Iron Mountain Inc (IRM) — Q3 2016 Earnings Call Transcript

Thank you, Kwashia, and welcome everyone to our third quarter 2016 earnings conference call. This morning, we'll hear first from Bill Meaney, our CEO, who will discuss highlights and progress toward our strategic initiatives; followed by Stuart Brown, CFO, who will cover financial results and guidance. After our prepared remarks, we'll open up the phones for Q&A. As we've done for the last several 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 two of the supplemental, today's earnings call and presentation will contain a number of forward-looking statements, most notably our outlook for 2016 and 2017 preliminary financial and operating performance. All forward-looking statements are subject to risks and uncertainties. Please refer to today's slides, our earnings commentary, the Safe Harbor language on this slide and our most recently filed annual report on Form 10-K for a discussion of the major risk factors that could cause our actual results to differ from those in our forward-looking statements. In addition, we use several non-GAAP measures when presenting our financial results. And the reconciliations to those 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 a solid quarter, and I'm also happy to be partnering with Stuart Brown for his first Iron Mountain quarterly conference call. Stuart's been on board since the time we reported Q2 and has been spending a lot of time in the field, familiarizing himself with the business and working closely with Rod during the transition. Stuart will deliver financial highlights in just a bit. For the third quarter, we delivered revenue and Adjusted OIBDA results right in line with our expectations and notably drove our Adjusted OIBDA margins back to 31.2%, more in line with historical norms prior to integrating the historically lower margin Recall business. In addition, we continued to see consistent trends in our core business with positive internal storage rental revenue and volume growth in developed markets, a greater portion of our revenue coming from faster-growing emerging markets and good momentum in our adjacent business segment, particularly data center. As noted last quarter, due to our quick actions, we are getting Recall integration synergies faster than expected. In fact, we now expect to exit 2016 having achieved more than 85% of the total synergies we expected to have achieved by year end 2017. This is up from 80% in our Q2 call, and we continue to expect in-year synergies to be $80 million. It is this achievement of getting synergies faster and the added benefit from our transformation initiative, which is the fuel that allowed us to increase the dividend per share starting in Q4 by 13% from $0.485 to $0.55 per share. As you will recall, this is in line with what we laid out at our Investor Day a year ago, but we are achieving it a full quarter earlier despite closing the Recall transaction later than originally expected. Before going into Q3 performance, let me first provide a little more color on the Recall integration. As we've noted in the past, the Recall transaction benefits us in three primary ways. First, the level of synergy enables meaningful growth in AFFO and cash available for distribution, which funds increasing dividends and provides cash for continued investment in the business, all whilst over time delevering. Second, it strengthens our ability to reach the high-margin mid-market business, where Recall had a strong presence compared with Iron Mountain's enterprise focus. And third, it enhances our global footprint, particularly in emerging markets, giving us more exposure to these faster-growing and attractive markets. As noted in the past, integration efforts will increase the Recall base margin business, which has historically operated at 600 basis points to 700 basis points lower than ours in three areas: SG&A; labor; and in the longer term, real estate consolidation benefits. We also continue our detailed review of our real estate platform, as we consider further consolidation opportunities, which we believe can provide additional benefits over time. Further, the growth in cash flow allows us to invest in new products and innovation for the benefit of our customers, innovation around areas from how we bundle services in simplified pricing, to utilizing excess building capacity for other types of storage, to leveraging our sector-leading knowledge to offer technology solutions to our customers. An example of this is our Analytics Dashboard that we recently introduced to help records and information managers demonstrate the effectiveness of their information governance program and uncover the value of their data. The Dashboard helps them manage retention schedules, improve inventory tracking, identify potential risk and compliance concerns, and conduct internal and peer benchmarking of best practices. In addition to improving tools such as the Dashboard, we're also testing better and easier ways for customers to interact with us through mobile devices that enable voice recognition. When we refer to innovation, we're talking about tapping the ideas our customers and employees have for new products and solutions, vetting them, and then incorporating them into our customer solutions and processes in order to further strengthen our differentiation and profitability. We have discussed some of these items previously, such as our emerging partnership with the likes of EMC/Virtustream, and now, Dell, in building air gap, which provides customers with the added cybersecurity all of us