Iron Mountain Incorporated

Good morning and welcome to the Iron Mountain second quarter 2019 earnings conference call. All participants will be in listen only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Grier Aviv, Senior Vice President of Investor Relations. Please go ahead.

Thank you Kate. Good morning and welcome to our second quarter 2019 earnings conference call. The user controlled slides that we will be referring to in today's prepare remarks are available on our Investor Relations website along with a link to today's webcast, the earnings press release and the full supplemental financial information. On today's call, we'll hear from Bill Meaney, Iron Mountain's President and CEO, who will discuss second quarter performance and progress scored our strategic plan, followed by Stuart Brown, our CSO, who will cover additional financial results and our outlook for the remainder of the year. After our prepared remarks, we'll open up the lines for Q&A. Referring now to slide two of the presentation, today's earnings call, slide presentation and supplemental financial information will contain follow-looking statements, most notably our outlook for 2019 financial and operating performance. All follow-looking statements are subject to risks and uncertainties. Please refer to today's press release, earnings call presentation, supplemental financial report, the safe harbor language on this slide and our annual report on form 10K for discussion of the major risk factors that could cause our actual results to differ from those in our follow-looking statements. In addition, we use several non-GAP measures when presenting our financial results and the reconciliations to these measures as required by Reg G are included in the supplemental financial information. With that, Bill, would you please begin?

Thank you, Greer, and thank you all for taking time to join us. We're very pleased with the continued durable revenue growth across our businesses and the improved operational execution in line with our previous outlook. Some of the highlights of the quarter included total organic storage revenue growth of .4% and total storage growth of 4.6%. We continue to make good progress in identifying new storage opportunity whilst organic volume increased 40 basis points in our global records management business. Good momentum driving improved operational efficiencies across the organization and data centers delivering strong organic growth. We have leased 7 megawatts through the second quarter in line with our full year expectation of 15 to 20 megawatts. Moreover, Q3 is getting off to a strong start with a 6 megawatt lease signed in Northern Virginia. Starting with a review of our financial and operating performance in the quarter, total revenue increased 3% year over year on a constant currency basis to $1.1 billion. This growth was driven by an almost 5% increase in storage revenue, partly offset by lower service revenue growth, reflecting lower recycled paper pricing, which I will touch on in a few minutes. The cost issues we experienced in Q1 were fully corrected during the quarter, which is evident in the sequential adjusted EBITDA margin expansion of 210 basis points, above the high end of the 150 to 200 basis point margin expansion we guided to in our last call, despite some one-time costs. As you saw from our press release this morning, we have tightened our guidance ranges given we are halfway through the year and there has been less variability in FX rates than expected when we provided our initial guidance. We now expect revenue to increase between 2% and 4% year over year and adjusted EBITDA to increase between 2% and 5% year over year on a constant currency basis, remaining within our initial guidance ranges. We remain focused on successfully executing in the second half, despite some external headwinds with a strong finish to the year anticipated, setting us up to enter 2020 in a good position. Turning back to Q2 performance, we also continued to see good organic growth, with organic storage revenue growth up .4% for the second quarter and .2% year to date, reflecting continued strong growth from data center, the other international segment, adjacent businesses, and stable performance in Western Europe and North America. Revenue management, particularly in North America, is trending ahead of our expectations. Total organic service revenue growth was negative 2% for the quarter and roughly flat year to date due to lower recycled paper prices. We expect this to remain a headwind for our service business for the remainder of 2019 as we cycle over record pricing a year ago. It should be noted, however, the headwinds from paper price on a year over year basis amount to $20 to $30 million on what was last year $115 million of revenue from the sale of paper. The actions we have taken are more than enough for us to manage this headwind and maintain our profit goals given it is less than 1% of the revenue in the overall business, albeit a little less than 2% of the profit. Turning to business performance, we continue to see good growth in the alternative storage categories including adjacent businesses, consumer, and other. Volume in consumer and other grew more than 760,000 cubic feet sequentially, or 31%, in part reflecting strong demand for high touch consumer storage during the peak season. In our records management business, we organically added roughly 3 million cubic feet of net record storage volume worldwide over the past 12 months representing 40 basis points of growth, an increasing trend driven by both new sales and lower destructions. More specifically, developed markets organic volume declined by about 60 basis points, a slight improvement from Q1. Organic volume growth in the other international segments continues to grow at a faster clip, increasing .4% driven by an increase in new sales of .7% and modestly lower destructions. We are encouraged by the consistent performance of our global records management business and continue to see a solid commercial pipeline. Shifting to our digital solutions business, we continue to support our customers' evolving needs by providing a number of digital solutions. To this point, our information governance and digital solution team, or IGDS, had a very good Q2 with a number of wins and a healthy pipeline that is expected to deliver strong double digit revenue growth this year. In conjunction with our federal team, IGDS was awarded a nearly $13 million contract from General Dynamics Information Technology. Under a sub-agreement, Iron Mountain will perform work as part of a digital transformation initiative for a government agency. As it relates to our Iron Mountain Insight platform in partnership with Google, we continue to see good momentum for this innovative solution, which is powered by existing Iron Mountain products and services, adding even more value to our portfolio of digital solutions. In Q2, we signed a deal with a large financial services customer for a comprehensive solution to manage the document workflow process of auto loans. In addition to providing this customer with scanning and secure storage of loan documents, Insight extracts and validates the data, verifies the signatures, and certifies authenticity of the loans and associated collateral. We decided this quarter to evaluate alternatives with regards to the infrastructure supporting select offerings within our Iron Cloud portfolio. We generally approach our digital solutions based on a hybrid model in terms of what we develop internally and who we can partner with for -in-class technology solutions for the right cost. This evaluation has led us to a shift in partnership approach for some of our Iron Cloud solutions, such as Object Store, and resulted in a one-time drag on our reported results this quarter, which Stuart will discuss in a moment. Finally, as mentioned earlier, our data center business continues to build leasing momentum in conjunction with the buildout of our platform. As mentioned earlier, in early July, we signed a 6-megawatt deployment in Northern Virginia, which is expected to commence later this year. I want to congratulate the data center team for the successful execution of this deal. It's a great accomplishment and should add significant value to our campus ecosystem. Looking at data center leasing activity in Q2, we signed 3 megawatts of new and expansion leases primarily driven by enterprise demand. -to-date, including the new lease in Northern Virginia just mentioned, we have leased 13 megawatts with clear line of sight to achieving the high end of our annual target of 15 to 20 megawatts. Furthermore, we continue to demonstrate the strengths of our customer relationships when winning retail sales focused on large enterprises building private cloud infrastructure. Consistent with the first quarter activity, approximately 40% of our leasing pipeline was generated by our non-data center sales team. Cross-selling opportunities like this will continue to help us realize synergies as the data center business grows. As it relates to development activity, we are on track to deliver the first phase of Q2 capacity at our Phoenix campus expansion with the grand opening scheduled for August 15th and an additional 5 megawatts of capacity scheduled to be delivered across three international markets in Q3. In summary, Q2 was a strong quarter that demonstrates the durability of Iron Mountain with continued improvement in global storage, organic revenue, and volume growth enabling us to continue to invest in new growth areas to support our long-term business model. We are encouraged by the momentum we see in our data center business and will continue to expand that platform and drive further synergies across the business whilst our digital services and solutions are helping our customers solve new business challenges. With that, I will turn the call over to Stuart.

