鐵山公司 (IRM) 2015 Q2 法說會逐字稿

Good morning. My name is Kayla, and I will be your conference operator today. At this time I would like to welcome everyone to the Iron Mountain Q2 earnings conference call.

(Operator Instructions)

Thank you. I would now like to hand the call over to Senior Vice President Investor Relations, Melissa Marsden. Please go ahead and ma'am.

Thank you, Kayla, and good morning, everyone. This morning we will begin our call with remarks from Bill Meaney, our President. and CEO, who will discuss highlights for the quarter and progress towards our strategic initiatives, followed by Rod Day, our CFO, who will cover financial and operating results. After our prepared remarks, we will open up the phones for Q&A. As we have done for the last few quarters, we have posted our earnings commentary and supplemental disclosure package on the investor relations page of our website at www.IronMountain.com under investor relations/financial information.

Referring now to page 2 of the supplemental, today's earnings call and supplemental package do contain a number of forward-looking statements, most notably our outlook for 2015 financial performance. All forward-looking statements are subject to risks and uncertainties. Please refer to today's supplemental, the safe harbor language on this slide and our most recently filed annual report on form 10K for a discussion of the major risk factors that could cause our actual results to differ from those in our forward-looking statement. In addition we use several non-GAAP measures when presenting our financial results, and the reconciliations to those the measures as required by reg G are included in the supplemental reporting package.

With that, Bill, would you please begin?

Thank you, Melissa, and good morning, everyone.

We are pleased to be reporting solid second-quarter results that were in line with our expectations on a constant currency basis and underscore the durability of our core business. Despite the FX headwinds, we are comfortable maintaining our guidance for 2015 as we typically see a bit of a ramp in the second half of the year.

It was a very eventful quarter with the announcement of our agreement to acquire Recall Holdings and the initiation of our transformation plan which will drive significant improvement in our overhead cost structure and support strong cash flow generation in years to come even prior to the substantial and additional synergies we anticipate from our acquisition of Recall. I will get to the last two items shortly, but first I would like to briefly cover certain financial and operating highlights.

Our momentum in the storage rental business continues to build and drive durable results in line with our strategic plan. On a constant dollar basis total revenue growth for the quarter was 2.2%, reflecting continued solid storage rental gains of 4.1% in service revenue declines of just 0.6%. Foreign currency impact year-over-year in total revenue by roughly 6%, reflecting the strong appreciation of the dollar experienced since this time in 2014.

We also continue to see good internal growth with storage rental up 2.7% for the quarter and 2.9% for the year-to-date, reflecting continued strong growth from data management, or DM, and the other international segment. In stable performance in Western Europe in North America rim as we look at the remainder of the year, we are seeing consistent trends and are maintaining our view for internal storage rental revenue growth for 2015 in the mid 2% range.

The realignment of our data management business we initiated last year is yielding good results. DM storage continue to strong very internal growth, with a 5.3% increase over last year. Total service revenue internal growth was flat for the quarter and down just half a point year to date, in line with our expectations for continued, yet moderating top line headwinds. Looking at volume in records management, we added roughly 14 million cubic feet of net storage volume worldwide on a trailing 12 month basis representing 2.8% net growth.

This growth was obtained in part as a result of the significant turnaround we are continuing to achieve in North America from negative to positive internal volume growth, or in other words, before benefit from acquisition. Net volume growth in North America was 1.2%, or 0.4% on an internal basis excluding acquisitions in line with Q1 levels. Globally we maintained customer retention of 98%, in line with the first quarter and a 20% improvement over the level of customer turnover experienced just two years ago.

Now turning to our transformation overhead optimization program we announced in June prior to the Recall acquisition news, we've spoken with many of you about this over the past several weeks and highlighted how our reorganization in April, in which we put a single leader over our developed markets, has facilitated this important program. This initiative calls for taking $100 million out of overhead cost, or SG&A between now and 2018, and is independent of and additive to the Recall acquisition. This will bring us to our current overhead of more than 28% of total revenue down to the mid-20% range and more in keeping with best practices for companies of similar size and global reach.

Importantly, we have already implemented a portion of this program and achieved $50 million of cost reduction or half of these savings with a charge to be taken in Q3 and the full benefit of the $50 million to be realized in 2016. With the partial year contribution from this program we expect the net impact for 2015 to be neutral.

Also in recent communications we've illustrated how the decline in our service margins over the past few years, and more recently FX headwinds, have offset the attractive returns we achieved from investment in real estate and acquisitions. And fact, during this period, we have been achieving unlevered returns on invested growth capital in the low teens and have seen significant contribution flow-through in the past couple of years.

We initiated some programs last year and are continuing to implement changes that we believe will allow us to stabilize the service margin trend line and get back to around 27% by the end of the year. It is important to keep this in perspective. While service represents 47 % of our total revenue today it represents just 17% of our total gross profit.