seek. It is these innovations and others, which not only provide additional value to our customers, but will also add to future earnings growth both as stand-alone products as well as further differentiating our existing offerings. We're planning to host our next Investor Day in late April 2017, at which time, we intend to share a few of these innovation ideas with you. We'll also have about a full year of Recall under our belts by that time. In addition, we continue to make progress on the dispositions required by the regulators. You may have seen that just last week we received approval from the ACCC, or the Australian regulator, for the disposition of our legacy business in Australia to Housatonic Partners, a private equity firm. This AUD $70 million transaction closed yesterday. In addition, we continue to make progress on the sale of the required assets in the U.S., Canada, and the United Kingdom. We're pleased with our progress on these dispositions, and we'll bring you updates as those transactions are approved by the regulators and closed. We now expect that total dispositions will generate approximately $185 million in gross proceeds compared with our initial estimate of $220 million. While this total is a bit lighter than we originally expected, we are pleased with where we've landed and believe the transactions are consistent with our commercial goals in those markets. Let me now turn to some highlights before Stuart walks you through the details that can also be found in the bridging graph in our supplemental report. Total revenue growth in constant dollars was up more than 27% with similar growth rates in constant dollar storage rental and service revenue. Adjusted OIBDA, as I mentioned at the beginning, is back to nearly our high levels before the acquisition, with Adjusted OIBDA margins up 150 basis points from Q2. On an internal basis, storage rental growth was 2.6%, and we continue to expect average storage rental internal growth to be around 2.5% for the full year. Internal volume growth, which excludes the initial Recall volume we added when we closed the transaction, was positive in all storage segments and at 1.8% for the quarter. In short, we maintained our focus even in the midst of the Recall integration related activity. Year-to-date, service revenue was basically flat over last year, reflecting the variability and timing of the projects. Based on our service project pipeline, we expect internal service revenue growth to be roughly flat for the full year. As we've talked about on previous calls, given our expected change in service mix, we continue to focus on improving service gross profit and protecting returns on invested capital rather than on service gross margins. We continue to focus on driving productivity improvement in our service business, but it's important to keep in mind that 83% of our gross profit is from storage. Whilst we continue to devote a fair amount of attention to how we can grow and enhance our service business, our service lines first and foremost provide a strong differentiation to our core storage business. Turning to progress on our strategic plan, which entails getting the most out of our developed markets, increasing our presence in the fast-growing emerging markets, and expanding in faster-growing adjacent businesses, we continue to make progress on each of these pillars and the foundational elements that support them. In developed markets, which includes both North America RIM and our Western European segment, we added 3.6 million cubic feet of internal volume growth. North America RIM storage growth was 1.1%, reflecting positive volume growth. This is all before the impact of Recall and any other acquisitions during the period. In emerging markets, it is important to note that these markets are differentiated through higher levels of internal storage growth of roughly 10%. Our goal is to expand our presence and leverage our scale to drive these markets to 20% of our total revenue by 2020. You may remember, we announced the beginning of this journey about three years ago, where we started at 10% of our sales coming from this fast-growing segment. By the beginning of this year, we had approached 16% of our sales coming from emerging markets, and now, with Recall's footprint, we are at 17.1% of total revenue on a 2014 constant dollar basis. While we did not close any international acquisitions during the quarter, we continue to expect total M&A investment in the range of $140 million to $180 million this year, having closed on roughly $56 million year-to-date excluding Recall. More specifically, we expect four significant transactions in the emerging markets to close in Q4, which will utilize about $75 million of the remaining M&A budget. In addition to this final stage pipeline in the emerging markets, there are a number of smaller tuck-ins mainly in developed markets, which are expected to close. An example of this focus and continued execution can be readily seen in our Southeast Asian markets plus China. At the start of the year, this region represented just $14 million of annual sales. With the acquisition of Recall and upon closing the Santa Fe transaction we discussed last quarter, we'll have grown our business in this region to annualized revenue of more than $100 million, with leading positions in virtually all countries where we operate within the region. In our adjacent business segment, we are on track to achieve our stated goal to generate 5% of our total worldwide revenue from adjacent businesses by the end of 2020, up from just 2% at the end of 2015. In