Thank you, Bill. Thank you all for joining us to discuss our second quarter 2019 results. As Bill mentioned, we are pleased with our second quarter performance with revenue of nearly $1.1 billion. Total revenues increased .6% or .1% excluding the impact of the stronger dollar. Our storage rental revenue increased .6% on a constant currency basis driven in part by growth in our data center, emerging markets, and adjacent businesses. Total service revenue increased .7% to constant currencies. As you can see on slide 6, total organic storage rental revenue growth accelerated to .4% in 2019, reflecting results from revenue management and global volume growth. More specifically, developed markets organic storage revenue growth came in at .3% for the quarter, reflecting continuing contributions from revenue management and volume trends. In the other international segment, we achieved continued healthy organic storage revenue growth of 3.7%. Year to date, organic storage revenue growth was .2% and with a strong commercial pipeline and a modest decrease in records destructions, we now expect full year organic storage revenue growth of .2% to 2.8%. This underscores the consistency and durability of our high margin storage business and strength of our commercial teams. Organic service revenue, however, declined 2% in the second quarter as we cycled over the last year, with a growth of .6% a year ago. This mainly reflects the swing in paper prices, which were at record highs last year and currently about 20% below the five-year average, driven in parts by two large paper mills in North America that were offline in Q2 and lower pull prices, leading to an oversupply of paper for recycling. Assuming prices stay at these low levels, the -over-year impact to revenue and adjusted EBITDA is about $25 million and assumed in our current outlook. Given this and lower destruction service revenue, we now expect service organic revenue growth to be flat to down 50 basis points for the full year and therefore total organic revenue growth to be in a range of .3% to 2% in 2019. While reported service revenue was lower than we anticipated, remember that many of our services provide important support to our core storage business, promote deeper customer relationships, and are increasingly designed to solve our customers' problems managing and analyzing both physical and digital assets. Our digital services are growing nicely and we continue to evaluate, test, and grow them to enhance our business and grow new lines of revenue over time. Lastly, as it relates to organic revenue growth, we generate some of our best returns on capital from acquisitions of customer relationships, which are not dissimilar from paying commissions to our sales teams as we pay a local competitor for their customer contracts and integrate with our existing business. We include the revenue as well as the investment as part of our organic growth given their similarity to competitive takeaways, so timing can be a bit lumpy. To give perspective, over the past three years, annual investments have ranged from $30 million to $70 million. These low-risk, high-return sales-enabled acquisitions are part of our core growth strategy, particularly in developed markets. -to-date, they have contributed about 60 basis points of the .2% total storage organic growth. Now turning to our data center business, we are very pleased with the leasing progress momentum. The data center business delivered organic revenue growth of around 6% in Q2 and signed 3.2 megawatts of new and expansion leases. Turned during the quarter was a more normal 1%, but this will vary over time given the size of our data center portfolio and will tick up again in Q3. Additionally, we agreed with one of our customers to shorten leases in two of our markets in exchange for higher rental income during the remainder of their modified term. While this will generate elevated turn in the first quarter of 2020, this was a strong positive for our data center business as it freed up capacity in Northern Virginia, enabling us to win the 6-megawatt deployment that Bill mentioned. As you can see on slide 7, SG&A excluding significant acquisition costs grew about $8 million from a year ago. This was primarily caused by higher compensation expense related in part to the consolidation of acquisitions and our investment in a global operations support team as well as by increased technology expense. Our adjusted EBITDA declined $17 million -over-year of 5% to $351 million. Excluding the impact of currency changes, adjusted EBITDA declined $9 million or 2.6%. As Bill mentioned, there were several one-time items that impacted adjusted EBITDA by approximately $10 million in the quarter. These included a $4 million charge related to our iron cloud infrastructure and the remainder for charges related to building damage that occurred during the quarter. AFFO in the second quarter was $210 million compared to $228 million a year ago. This decrease reflects the stronger dollar and other changes impacting adjusted EBITDA as well as somewhat higher interest expense in quarterly cash taxes, partly offset by lower nonreal estate investments. Slide 8 details the adjusted EBITDA margin performance by business segment. The North America RIM margin resumed -over-year expansion in the quarters we address the cost issues experienced in Q1. Excluding the change in lease accounting, which reduced margins in the segment by about 20 basis points compared to a year ago, the EBITDA margin in this segment expanded 30 basis points. The North America data management margin declines continue to be driven by lower volumes as well as product mix. Revenue management is helping to offset some of the declines and support healthy margins. In Western Europe, Q2 margins contracted 20 basis points, reflecting higher temporary facility costs and professional fees for process improvements. Some of our recent acquisitions of customer relationships in the region are operating at lower margins until we can fully synergize. Other international margins were up 30 basis points in the quarter despite the 75 basis point impact from the adoption of the new lease accounting standard, reflecting the increased scale of geographies and continuous improvement initiatives. In the global data center segment, adjusted EBITDA margins were 44.4 percent. In the second quarter, partly reflecting the acquisition of EVO switch in the Netherlands last May, which operates at lower average margins and the impact from the turn that occurred in Phoenix in Q1. As you have seen in our release, we have had an immaterial restatement of our prior period results. During the quarter, we received a notification of assessment from tax and custom authorities in the Netherlands related to value added taxes on specific business to business customs activity performed by our bonded business, which we acquired in 2017 and is part of entertainment services. As a result, we have made an immaterial restatement of our prior period financial statements, which can be seen in our 10Q to be filed later today. Starting to slide nine, you can see that our lease adjusted leverage ratio remains in line with other REITs and was flat with Q1. We are on track with our plans to generate $100 million plus of capital recycling proceeds this year from the sale of real estate, and we continue to explore options for a JV investment partner for our Frankfurt data center development. Therefore, we expect our leverage ratio to decline in the second half of the year. Also, we are encouraged by the recent momentum we have seen by the REIT coverage teams of the rating agencies. As we mentioned in Q1, S&P revised our outlook from stable to negative. Similarly, Moody's revised our outlook to stable in June based on the strength and value of our storage business. Our balance sheet remains solid and we continue to invest and grow the business at very attractive returns with low risk. Turning to outlook, you can find the details and underlying assumptions in the appendix or in our Q2 supplemental. Given the investments we have made to improve efficiencies, coupled with the operational improvements implemented in Q2 and additional initiatives underway, adjusted EBITDA should continue to ramp through the back half of the year. AFFO and adjusted EPS guidance ranges have been adjusted to reflect the revised EBITDA guidance and for earnings per share also for higher depreciation. We have also updated our expectations around capital allocation. Given the increase in leasing activity, we now expect data center investments to be about $50 million higher this year but have reduced our outlook for business acquisitions due to the expected timing of closings of deals in the pipeline. As a result, we are reducing our expectation for M&A capital to $100 million from $150 million previously. In summary, Q2 reflects healthy and consistent revenue performance from our storage business. While the paper price environment is a headwind, we have been taking steps to mitigate its impact on profitability. Our actions to improve margin performance from Q1 levels are evident in our results and we are confident in further improvement in the back half. We are excited about the leasing activity and pipeline in our data center business and remain pleased with the solid and sustainable revenue growth our teams are delivering. With that, I will turn the call back over to Bill for some additional comments before opening up the line for Q&A.