Again, to be clear, we are talking about a slowdown in the activity of physical records and tapes being retrieved not a slowdown in incoming volume of records and tapes to be stored. Whilst the demand for typical office cut sheet paper has declined between 2% and 4% in mature markets in the past few years we continue to see the same number of boxes being inbounded from our existing customers year after year demonstrating the durability of the storage rental business.

We do continue to expect service revenue headwinds of negative 1% to negative 2% annually over the next few years, and in fact we did see flat service revenue this quarter compared to a year ago period. And whilst we can't completely offset the impact of lower service revenues due to a decline in retrieval and refile and transportation activity, we can do more to align our service cost structure with this decrease in activity levels. So what are we didn't address the service margin decline?

First, we are looking at ways to variablize more of our cost. Second, we are exploring efforts to make more efficient use of third-party logistics suppliers or 3PLs where we can be assured they we will maintain our quality and focus on secure chain of custody. We have used this in Europe on a smaller scale and believe we can expand the use of 3PLs elsewhere. And third we are using technology more proactively such as using sensors to detect when shred bins things are ready to be emptied to make routes more efficient.

Additionally in this quarter, we have seen an uptick in our bad debt. This has come out of our North American business and is primarily the result of refining our billing process over the past 18 to 24 months.

During this transition, we didn't adequately refine the process before moving responsibility for the North America billing offshore. There is now a robust plan in place addressing this.

Now let's turn to the Recall transaction. This deal is extremely compelling in terms of industrial logic and strategic fit and is supported by meaningful synergies that drive significant accretion.

I assume by now you are familiar with the basic terms of the deal, so I won't review all of the information, but rather just touch upon the highlights. In the announcement presentation, we illustrate estimated total net synergies of $155 million with $110 million of that to be achieved by 2017.

These synergies are driven by economies of scale from the combination of infrastructure overhead, and when fully realized will lead to double-digit accretion in adjusted EPS, FFO per share and AFFO. At 25% of our size Recall is managing a similar global platform in terms of country coverage as they are in 24 compared to our 36, which drives much of the overhead synergies.

Another benefit of the proposed transaction in the medium-term is that it supports our deleveraging strategy. With the additional cash available to us from our transformation plan, as well as Recall synergies, we can not only fund a stable and growing dividend per share, but we also generate the capital need for growth.

Additionally, we have complementary market platforms with Recall having a more developed presence in the small to medium business whilst we have more significant presence with the larger enterprise customers. We've been on the road over the past several weeks and have met with a number of our shareholders, as well as Recall's major holders in Australia. And what we're hearing is universal agreement that our two companies are worth more together than they are separately.

You can see that several Recall shareholders have increased their holdings and appreciate the attractiveness of owning the combined company. Even our most seasoned advisors have noted that they cannot remember a deal that delivered 26% EPS accretion in three years time. In the next several weeks, we expect to file the shareholder meeting document seeking approval of the acquisition which will have additional details including pro forma results.

Turning back to Iron Mountain, on past calls we have discussed progress on our three-year strategic plan, which rests on three pillars: getting more from our developed markets, expanding our present in faster growing emerging markets, and continuing to explore adjacent opportunities in our emerging business segment.

Whilst Recall -- whilst the Recall acquisition and transformation plan have garnered a bit more internal and external attention of late, we continue to make good progress on our base plan achieving consistent positive storage volume growth and developed markets and completing an organizational realignment to put developed markets under common leadership, which enables ability to implement our latest transformation program, as well as to accelerate our service margin initiatives.

Additionally in emerging markets we continue to progress towards our goal of 16% of total revenue from these markets by the end of next year. We pressed the pause button on acquisitions for a moment to assess how some of the transactions in the pipeline might be affected by the Recall acquisition, but we are resuming activity and continue to be pleased with the quality, size and scope of our pipeline.

We've also discussed on recent calls how we been impacted by the effects of currency translation in terms of absolute earnings and cash impact in US dollars. Whilst FX variability does impact the absolute dollars we report, the impact on our gross and adjusted OIBDA margins is muted, because most of our expenses are denominated in local currency, thereby creating a natural hedge.

On the other hand, we continue to believe that the current strong dollar is positive in terms of investment opportunity. Given our intent to expand what is today a relatively small international base, we believe we can create significant value over time by investing selectively in these higher growth markets using strong US dollars during this part of the currency cycle. This may take the form of M&A or in the purchase or development of real estate. In both cases we can benefit from investing at a low basis.

In addition, we have deepened our focus in the real estate investment area adding an experienced REIT asset manager to accelerate our plans to buy $700 million to $1 billion of our leased facilities over the next 8 to 10 years. As we seek to shift our mix to a higher percentage of owned properties, on average we are achieving a spread of roughly 150 basis points between our going end cap rates and our market cap rates whilst positioning ourselves to capture long term residual value from ownership. We think this is important and appropriate as a REIT as it supports us being viewed more in line with traditional REITs by the rating agencies and investors.

Importantly our debt to total market cap and our debt to EBITDA measures are in line with major REIT sector leaders, and our internal storage rental revenue fared better than these sectors during the recent recession when we did not have a down year. Our low volatility business is distinguished by a track record of 26 years of consecutive growth in storage rental revenue.