our data center business, we announced a major lease in the quarter in our purpose-built Boston data center with SimpliVity, a leader in infrastructure enterprise IT. SimpliVity needed data center resources to support its engineering lab, and our colocation solution was the right fit from a cost, capacity, efficiency, and security perspective. They noted that our 65-year track record of protecting proprietary assets gave them the confidence to trust a third party with such an expansion. In addition, a couple of weeks ago, we broke ground on the construction of the first building of our 83-acre data center campus in Manassas, Virginia using a development partner for this first 150,000 square foot data center. This building will deliver superior physical security, lower power costs, and a reduced tax structure compared to other national locations. In total, our Northern Virginia data center campus will support 42 megawatts of critical load spread across a planned four individual colocation facilities. This represents a four times expansion of our current capacity. The first building expected to open in summer 2017 will offer 10.5 megawatts of critical power and a flexible design that can meet the more exacting requirements of cloud service providers, federal government, system integrators, financial service firms, and healthcare companies. It will also comply with federal technology and environmental regulations, enabling federal agencies and integrators to comply by stated deadlines for efficient, sustainable data centers. We're pleased with the momentum we're seeing in the business and are continuing to manage capacity utilization to stay ahead of demand whilst benefiting from pre-leasing activity in existing markets. Combining our Boston facility with the undergrounds of Boyers, Pennsylvania, and Kansas City, our data center space is greater than 90% committed. And we are on track to achieve internal growth of 20% to 25% in this business area. While we don't break out our data center business separately in our financials, we continue to achieve top line organic growth in this business. And we expect to end 2016 with an exit run rate of $25 million in sales, which compares favorably with our 2015 exit rate of $20 million. In terms of supporting foundations for the strategic plan, we continue to make progress on our transformation initiative to remove $125 million in SG&A. We expect to action an additional $18 million of savings by the end of this year, bringing us to $100 million in run rate savings to be recognized in 2017. While we didn't incur much in the way of additional cost in Q3, we laid the groundwork for improvements to be implemented next year focused on achieving the final $25 million of this $125 million program. Given the timing of Recall synergies, our transformation program, and positive business trends, we remain confident that we will generate cash flow in line with the growth expectations we highlighted during Investor Day and updated in recent presentations. This provides the foundation for our dividend growth. Our newly declared quarterly dividend of $0.55 per share equates to an increase of about 13%, reflecting the benefit of synergies and transformation. Our expectations continue to be – to grow the underlying business and cash flow, which will support an increase in our dividend per share by an additional 7% in 2018, and 4% annual growth thereafter in line with our strategic plan whilst also funding core growth, M&A, and overall investments. As we progress our plan, we'll generate more cash available to support discretionary investments. So, we'll borrow less to fund our growth plan and continue to delever. Our operations are underpinned by our very durable growing business that performs consistently throughout business cycles. We have a durable storage business that generates roughly $1.9 billion of annual storage net operating income, which exceeds that generated by leaders in both the industrial and self-storage real estate sectors. Our lack of volatility through economic cycles and business durability clearly distinguishes our business. It is this durability that delivers consistent operating performance with high rates of utilization and stable pricing in both good and bad economies. Another thing that distinguishes our business is our relative insensitivity to higher interest rates compared with most REITs. First, our customers' storage needs are largely unaffected by interest rate movements. Second, our core storage NOI doesn't change with the value of the underlying real estate. Third, we incur virtually no TIs or tenant improvements if a customer leaves and we bring in a new one. Importantly, we have an operating business, and we effectively control real estate through long-term leases with multiple lease extension options and direct ownership in strategic locations of about one-third of our properties. In an increasing rate environment, this structure reduces our exposure to real estate value fluctuations compared with REITs that own their entire portfolios. Additionally, it should be noted that we generally enjoy higher levels of real price increases during periods with more inflation. In summary, it was a solid quarter with good execution on all three pillars of our strategic plan even in the midst of the Recall integration. We achieved solid internal and constant dollar growth, continued volume increases, and meaningful expanded OIBDA margins, all of which support increased cash flow and the 13% increase in our dividend per share. With that, I'd like to turn the call over to Stuart.

