proposition.

And that's an area that we will continue to invest, although to the untrained eye, it could appear to be overinvesting.

But we are about long-term preservation and security and storage of our customer's data.

So that will be an area we'll perpetually invest in.

Sure.

Much appreciated.

And then just one other, can you remind us what the '07 revenue contribution was from the product sales business that we're divesting?

It was about 1% of our revenues last year.

So it's a relatively small business and had pretty limited profit contributions.

So it was, as Bob mentioned, something that wasn't as large a business.

As you look at the balance here and our growth rate, keep in mind that's factored into to how we think about growth so that will offset much of the acquisition benefit that we've seen.

But it was a relatively small business and shouldn't have a big impact on our bottom line.

Thank you both.

Your next question comes from the line of Michel Morin with Merrill Lynch.

Hi, yes.

This is [David Ribbonlane] for Michel.

Can you -- just a question on the impact of higher gross margin acquisitions and then the divestiture of the lower gross margin data products business?

Can you quantify that net impact on gross margins?

I am trying to follow -- the benefit of technology acquisition growth and the impact of the product sales piece?

Right.

So you divested a relatively lower gross margin business and you also acquired relatively higher gross margin businesses.

I am trying to get an idea of the impact of those two.

We don't get down to fine-tuning the numbers at that level.

But I would say they are moving in different directions and are -- they were not one of the bigger factors impacting our gross margin performance in the quarter, if that helps in the context.

There was some impact but it was not highlighted as one of the big factors.

Can you remind us what percentage of your revenues are in the complementary services area?

Overall for our Company annually it's about 15% of the total revenues.

Okay, thank you very much.

Next question comes from the line of Franco Turrinelli of William Blair.

Good morning.

Good morning.

Actually, this ones for Brian.

I just want to see if we can clarify -- one of the previous questions that concerned me a little bit, there's was an implication that the fuel surcharges had a material impact on the growth of our services and I wonder if you could give us more clarity on that.

I was referring to core service growth and the question was, seems to have improved from Q1 to Q2.

And it was 7% in Q1 and 9% in Q2, and just highlighted at the margin, thing that's benefiting us on that particular service line is increased fuel surcharges.

And I just want to highlight that that does have some impact at the margin on things like core service growth, it doesn't really have -- has not had a significant profit impact as it really is to offset higher energy costs.

Thank you, congratulations.

(OPERATOR INSTRUCTIONS) Next question comes from the line of David Rainey with Akre Capital.

Could you all just remind us?

I was looking on slide nine of the handout.

How do you all think about maintenance CapEx spend to maintain the earnings power of your assets versus growth CapEx?

Is it captured on this slide or is it additional information you can share?

We don't disclose that in our regular reporting.

We do make reference in our SEC filings that we estimate overall as a Company that about 15% of our capitol spending over time has been what we categorize as more maintenance oriented.

If you think about the nature of our business and the way the capital intensity is typically about adding physical, and now, digital storage capacity as we add records, physical records, or bits and bytes that we are storing.

So the bulk of our capital investments are more growth oriented and we would characterize as more maintenance oriented capital as a smaller percentage of the total.

It is important to understand in terms of our business, because we are a growth business and because we are deploying growth capital, that limits to a degree our cash flow in the near term, but we believe over the long term, given that the maintenance capital is relatively low in our business, that our business has very attractive long-term cash flow characteristics.

So then 15% of your CapEx guidance for the year would be about $70 million?

That math would work.

We don't get that specific in how we talk about guidance.

It is more directional and an estimate of what percentage of our spending over a period of time has been maintenance and major.

Okay.

I have a follow-up.

Across your different lines of business, how do you look internally at forecasting rates of return on growth in digital core storage services versus the potential for share repurchases?

And I don't ask this so much in the context of when are you going to but stock, in the third quarter or the fourth quarter, I am just thinking about it in the context of everyday management has the decision whether or not they pay a dividend, buy shares, pay down debt, sit on their cash or invest in growth assets.

And so I am curious as to how you look at that framework to work to optimize the business long term.

Sure.

Just as a principle, you should know that we have -- we are very focused and disciplined on management of capital.

We control our capital decisions centrally.

As I highlighted -- we highlighted last year in our investor day discussion, we -- our financial objectives imply a return on incremental invested capital of 15% to 20%.

And we believe we have very attractive opportunities to invest in our business and deploy capital on that front, and we look at those type of metrics as we make capital decisions.

We did highlight that, over time, given our -- the profile of our business and our objectives and our ability to attract investment that we may have the opportunity for funds beyond what's required to invest in attractive opportunities in our business and have not made any decisions on that front relative to deploying those funds.

We did highlight share repurchases and dividends as options, but we don't have any news on that front at this time.

That is a finance discussion that happens between a few of us and with the board of directors from a day-to-day perspective.

We are really focused on how we're driving returns with growth out of our core business and juxtaposing that against and comparing that with investments that we can make an international expansion and expanding our service base.

That is the strategy that the operating team focuses on on a day-to-day basis, which is really not our day-to-day business to talk about returning cash to shareholders.

That is very limited discussion that's controlled centrally.

Okay.

Just to follow up, when you talk about 15% to 20% incremental returns on investment capital, are you discussing that on a levered or unlevered basis, taxed or and untaxed?

How do you all think about that?

That is a metric that is really looking at the incremental OIBDA we expect to generate for the capital that we are deploying.

It is a pretax number.

It is unlevered.

David, thank you for your question.

I do very much appreciate all of your support.

We are at the end of our hour.

Thanks for your support of Iron Mountain, to the extent that you can enjoy any of your summer that is remaining, please do.

And we look forward to seeing you on October 8th in New York City at the Grand Hyatt Hotel for our annual investor day and again on October 30th for our next earnings call.

Thank you all and have a good day.

This concludes today's Iron Mountain second quarter 2008 earnings conference call.

You may now, disconnect.