As we think about the opportunities to grow our storage rental business, it is important not to lose sight of the durability of the business which is underpinned by roughly $1.5 billion of net operating income from our storage business alone. This amount of NOI is comparable to that generated by leaders in both the industrial and self storage sectors.

As we have noticed in recent calls the REIT structure is consistent with our capital allocation goals. It does not limit our ability to fund our business plan as we become more active in buying in our properties and executing on our acquisition pipeline. We expect to fund that incremental investment with excess cash flow or additional borrowing.

Now I'd like to turn the call over to Rod.

Thanks, Bill.

Our results continue to demonstrate the durability of our storage rental revenue stream and the underlying strength of our business fundamentals. Our performance is tracking in line with our full-year expectations. To frame my remarks, I'll begin today with an overview of our second quarter and year-to-date performance including a review of results by segment. Then I will address plans and expectations related to our transformation program and our initiative to improve service gross margins.

I will briefly touch on the Recall acquisition costs and also our outlook for 2015, which remains unchanged since June on a constant dollar basis. Finally I will just other metrics through our REIT loans.

Let's turn to our worldwide financial results. Referring now to pages 8 and 9 of our supplemental, total reported revenues were $760 million compared with $787 million in Q2 of 2014 down by 3.5% year-over-year. This reflects the continued strengthening of the US dollar, which impacted total revenues by approximately 5.7% or $44 million. Excluding FX and so on a constant dollar basis revenue grew by 2.2%.

Year-to-date reported revenues were $1.51 billion compared with $1.56 billion in 2014. Again on a constant dollar basis, first half total revenue growth was also 2.2%.

Worldwide revenues were driven by solid constant dollars storage rental revenue growth of 4.1% for the quarter and 4.3% year-to-date. This was offset by service revenue declines of roughly 1% for the quarter and year-to-date. As we did for the prior quarter we are providing bridging schedules for revenue, OIBDA and earnings which explain key variances in year-over-year performance. These are on pages 20 to 22 of the supplemental.

Adjusted OIBDA for the quarter was $223 million compared with $242 million in 2014, down 7.7% on a reported basis, and 3.3% on a constant dollar basis. The constant dollar adjusted OIBDA decline was driven by investments in new products introductions, for example in data management. In addition, we had a $4 million increase in bad debt expense. As Bill mentioned, during the off shoring of our billing activities our collection efforts fell behind. However, we now have a strong remediation in place.

Service margin declines were a further drag on the business although these were offset by improvements in storage contributions. Adjusted EPS for the quarter was $0.28 per diluted share compared with $0.41 in the second quarter of 2014.

The decline in adjusted EPS year-over-year is driven by a 10% increase in share count related to the special distribution which we made in the fourth quarter of 2014. In addition to the earlier OIBDA breakdown adjusted EPS was also impacted by an increase in interest expense related to higher levels of debt. As stated in our earlier calls, this year-over-year increase in borrowing was driven primarily by REIT conversion-related expenses such as E&P purged and the depreciation amortization recapture payments.

On the subject of debt, please note that is our intent to refinance our high coupon debt when conditions allow. Our structural tax rate for this quarter came out to 13.9%, compared with 15% in the prior quarter, primarily as a result of mix change in income from foreign jurisdictions. We continue to believe that our tax rate will be approximately 15% to 16% over the long term. Normalized funds from operations, or FFO per share, was $0.48 for the quarter and $0.98 year-to-date while adjusted funds from operations, or AFFO, was $130 million for the quarter and $255 million year-to-date.

Let me now turn to records management volumes trends on page 10 and 11. As you can see, we achieved positive volume growth of 1.2% in North America, 3% in Western Europe, and 9.7% in the other international segment. Delivering global records management net volume growth of 2.8%.

We continue to experience strong organic growth with second-quarter total year on year volume growth of 1.8% excluding acquisitions. Underlying this growth, is the stable incoming volume from existing customers. We continue to add approximately 30 million gross cubic feet of storage in the last 12 months, consistent with prior periods.

Let's now turn to our financial performance by segments. In North American records management and information, or RIM, internal storage rental revenue was flat for the second quarter. Year-to-date North American RIM internal storage rental revenue grew by 0.2%.

Internal service revenue growth showed a small improvement in Q2 with a decline of 1.3% compared to a decline of 1.8% in Q1. Adjusted OIBDA margins in RIM remain solid at 39.4% for the quarter and 40.2% year-to-date. North America data management delivered storage rental internal growth of 5.3% in both the second quarter and year-to-date.

While the service declined by 1.7% for the quarter and 3.8% year-to-date as we continue to see declines in refile and transportation activity. During the second quarter DM adjusted OIBDA declined to 50.8% from 52.7% in Q1 as we continue to invest in new products. The western Europe segment generates solid results with 3.5% storage rental internal growth for the quarter and 3.6% year-to-date. This growth was partially offset by declines in internal service revenue, 4.8% for the quarter and 3.7% year-to-date.