Thank you, Bill, and good morning, everyone. Let me start by saying how excited I am to be a part of Iron Mountain and working with mountaineers around the globe. The durability of Iron Mountain's records management and related businesses and the substantial opportunity to continue to optimize performance following the Recall acquisition and through our strategic plan is just part of what drew me to Iron Mountain. I am really pleased that our strong results this quarter demonstrate our ability to execute. There are many opportunities ahead, and I believe it's a very exciting time to be a part of the team. Before diving into the details of our financials, let me take a moment and walk you through the key highlights of the quarter. First, we achieved strong internal storage rental revenue growth of 2.6%, excluding Recall and other small acquisitions. This compares with 2.1% last quarter, reflecting solid underlying business fundamentals and continued volume growth across all major markets. Making up over 80% of our gross profits, growth in the storage rental business remains our key execution focus. Second, we enhanced our profitability. Adjusted OIBDA margins improved by 150 basis points from the second quarter, as benefits from the transformation program and synergies from the Recall transaction flow into our results. Third, we are making great progress on the integration of Recall, and over 85% of the $115 million of 2017 growth synergies will be in process by the end of this year. Fourth, since June 30, we completed approximately $380 million of debt refinancing at attractive rates, including the recent $50 million mortgage, resulting in about 74% of our debt now being fixed after paying down the revolver in early October, and that compares to 68% in the second quarter. Our average maturity was 5.1 years, and our weighted average interest rate was 5.1%. Our Canadian debt offering tied to the lowest coupon ever in the high yield Canadian market demonstrates our debt investors' appreciation of our solid cash flow and recognition that our leverage is in line with many investment-grade REITs. We remained steadily on track to deliver on short-term financial objectives and long-term goals. And as Bill mentioned, it is based upon this continued demonstration of growth, the durability of our cash flows, and capital efficiency that our board of directors increased our dividend by 13% to $0.55 per share. Now that I've covered the highlights, I'll go over our worldwide financial results followed by a review of our performance by segment and conclude with the discussion of our outlook for 2016 and a preliminary view on 2017. Consistent with prior quarters, we provided bridging schedules for total revenue, Adjusted OIBDA, Adjusted earnings per share, and FFO per share to explain key variances in our year-on-year performance. These schedules can be found on pages 23 through 26 of the supplemental. Let me walk you through the highlights. For the third quarter, our total reported revenues increased 26.3% or 27.4% on a constant dollar basis. Excluding the Recall and other smaller acquisitions, total internal revenue increased 1.4% in the third quarter compared with a 0.4% increase in Q2, again with improvement in all regions and segments. We expect total internal revenue growth in 2016 to be between 1.5% and 2%, reflecting continued solid performance in our higher margin storage activities and growth in adjacent businesses, offset by modest declines in service revenues. Let's look at storage and service revenue performance in the quarter. Storage rental revenue is the core economic driver of our business, representing 61% of revenue and 83% of our total gross profit. As I mentioned earlier, our third quarter storage internal growth accelerated to 2.6% from 2.2% growth in the first half of the year, and we continue to expect full year storage internal growth of approximately 2.5%. Service revenues, which make up 39% of total revenues and 17% of our gross profit, declined 0.5% from a year ago compared to a year-over-year decline of 2.1% in Q2. As we've highlighted in previous calls, the mix shift in our service business growth rates can be a bit volatile on a quarter-on-quarter basis. However, we expect internal service revenue growth to be about flat for the full year. Total third quarter gross profit margin declined slightly from Q2 due mainly to the additional month of Recall results. As we've previously highlighted, Recall pre-acquisition operated at a lower margin than Iron Mountain due