Thanks, Stuart. Before we open up the call to your questions, I wanted to take a step back from the quarterly detail and remind you of our long-term business model which is supported by the durability of the records management business. As an organization, one of the biggest assets we have is the extremely deep and long-lasting customer relationships which provide us access to 950 of the Fortune 1000. These relationships are built on decades of trust and delivering -in-class storage and value added services. Having earned the reputation of trusted guardian of our customers' assets allows us to leverage these relationships to identify cross-selling opportunities and drive significant synergies across our growing data center platform, particularly amongst enterprise customers establishing a private cloud infrastructure and looking for a secure and reliable IT environment. A second key asset that RE Mountain possesses is our durable developed markets record management business which has allowed and will continue to allow us to consistently deliver strong organic cash flow enabling us to fund future data center growth, scale our emerging markets footprint, and invest in innovative solutions to meet our customers' needs. These two significant assets underpin our overall financial strategy and continue to support and grow our very strong customer relationships. The resulting sustainability of the core business and growth in the data center business will support our target of achieving consistent 5% plus organic adjusted EBITDA growth flowing through to AFFO growth and generate returns above our cost of capital. We will remain very disciplined in our capital allocation decisions balancing investments that will create value for shareholders while providing more solutions to our customers. With that operator, please open up the call to Q&A.