The decline in service revenue was driven mostly by the sale of our shred business in the UK and Ireland towards the end of last year. Adjusted OIBDA margins declined in Western Europe this quarter due to legal costs related to a customer dispute. The other international segments, which made up of emerging markets and Australia, showed strong growth in both storage and service revenues.

Storage rental internal growth was 11.5% for the quarter and 11.3% year-to-date. The service internal growth was 13.5% for the quarter and 10.2% year-to-date. This quarter, emerging market revenues represented approximately 14% of our total revenues on a constant dollar basis. We expect adjusted OIBDA for the segment to deliver profitability on a portfolio basis in the high teens, the low 20s range as we continue to expand our exposure in the fast-growing markets.

As Bill mentioned, we are leveraging our new leadership structure to focus on integrating costs across developed markets. Through our transformation program which was announced last month, we expect to achieve approximately $100 million in reduction in overhead expense by 2018.

Actions we have taken this month were expected to yield a full-year $50 million benefit in 2016. We will see partial benefits this year at the end of the year. However, these will be offset by severance related charges. We are anticipating approximately $10 million of severance-related expenses in the third quarter as a result of this program.

Let's now discuss our initiative to maintain and enhance service gross margins. As Bill outlined the decline in service gross margin has acted as a drag on our performance in the last four years partially masking the strong returns that we are seeing from investments in real estate and M&A. That said it should also be remembered that on a constant dollar basis, we have seen good improvements in overall contribution year-on-year in 2014, and we expect the same in 2015.

As discussed earlier, and as you can see in the supplemental on page 26, in the second quarter service gross margins have declined year-over-year. The actions we are now taking are not yet reflected in our results. However, in the second half of the year we expect to see an improvement in service margins and continue to target a year end run rate of about 27%.

Let's touch on the Recall acquisition briefly. As Bill mentioned, we're making good progress regulatory filings. To prepare for closing we incurred approximately $6 million professional and advisory fees this quarter. We expect about $10 million to $15 million of additional spend in each of the third and fourth quarters of this year.

In addition to these advisory fees, we're expecting approximately $20 million to $25 million charge in the second half of the year to prepare for integration, including Recall's REIT conversion. Please note that these cost will be excluded from our adjusted OIBDA calculation, as they are one time in nature. These cost rules are were also included in our guidance related to the Recall acquisition when we announced the deal.

As I mentioned at the outset, our outlook for 2015 remains consistent with the guidance we provided in June when we announced the definitive agreement to acquire Recall. Please note that at this time, our guidance doesn't reflect the benefit or impact of the potential Recall transaction.

We will provide details guidance for 2016 and beyond on our upcoming investor day in October. For 2015, although we expect revenue to be as anticipated on a constant dollar basis for the full year, given FX movements we expect reported dollar revenues to be towards the lower end of our range. As regards other metrics for both constant and reported dollars we expect them to be well within our ranges.

Our strong cash flow continues to support our dividend at current levels in 2015, and we intend to maintain our dividend per share rate for the remainder of the year subject to board approval. Our asset for cash available for distribution and discretionary investments for 2015 remains $470 million, giving us ample dividend coverage and the ability to fund our core real estate investments or growth racking, which support approximately 2% organic growth in our adjusted OIBDA.

In 2016 and beyond, assuming the Recall acquisition closes, and with the transformation benefits, we have excess cash that can support potential growth in the dividend and or fund discretionary investments in real estate, M&A or emerging business opportunities. These investments achieve returns above our rack and are accretive to shareholders. To sum up, we have adequate dividend coverage, excess capacity and attractive investment options.

Shifting to the balance sheet, at the quarter end we had liquidity of approximately $750 million. At the quarter end our lease adjusted debt ratio was 5.7 times as expected.

Turning now to REIT specific metrics, we continue to achieve strong storage NOI approximately $28 per rack square foot worldwide which compares favorably to NOI per square foot for most property types within the REIT sector. Our racking and building utilization rates are high at 91% and 84% respectively for the records management portfolio. We believe that due to frictional vacancy our maximum racking utilization is in the mid-90s.

When we enter a new facility, we generally target to achieve stabilized utilization at about three years time. The investment page, page 32 of the supplemental, highlights our investments for racking projects in process, building development and building acquisitions by major geographic region, their total expected investment and anticipated NOI on returns.

Please note that these investments represent growth related investments and exclude consolidation-related spends. As you can see on this page, we achieve high returns in our growth racking and building development projects. Lastly, similar to prior quarters, we are providing components of value, a summary various metrics of our business to facilitate evaluation. As a reminder, we present both storage NOI and service OIBDA, excluding rent expense, in order to present storage economics on a consistent basis for the facilities, whether facilities are leased or owned. To balance that, we provide total rent expense in the liabilities area.

Overall, we believe this was a solid quarter, and we are pleased with the momentum we continue to see in the business. We remain on track to deliver our guidance for 2015. Looking ahead, we continue to focus on enhancing shareholder value by extending the durability of our storage rental business, improving service margins, achieving overhead cost reductions through our transformation program and realizing the synergy benefits of the Recall acquisition. And that, Bill, concludes my summary for the Q2 financials.