in part to having higher rent expense as a percentage of revenue, as Recall leased almost all of their facilities. However, we were able to capture overhead efficiencies and other synergies to more than offset this margin decline resulting in expansion of Adjusted OIBDA margin. In the quarter, we grew total Adjusted OIBDA by 29.1% on a reported dollar basis and by approximately 30% on a constant dollar basis. Importantly, Adjusted OIBDA margins expanded year-on-year and sequentially to 31.2% as we continue to see benefits from transformation actions and from Recall synergies. Adjusted EPS for the quarter was $0.27; Adjusted EPS was impacted by the amortization of Recall's customer relationship values and the depreciation expense of legacy Recall racking structures. As a reminder, the amortization expense of customer relationships flows through to funds from operations. However, the increased depreciation does not because real estate depreciation is excluded from FFO. Normalized FFO per share was $0.44 for the quarter. The decline in FFO per share was driven by two factors. First, the increased non-cash amortization of Recall's customer relationship intangibles as discussed back in April, that is not added back to calculate FFO. Second, is the tax impact of Recall related expenses. As most of the costs of this integration phase were incurred in our qualified REIT subsidiary, they did not provide a tax shield. This last item also impacted our effective tax rate which appears high as the Recall costs and the $14 million impairment reduced pre-tax income, however they did not reduce taxes recorded in our taxable subsidiaries. This is a short-term effect of the integration effort. Third quarter AFFO was $169 million compared with $134 million in the year-ago period, fueling our dividend increase. Remember AFFO adds back non-cash items such as amortization and non-cash or discrete tax items, so AFFO was not as impacted by the same items that impacted FFO. Let's turn quickly to our financial performance by segment. Pages 15 and 16 of the supplemental outline our performance by segment in detail for the quarter, and on a year-to-date basis. Let me touch on a few highlights from these pages. In North America Records and Information Management or RIM, internal storage rental revenue increased by 1.1%, reflecting strong internal volume growth. In North America Data Management or DM, we saw strong internal storage rental growth of 2.2% reflecting an improvement from the second quarter. However, service internal growth declined due to the timing of projects and the ongoing reduction in tape rotation as we have discussed previously. The Western European segment had 0.3% of internal storage rental growth, having been impacted by the carry forward of certain contract negotiations that we mentioned on our last earnings call. In the Other International segment, we continue to see strong storage and service internal revenue growth of 11.6% and 6.9% respectively. Let me now talk about the Recall integration progress and the costs that we have incurred so far to achieve synergies and integrate Recall with our business. Bill explained we remain on track to achieve the synergies in total, albeit we are getting there a bit faster. Our expectations of total cost to achieve synergies are still consistent with prior projections, $380 million and deal costs of $80 million. In the fourth quarter, we expect to incur roughly $50 million in operating expenses and $17 million in capital expenditures as we accelerate the cost savings programs. Year-to-date, Q3 we have incurred $103 million of integration in deal close costs and $7 million in capital expenditure. Additional details can be found in our 10-Q which will be filed later this week. Please note that these one-time items are excluded from our Adjusted OIBDA calculation. Let's turn to our outlook for 2016 and preliminary outlook for 2017 summarized on pages 10 and 11 of the supplemental. Our outlook for business trends and fundamentals remains unchanged with consistent storage rental growth and accelerating growth in our International and Adjacent Businesses. In addition, our expectations for Recall's contribution and our standalone business contribution remain unchanged as seen in the table at the bottom of our guidance page. Our guidance is now on a reported dollar basis given foreign-exchange differences during the year have been small and this now serves as the baseline for our 2017 outlook. Further, we have updated our 2016 FFO guidance to adjust for