We will now begin the question and answer session. To ask a question, you may press star then one on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw from the question queue, please press star then two. You may submit questions throughout today's webcast by clicking in the submit a question box on your screen. At this time, we will pause momentarily to assemble our roster. The first question is from Sheila McGrath of Evercore. Please go ahead.

Yes, good morning. Bill, at first quarter you did have some impact from excess labor that impacted margins. It looks like you righted the ship better than your guidance in second quarter. I was just wondering if you could update us on cost optimization initiatives, how they're progressing, and if you have any change in how you expect the margin improvements to play out for the second half of the year.

Thanks, Sheila. We were pleased, as you noted, that we were above our guidance in terms of sequential EBITDA margin improvement. We've updated the guidance by actually tightening the range. What we will see is continuing stepped up at the margin over the course of the year. In other words, there will be a ramp in the second half of the year, but we feel really good about the line of sight that we have to be able to finish up the year in strong shape. The improvements that we made in Q2 more than offset the change in things structurally, that more than offset that miss on the labor in the first quarter. We feel really good in terms of the setup for the second half, but there will be a ramp.

Okay, great. I just wanted your view on the markets not giving you credit clearly right now for the premium dividend yields, given where shares are. Just your bigger picture thoughts on either bringing in a capital partner on some of the data centers to create liquidity to maybe buy back shares at these levels.

Well, I think you can probably appreciate we're not going to talk about buy back on the call. From a capital allocation standpoint as a board, we look at everything about in terms of where we invest money and how we deploy that. That includes everything from how we give money back to the shareholders, whether that's through a dividend or share buy back. Everything is always on the table when we look at it. But at these dividend yields, at some point, your shares become pretty good value, but we look at the full range of options. Right now, we really like the capital allocation decisions we have in terms of growing the data center business and also building out our business, our traditional business in emerging markets in some of our new digital solutions. We're seeing the growth. I'm always the optimist. I feel that at some point, our dividend yield reflects probably a lack of appreciation for what we're doing as a company. Eventually, gravity does reinsert itself and that is self-correcting as the share price goes up.

Okay, great. Thank you.

The next question is from Nate Crossett of Barron Bark. Please go ahead.