Okay. Thank you, Rod.

Before we turn to Q&A just to wrap up, I just want to emphasize a few things. That first of all we have a number of exciting developments underway. We have already executed on half of our plan for significant cost reduction of more than $100 million, and we will see the full benefit of the first million -- $50 million for 2016.

We have actions underway that we expect will stabilize the margins in our service business. We are teeing up to close the Recall deal early next year and are organized internally to support the smooth integration of Recall, and our attractive emerging business pipeline is delivering interesting adjacencies that can further extend the durability of our enterprise storage business.

Finally and most importantly, the strength of our business plus the transformation program support approximately 11% to 14% growth in the cash we have available already next year to grow our dividend per share over time and fund our growth investment. This is even prior to the Recall acquisition.

With that, operator, we are ready to take questions.

(Operator Instructions)

Kevin McVeigh, Macquarie.

Great, thanks. Bill, very helpful comments. Are there any type of goalposts you can give us in terms of the cadence on Recall? I know there's a process involved in antitrust review and so on and so forth, but is there anything you could point to that would just give us cadence as the deal progresses over the course of the year?

Good morning, Kevin. Thanks for that. I think there's -- the same goalpost that we set from the beginning is that we started the regulatory review process, [rent] engaging the regulatory review process, and that's a 6- to 12-month process. We feel that we should be able to do it at the lower end of that range; so, our expectation is still the first quarter for 2016. We will continue to update if that changes, but I think right now that's our expectation.

I think the other goalpost, as we've said on this call is, in the next few weeks both us and Recall will be issuing documents for their respective shareholders, getting ready for the shareholder votes. But those are probably the two goalposts that are important to highlight.

And then just the $20 million to $25 million of Recall reconversion costs -- if I'm thinking about it right, does that mean it's a dual track in terms of you start that reconversion process now, so when the deal occurs, it goes live day one?

Yes, I think the -- it's a very good point. Yes, we will start incurring costs, and Rod can give you more detail on that. We will start incurring costs as we speak now in preparing for the REIT conversion, because we need to convert before the close of the first quarter.

So, you'll also notice in the documentation is that we have set it up, the documentation, that we will close at the beginning of a quarter. So, the idea is that we would close either at the beginning of the first quarter, ie, the first month of the first quarter, ie, around the month of January, or it would be the beginning of the month of the second quarter, again, to give us time to actually execute the conversion. But the prep for that conversion obviously starts way in advance of closing the transaction.

I don't know, Rod, if you want to add any?

I think that's a good summary, Bill. Kevin, it's not exactly day one, but it's sort of by the end of the first quarter. And obviously, given the limited amount of time that we have, it's important we get our preparation right in advance of that. So, that's really what the spend primarily relates to.

You'll see that in the documentation on the deal is that it's very clearly set out that if we miss roughly the first, say, four or five weeks of a quarter, then it delays to the next quarter because, again, we have to get the conversions done during that period.

Got it. And this will be my last question, I apologize: Would there be any incremental tax expense like there was the step up from the racking on the initial conversion or, that $20 million to $25 million, is that primarily professional fees, things like that?

Yes, that relates primarily to professional fees.

Okay. Thank you.

Andy Wittmann, Baird.

Hi, good morning, guys. Bill, I had a strategic question. We've seen some consolidation in the shredding industry. You guys have aided that as you got out of your European shredding.

I was wondering, as you look at your Business today, particularly as a REIT, does even more disposition of the shredding assets make sense for you, particularly if you could find a partner that you would be able to do this with? Would that be something you'd be open to considering or are considering today?

I think, first of all, just from a general capital allocation standpoint, we look at all our businesses and say -- are we the best owner for that? Or is that where we should invest capital? So, we look across all our businesses. To say that we are open to certain segments and not open to others would be probably a false premise.

But, I mean, we, like you, look with interest in terms of what seems to be happening in the shredding business. We feel good in terms of what we've done over the last, say, 12 months in terms of, first of all, divesting those shredding operations -- the one in Australia, the one in the UK -- where we didn't think we had the scale to get the kind of returns that we expect and demand, whilst separating the US operation to be more of a stand-alone unit, so that it has the right focus and cadence associated with it to achieve the results that we think are possible. So, I think we feel comfortable where we are, but we are also very pleased in terms of the way the market seems to be valuing these assets, whether we own them or we sell them.

Yes. Okay. Good, that's helpful.

I guess I wanted to dig in a little bit more on the transformation initiatives. Can you give us a little bit more detail about what some of those are, and maybe some confidence that they're not going to affect the customer experience and hurt your retention rates or other business drivers?

It's -- excellent question. I think, first of all, we need to start at the top that we are starting from a base where our SG&A is 28% of sales, which is clearly on the upper end of what a company with our scale and scope should be able to achieve. It should -- a company of our scale and scope should be in the, let's say, the mid-20%s, and probably the lower side of the mid-20%s. So, in other words, it's probably more the 23% to 25% range is where a company of our size and complexity should be. So, that's the first thing to give you a sense of what's possible.