the increases in income tax expense, amortization, and interest. Our AFFO guidance remains unchanged at $610 million to $650 million reflecting savings we have identified in maintenance capital since the Recall acquisition, as well as non-real estate capital expenditures which were partially offset by increases in interest expense and cash taxes. However, we anticipate AFFO for the full year to come in above the midpoint of our guidance. Our interest expense for the year is higher than we originally assumed due to the timing and amount of divestiture proceeds as well as additional Recall integration related spend. AFFO continues to provide ample funding for dividends and core growth tracking investments. Given the higher interest in taxes than our original guidance, we expect Adjusted EPS to be near the low end of our guidance range for the year. Upon further review of Recall's real estate assets and overall systems requirements, we reduced our capital expenditure outlook, real estate, and non-real estate maintenance as well as non-real estate investment by $25 million for 2016. The capital efficiency that is created by bringing the two businesses together is better than we had originally anticipated. Therefore, this is an elimination, not a deferral of spend. In addition, we reduced our real estate investments by $95 million driven mostly by delayed spending on lease conversions and certain real estate development as we make sure we take the time to optimize each market's needs and negotiate with landlords to consolidate facilities in light of the Recall transaction. Note that the reduction in real estate spend this year is not impacting our synergy or margin outlook or 2020 vision as we know that these types of investments take a period of time to stabilize. Distributions for the year will total around $500 million resulting in our dividend payout ratio as a percentage of AFFO consistent with our prior guidance under 80%, and becoming more aligned with REIT peers over time. Let's touch on our preliminary guidance for 2017 which is based on September 30 exchange rates. At a high level, this guidance is consistent with long-term expectations with slightly lower growth from acquisitions given our focus on Recall this year. At the midpoint of our guidance, we expect adjusted OIBDA to grow by 17% and AFFO to grow by 12% in 2017 compared with 2016. We'll provide more detail on capital allocation and other guidance for 2017 in February after we finalize prioritizing investments. We expect maintenance capital expenditures and non-real estate investments to be approximately $170 million next year, together representing roughly 4.5% of revenue consistent with 2016. Shifting briefly to the balance sheet, we currently have liquidity of approximately $1.1 billion and a lease adjusted debt ratio of 5.7 times as expected. In the short-term, given the timing of proceeds from the divestments, we expect to end the year at a leverage ratio around 5.8 times and to trend down from there in line with our 2020 vision. Lastly, we continue to focus on strengthening our debt structure through increasing exposure to long-term notes and shifting a greater percentage of our debt to foreign jurisdictions, which creates a natural currency hedge to mitigate translation exposure while also being tax efficient. In September, we raised CAD 250 million in senior notes at 5.375% due in 2023 and closed on a AUD 250 million dollar syndicated term loan B facility which matures in September 2022 and currently bears interest at 6.05%. Overall, we are pleased with our performance this quarter and with the progress we have made integrating Recall and executing on our transformation program. Looking ahead, we are confident that we are well positioned to deliver on our short-term and long-term financial projections. Our expectations are underscored by the durability of our business, and we are extending that durability through solid execution of our strategic plan and optimizing our costs. Before closing, I want to mention that I continue to be impressed with the caliber of the team here at Iron Mountain and appreciate the passion that our teams in the field have to care for our customers. Their focus on moving the business forward during a major acquisition integration was evident in the performance this quarter. I continue to expand my knowledge of the Iron Mountain business and look forward to meeting with many of you in person over the coming months. With that, I'll turn the call over to Bill for closing remarks.