Then, the thing that triggers it is -- really, if you think about it, there are, I would say, three buckets. One is just getting efficiency through the reorganization. So, when we put all of the developed markets under one person, then it allows you to rationalize -- you know, you have two finance groups, you have two HR groups, you have two commercial leadership groups, you have two engineering groups, et cetera. So, you are able to actually shrink that to one to get some of the efficiencies and economies of scale that you would expect.

I think the second aspect of it is looking at what we call just general spans and layers -- probably it's triggered by that move. But just saying -- what is the right breadth of responsibility in the Organization? Do we have too many layers? And I think that's just good housekeeping that all companies our size need to go through every so often to make sure that we don't have what I would call organizational creep, or layers building into the Organization.

And to me, that's important not just from a cost standpoint, but it's also important from a dynamic standpoint. And I mean by dynamic is to be quicker, nimble -- more nimble, less bureaucratic. So, I think that's a -- it shows up in the cost line, but we also expect that to show up in the revenue line.

And then the third aspect is -- it's related a little bit to the aging of some of our -- aging of our receivables slipped, which led to a bad debt charge, is that we need to look at our processes, first and foremost, in terms of how can we make those more efficient, and then where should those be done? Should they be done internally? Should they be done internally offshore? Or should they be done by an outside party?

And that's the third bucket that we're going through is to both optimize those processes, and then figure out where they should be done, either within Iron Mountain or by an outside vendor. And that's kind of the three buckets that we're going through. On that last one, you can imagine we're actually using also some outside help that have done this a number of times.

So, we feel very confident in terms of the targets. We feel very confident that we are doing this in areas that doesn't impact the customer experience and service levels. And in fact, I think our expectation is it should improve it as we look to make the Organization quicker, more nimble, and less bureaucratic.

Yes, and I would just to add to that, Bill. I think if you benchmark Iron Mountain against comparable type companies, I think you could say we are behind where we should be on some of the stuff. And that gives us confidence around the program that we have. So, things like offshoring -- we've done some of that, but nowhere near enough. We've done some process improvement, but nowhere near enough.

There has been some improvement in our SG&A and as a percent of revenue over the last couple of years. But again, if you look at benchmarks, these median benchmarks, you referenced the 25%, Bill -- compare that to where we are with (inaudible) again, I think that gives us additional confidence. What we're trying to do is not rocket science, it's just what we should be doing.

Yes. Okay. I'll leave it there. Thank you.

George Tong, Piper Jaffray.

Hi, good morning.

Good morning, George.

You talked a bit about various puts and takes, and OIBDA margin performance in the quarter, and some of it appeared to be transient in nature. Can you frame up how you think about OIBDA margins on a go-forward basis and any planned reinvestments of the benefits you expect from the transformation program?

So, George, I'll let Rod kind of go through a little bit more detail. But the bridging to get at a high level, and that's one of the reasons why we provide these bridging schedules is so that you can -- we're highlighting the things that we -- in our view, are one-off, either because of the something specific we had in the quarter, or when we're talking about service, where we think we're going to end up at the end of the year in terms of service margin based on some of the improvements that we're making.

So, the intent of those bridging schedules is to guide you to where we think we're moving towards -- where we should be on a normalized basis on an OIBDA margin basis. But Rod may want to comment in more detail on that.

Yes, to answer the question in two parts, George. First, in terms of the underlying structure, if you like, of the P&L, effectively what we expect to see is continuous improvement in performance as the year progresses. And that is to be expected as cube volume continues to build at a decent price, and it flows through at a decent margin.

So, quarter after quarter after quarter, we should continue to build. Around that, obviously, then you have some of these one-offs. In the quarter, we called out a couple of them. One was this bad debt expense issue, and Bill referenced in terms of the -- related to the offshoring of our billing activities.

We also had an investment in the data management space around new product introduction, which obviously the expectation of that is there'll be returns coming from that in the future. There are a couple of key one-offs for the course, but underlying sort of the fundamentals of the P&L is just relentless drive upwards on the storage side.

Got it. And can you talk about how your storage pricing strategy compares with Recall, and how you think about pricing as a contributor to storage revenue growth going forward?

I think, first of all, I can't comment in terms of compared to Recall because we haven't exchanged or shared any commercial information -- we have to go through the regulatory aspects. I can't comment on how we compare to Recall.

But I think if you look at the results that we're getting, as you can see, I mean, I think the way to look at it is a couple ways. We're getting, I would say, fairly regular yet modest price increase that offsets the inflation that -- the low inflation levels. But I think, as I said a number of times on calls, is that in a low-inflation environment, price increases are more challenging.

I think the other thing to look at is if you look at what's been happening to our gross margins associated with storage, you can see they actually -- there is a slight uptick. So, that gives you a view that in a low inflation environment -- obviously, we have wage inflation that is still real in terms of what we pay our folks. But we are able to get both productivity increases and pricing increases that allows us to either maintain or slightly enhance our gross margin. We feel pretty good in terms of what we're getting in terms of pricing. It's something that we continue to work on.

I think I told you we brought somebody in about a year ago just to -- our new leader for the pricing group. That seems to be getting some good traction. But I also think it's important to understand that in a low-inflation environment, you know, these are small numbers that you're dealing with. You're not dealing with large order of magnitude. But the results are good. I mean, our gross margins are stable, and I'd say they are slightly higher than they were a year ago.

Great. Thank you.

Andrew Steinerman, JPMorgan.

Hi, there. I just wanted to know if the data management, new products were as planned. Should we expect a similar level of investment -- the 1.5 -- in the quarter and in the second half of the year. And if you could just give us a little description -- are these new products in the area of tape vaulting, or is it something a little different within data archiving?

Hi, Andrew. There's a couple aspects. First of all, what we have in the bridge was a very specific one-off associated with our relaunch of a product that's associated with secure destruction. So, that was a very specific one-off relaunch of that particular product.

I think that there -- even if you add that back, you will notice that our margins are slightly down from where they were a year ago, albeit they are very good margins, but they're slightly down. And we didn't bridge to that for the reason that you're highlighting right now. We have made a conscious decision to incur some additional OpEx, which is associated with launching new products in that area. So, one of the areas that I think we've publicized is that we have a partnership with EMC that offers both their customers and our customers a joint -- it's kind of a combination of our data center, our tape business, and EMC's data domain business, which is a data center replication hardware offering they have.

And that -- there is investment associated with standing up those new products. Our expectation -- the reason why we didn't bridge that is you could say that that was a one-off for this quarter, but our expectation is we will continue to make those kind of investments as we see a pipeline of further products like this one that we've announced publicly with EMC.

So, I think that's the way I would think about it. So, what we have in the bridge was very specific to a product launch that we did this quarter that we really anticipate as a one-off. But we have incurred, and we expect to continue to incur, some OpEx investment in terms of new product launches.

Okay. And was that always envisioned in the plan, like so that spending now doesn't affect the guide for the year?

No, that was always in the plan. And that was part of separating data management under a separate leader, as you know that we brought in Eileen Sweeney just a year ago, specifically. So, that was part of the plan.

Okay. And then, if you let me, one more: The bad debt write-off -- the $3.8 million -- obviously that's a surprise. Are you hoping some of the cost initiatives that you were talking about could offset that, or does that in some way tilt the EBITDA guidance towards the lower end?

I think that what we've said in the press release, as you noticed, we think that on a reported dollar basis, that we are still within the range of our guidance. On a revenue basis, we think we are at the lower end of the range, on a reported dollar basis. But still in the range that we've guided to. So, we still feel comfortable about maintaining our guidance that our OIBDA will be in the range, as we set out at the beginning of the year.

I think this specific -- think about the specific highlight that we've talked about on bad debt, and I'll ask Rod to comment further. But it's more about a aging issue in terms of when we moved the process, we didn't optimize the process fully before we moved it offshore. And when we moved that offshore, is we slipped behind on the dating. So, we feel good, over the next 6 to 12 months, that we will be able to get that back in shape, and we are well under way. But you can imagine that when you slip behind on the dating, it takes a while to pick that back up.

I don't know, Rod, if you want to add?

Yes, that's right, Bill, in terms of the general component of our bad debt provision, it's driven by the aging of our receivables. And as we move this offshore, the aging, it deteriorates a little bit. And therefore, that triggers an increase in the bad debt -- and bad debt expense by about 0.5 point. (multiple speakers)

I think we, just to make sure it's clear, we will get back to our normal range of about 0.5 point of revenue in terms of bad debt expense.

Correct. Absolutely right. So, that's -- and we have very rigorous plans to ensure that that is the case. And just to be absolutely clear, in terms of the contribution guidance, we're in no way signalling we're at the lower end of the range. It's very much within the range on that point.

Perfect. Thank you.

Dan Dolev, Jefferies.

It's actually Dan Dolev at Jefferies. Thanks for taking my questions.

I have a few questions. We talked a few weeks ago, when you did a conference call you mentioned service margin stabilizing. I see a 330-basis-points decline. What gives you confidence that -- that you could actually stabilize margin in the coming quarters?

Good morning, Dan. That's a good question. If we look -- obviously, the -- this quarter was below our target of getting 27% by the end of the year. But if you actually -- when we looked at the performance and as part of the improvement program we looked at, if we took the month of May out, May was a specifically weak month for us on this quarter in terms of our service margin and profitability.

If we took the month of May out, we would have a 26.1% service margin in this quarter, which is still 100 basis points, but we know how to bridge that gap. And even when we looked at May, some of the things that we were introducing gets us better to manage it. So, the month of May was particularly soft for really two things was, one is variablizing some of our costs quick enough associated with a normal downtick in revenue, because there is some seasonality in revenue, and plus it was a short month in terms of the way the holidays fell.