Thank you, Stuart. We are pleased with our underlying results as well as our progress with integrating Recall, and at a high level we should think about it as we've issued 20% more shares to purchase Recall. In less than six months in on a Q3 to Q3 basis, we have seen revenues up 26%, Adjusted OIBDA is up 29%, and AFFO is up 27%. All this has allowed us to increase our dividend per share by 13% and do this three months sooner than predicted. With that, I'd like to take questions.

Hi, thanks, good morning. Now that more of your services business is project-based, can you discuss how signings look for services and whether your signings trend support positive internal services revenue growth for full year 2016 and 2017?

Good morning, George. I think as we noticed what we expect is that service revenue for 2016 to be flat based on the pipeline that we've looked at, and then for 2017, we expect – we'll give you further guidance in February, but I think you can expect a slight improvement on 2017 based on what I see in the pipeline right now. But you're right, as we now have more and more is project based we need to take that into effect as the core services decline as the business becomes more archival. But right now, I would say 2016 is going to be flat, in 2017 we expect – we’ll give you more later in February, but I would expect that it’s going to be a slight improvement on 2016.

Got it. And can you, as it relates to Recall, discuss some of the early realizations of the synergies you saw in the quarter, and what aspects of the transaction helped allow for this early realization of synergies, and then whether there is potential for additional upside beyond what you already see?

That was a good try George. But I think you know what I'm going to say about the upside. Because right now we're very pleased that we're getting it faster. I think we still remain optimistic that there'll be upside as when we get into the real estate consolidation, but obviously that's a longer term. I think the biggest fuel to being able to get it faster, the answer was cultural. That when you always – when you have a competitor across you, you always tend to think they are more different than yourself, but actually when we brought the two organizations, there was a lot of common understanding and common way of doing things. And the result of that was we were able to bring the teams together much faster, because especially these early synergies are mainly headcount related. So, let's say we weren't – we are not going deeper than we expected in terms of the headcount reductions, but the speed at which we were able to align processes and then release people was much faster than we planned. So I would say it's probably that the key driver has been cultural. But let's say in terms of further upside is we remain focused, but we think there is going to be further upside when we start consolidating the facilities, but that's more in the midterm rather than the near term.

Another thing – this is Stuart. Another thing I'd add quickly is that just our procurement teams have done a really great job going through and comparing contracts to the better pricing and starting to capture that upside. Everything from facilities management cost in the third party that we used to help us with that to the paper business. So there's a number of things they are working hard on.

Very helpful. And then lastly, can you elaborate on any one-time items you expect to impact FFO and AFFO in 2017?

I'll let Stuart answer that. As he highlighted, FFO looks a little bit odd right now because of some of the one-time issues in terms of bringing the two companies together and especially some of the integration costs wasn't tax deductible. But I don't know, Stuart you may want to comment in terms of how FFO gets normalized or starts running in more of a clean fashion.

Yeah. We're starting to get more of a regular run rate, right? You'll expect on a year-over-year basis for the year you'll continue to see some amortization impact. The tax rate as well. While this year there has been some normalization items, so we brought our FFO guidance down this year. A lot of this has been due to integration costs and how those have hit. So our guidance next year for FFO is flowing all the way down has got a tax rate around 17% or 19%, so that's the only thing that will get normalized.

And the one thing – just to add is that I'm not saying that FFO doesn't matter, but the thing that in terms of driving that cash both to invest in the business and dividend growth is obviously AFFO is the main thing because it's the more pure thing that has purely focused on cash, because as Stuart pointed out on FFO, there are some non-cash items that don't get added back to FFO where they do you get added back to AFFO. So not saying that it's not important, but the cleaner measure in terms of cash generation of the business going forward is for sure, especially the way our business operates is the AFFO metric.

Got it. Thank you.

Thank you for taking my questions. Bill, what's going on with the North American Data Management Services line that was down 11.3% year-over-year last quarter, it was down 10.3%? We had a discussion about some tough comp on project-related revenue. It seems to have worsened a little bit this quarter. What's the story behind that?