So, those two things that, which is part of our program. If you remember our three-pronged approach to this is variablizing our cost base more, which, the month of May is a great example in terms of what that program is designed to offset. The second thing is using outside parties. The third one is technology.

Again, the data for the quarter looks worse than it is, if you know what I mean, in terms -- especially if we add back some of the programs that we've introduced to minimize that going forward. So, we still are sticking by our guidance that we think by the end of the year we will be at 27%.

Thank you. And two more quick questions: On the bad debt expense, I don't know if you've addressed it fully -- the uptick from 50 basis points to 70 basis points, was that a result of aging or did I misunderstand it?

It is primarily the result of aging, is the issue that we referred to earlier.

Got it. And did that result in any impairment to the capitalized acquisition cost on the balance sheet or --?

No.

Nothing? Okay. And then last question: When I was looking at -- EPS obviously was a little light, I would say, versus consensus. If you look at both FFO and EPS, is that [what you meant by] very significant acceleration in the second half of the year? Can you maybe talk a little bit about your confidence of actually getting it?

Well, I think, first of all, on an AFFO basis, you see we're actually a bit ahead of where the consensus had us coming out with. So, first of all, from a cash standpoint, we're actually ahead. I think the bridging schedules do a pretty good job in terms of what the puts and the takes were in terms of why we ended up a bit below on consensus.

But if you just look at our normal ramp in the second half of the year, part of this is just in terms of, we don't give quarterly guidance; we give a year guidance. And part of this is just the way that the street decides to carve up our annual guidance. So, if you just look at historical ramps in the second half, you don't find this as surprising. That's why I feel very comfortable in terms of maintaining our guidance.

Maybe just to talk specifically about EPS, year to date we're at, on an adjusted basis, $0.60 a share. The midpoint of our guidance for the full year is $1.225. So, you can see we're almost at the halfway point, as I was saying earlier, because of the dynamics of our Business, we know that the storage revenue and contribution growing quarter after quarter. I think you can sort of see how we can reach that point.

Right. I was also referring to AFFO at the midpoint. It implies about a 14% acceleration.

And I think it's the same logic, if you like, in terms of the flow through the P&L. So, we expect contributions to continue to build. That actually has a disproportionate effect in terms of the flow through to FFO. So, again, we feel comfortable around that number.

Great. Thank you very much. I appreciate it.

(Operator Instructions)

Shlomo Rosenbaum, Stifel.

Shlomo here; thank you very much for taking my questions. Bill, could you go into a little bit more detail what you mean about variablizing the cost with third-party logistics vendors? Are we talking about working with like a UPS or a FedEx or something?

Yes -- morning, Shlomo -- there's two parts. There's variablizing and there's using third parties. So that there you could say that there are two part, two ways of doing it. We also look at variablizing more of our cost under our own control, and we do use temporary workers that are trained and certified and cleared by Iron Mountain. It's getting that mix right.

So, first of all, we do have a variablized workforce internally, and making sure that we're using more of that, which is the thing that helps offset some of the variablization of some of the service revenue that goes through. And service revenue, for us, don't forget, is more than just transport; there are other bits that are contract-based. So, that's one aspect.

And then, on the 3PL side, yes, it is the FedEx, and UPS's of this world, and other courier services. We use some of them today. We use them more extensively in some European countries where we -- you know, the necessity has come even faster because of the size of some of our operations in some of the smaller countries. And we're using that same knowledge and know-how to accelerate that in North America. So, it is, many times, those logos and others.

Okay. Great. Thanks for the clarification.

Then, maybe this is for Rod: The non-real estate investments in the maintenance CapEx, at least for the first half of the year, are trending well below the annual targets. Is this expecting a tick up in the second half of the year, or for some reason we're just -- current levels are more of a good run rate? How should we think of that?

I think there will be a tick up in the second half of the year, back closer to the guidance numbers that we issued in June. It's just to do with the phasing of certain aspects of our activity.

Is there a seasonal component to that, or just happens to be year by year, and it works in different parts of the year based on what your plans are?

It's actually largely based on our own plans. There's an element of seasonality around some of the maintenance activity that we prefer to sort of backload as opposed to doing it in the middle of winter -- in January, February. But it's largely down to our own planning.

Okay. And then, am I understanding you correctly that, while you're guiding to the low end of the guidance range because of currency for revenue, you are not pointing to that for OIBDA, or am I misunderstanding that?

Yes, that's correct. That is correct. We're taking action on cost to ensure that we still steer towards the midpoint of our guidance, both from a constant and a real dollar perspective on contribution and cash.

And is that because of this program that -- or largely because of this program that you just announced with that big third-quarter charge?

No, not that specifically. In fact, the transformation program for us is neutral because we incur a severance charge during Q3 which will be offset by run-rate savings in Q4. This is more due to other activity that we are taking.

Okay. Great. Thanks.

We have no further questions at this time.

Okay. Thank you very much, everyone, for joining us this morning, and have a good day.

Thank you. This does conclude today's conference call. You may now disconnect.