Good morning, Shlomo. So actually it's pretty much consistent with what we've said. I think I've always said on the calls for the last, I would say few quarters that it's really the transportation and I'd say that's generally down between high single digits, low double digits in terms of revenue. So it's continuing – we've continued to see the trend. As I said before, I think on a couple calls ago, we see a kind of a flattening out of that archival drop in transportation when we look at the paper storage business or the record storage side of the business, but in the data management, it's still a little bit lagging that transition into becoming more about backup and recovery rather than rotating the tape. So – and we still aren't declaring a bottom. So if you say going forward, I'd still expect that we're going to see transportation declines in the tape business still in the high single digit, low double-digit level, so it's really – it's not the projects that are driving that. It's the transportation decline. So I mean the good news if you look at the storage, as we said that the storage, both on a revenue and a volume basis, if you look at revenue quarter-on-quarter, we're up a little over 2%. If you look at a trailing 12 months in terms of volume, we're up 2%, and to keep in mind is if we look at the margins of the business and the profitability of the business, whilst I think services is important, it's first the most important in terms of differentiating our storage product because that's where we build the reliability in and through the robustness of our transportation, but the part that's driving the cash in the business, we continue to be pleased with. But if you're asking me just specific on transportation, I have to say that I expect it to continue to decline in the high single, low double digits for a few more quarters because we still seem to be behind the transition that we've pretty much worked most of the way through on the records management side.

So I thought that that is true, but you typically get a certain amount of project related revenue and that helps offset it and you had a particularly strong project-related revenue quarter in 2Q 2015. And that's what made it tough to comp on that on 2Q 2016? Was I just misunderstanding how that was going through?

No, no, you're right because it was kind of mid-single digit decline, I think in the quarter that you're referring to, Shlomo, so you've got a very good memory. I think that specifically we do see – if you look at, especially in our film and sound, this includes our film and sound business, is we do have specific projects with some of the studios that rotate in and rotate out, and whilst it does drive the top line in terms of the revenue, again, if you come down to in terms of – if you backup and say, you see even though that we've lost that project which so you're now seeing kind of raw more the transportation decline and you see in some quarters, it hasn't affected our ability in terms of driving overall profit growth. But you're right, we do see those – and those typically, I'm not saying all, but most of those lumpy projects come in our film and sound unit.

And then can you – maybe this is a question for Stuart, can you talk about the specific items that resulted in the FFO guidance, just go through them like one-by-one into it, what change from last quarter of – for 2016?

Yes, it's pretty simple really. So, if you look at the change in guidance which on a total dollars basis is about $80 million or at the midpoint on FFO was about $0.35, you get the biggest piece of it's tax expense and it's really about half of it, and the reason for that is that the integration costs out of Recall are really hitting in the REIT subsidiary, so you're not getting any tax benefit from those and that is different from what we had originally assumed. You've got about a third of it is coming from the amortization of customer intangibles, right, that's really came out of purchase accounting and as we finalize purchase accounting, I'll point out that that's not in cash, so that you get that added back in AFFO. So that's about a third of it. And the last piece of it is really interest expense and that's the rest of it and that's really the timing as we talked about the divestment proceeds and a little bit lower proceeds from that on a cash basis.

So is it half from the first part of the integration of Recall cost or being in the REIT as opposed to not lowering the tax rate outside of the REIT?

Yeah. Yes.

And I guess is that something that flows through in 2017 as well or is that something that we're kind of in since most of this has been actioned this year?

It mostly will hit this year. There'll be a little bit next year. But next year we'll have it built into our – into the tax expectations in the guidance. We got that built in now, how that's going to flow through.

Okay. And then the amortization of customer intangibles hits the FFO, but not the AFFO because it gets added back. Is that the right way to understand it?

Yes.

And then the interest expense will hit both of them, right?

Yes.

That's just higher interest expense. Okay.

I think we've – if you remember, we talked about there is a specific customer that we have in Other International that was going through a specific kind of – I would say a legacy destruction project. So you see that kind of still flushing through.

Okay. And then you mentioned some of the one-time tax costs would be hitting in Q3, I think it was approximately $1.2 million non-cash associated with that restructuring, so effectively does that flow through what we're seeing in that tax rate as well? Or is that just a one-off, and that also can help some normalization?

Yes. That's part of how we structured that share, so yeah.

But to your point, we've all heard those projects in that necessarily both of us in Q3 so you'll see that next quarter.

Operator, I'm going to take the other stuff offline. Thank you very much.

Thank you. Appreciate everybody joining us this morning. And wish you all, as we start into the holiday season, a good holiday season. So, have a good day.