Hi, thanks. Good morning, guys. I just wanted to follow up on that margin improvement question. I think on the last call, you kind of got into 600 basis points ramp by the year end. So I know you said that it's going to ramp through year end, but is that 600, give or take, still in place?

Hi, Nate. This is Stuart. If you look at the ramp and the margin that's implied, I think the way to look at it, if you think about Q2 normalized EBITDA adjusting for the $10 million that we talked about, Q2 normalized EBITDA was about $361 million. So guidance of the 1440 to the 1480 by just backing into what the second half EBITDA growth is implies an EBITDA growth of 765 to 805 on that range. So that's a ramp from Q2 normalized of about $20 to $40 million per quarter. And you think about even just the first quarter, we improved $35 million from the first quarter. So the ramp and EBITDA margins you should continue to see and the benefits that we get as we move through the year we talked about in the last quarter call, right? We've got revenue management and most of our pricing takes place in Q2, actually more of it takes place in Q3. So you get the benefit as we move through the year of pricing and then the continuous improvement initiatives that Bill touched on led by the global operations support team which really continues to focus on improved labor productivity, particularly in things like Latin America service margins, focus on fleet utilization and a number of other areas. We've got initiatives underway to meet the guidance.

Okay, thanks. And then I'm just the organic growth number. I appreciate your comments on how much customer acquisition affects that number. So I just want to be clear that if you take the .2% and you subtract 60 basis points, is that 1.6 a true same store metric by real estate standards or?

I don't think you can compare it to real estate standards because real estate, the REIT industry does NOI on a building by building basis. You've got to restore our customers records and information. They don't care which building it is. So it's not a building by building basis. I think about for an office building or a warehouse. So that's why it's organic growth and not sort of the same store growth.

Okay. And then just one last question on the NOVA lease. I'd be curious to get a little more color on how you won that deal because some of the other guys have been saying that Northern Virginia is very competitive and there's pricing pressures and so I'd just be curious on how you won that.

Yeah, I think we continue to see our down selects ahead of where we have capacity deployed. And I think it's partly because of the brand and I mentioned the cross-selling, the fact that the last two quarters have been consistent about getting 40% of our lead generation from the other side, the traditional side of the business. And our focus on those customers that are heavily regulated or have very high requirements, which is mainly financial services, government and healthcare. I mean, not that all our customers are in those categories, but that's kind of our focus. So we continue, we look at Northern Virginia. I totally take your point. There's a lot of capacity in Northern Virginia. It is the largest data center market globally. So there's also a lot of absorption. But that focus, I think, is a lot of us to build a pretty good pipeline. So we feel really good about the pipeline we have for Northern Virginia right now.

Okay, thanks guys.

The next question is from Eric Lubachow of Wells Fargo. Please go ahead.

Hi, thanks for taking the question. I just wanted to follow up on the Northern Virginia lease. I know we've heard from some of your competitors that pricing and returns have been kind of compressed there. So I'm just curious if for some of these larger scale leases, if you're underwriting kind of a lower return, but a longer contract duration, or how you kind of look at that balance, particularly as you sign these larger scale leases in data centers.

That's a good question, Eric. So let me answer the question two different ways. So we actually had quite a bit of leasing activity in Northern Virginia in Q2. And we see those at kind of normal rates when I'm talking about the retail, what I would call retail contracts or leases. On the specific six megawatts, that is a hyperscale lease. So we're seeing kind of the eight to nine percent cash on cash returns, which is where we built our business model. So that will, when you start seeing that come through, you'll see that at a lower rate. But we think it's very consistent, not just with Northern Virginia. Globally, we expect those kinds of cash on cash returns when we sign up a hyperscale customer. You're obviously getting bigger deployments. So when you actually look at the overall returns and the returns on the campus, as we said, I think previously on calls, is we think that to maximize or optimize return on a campus the size of Northern Virginia, we expect to have somewhere between 40 and 50 percent of the leases in those kind of eight to nine percent cash and cash returns when the site is fully built out. And it's consistent with that. But I would say the pricing on that six megawatts is less to do with Northern Virginia, just to do with the returns that are in the market for those types of customers.

Okay, thanks. That's helpful. And then just one more for me. Given that you took data center development capex, about 50 million, curious how impacts your leverage outlook for this year and into next year versus previously. And then could you talk about potentially your ability to recycle more of your industrial real estate portfolio above the 100 million that 100 million plus you have in your guidance?

Yeah, thanks, Eric. As we said over the last couple of quarters, we see ourselves landing lease adjusted leverage around five and a half times at the end of the year. If you look at sort of how it's going to come down from where it was at the end of Q2, we benefit really from three things. First of all, the increasing EBITDA, year over year rate, the leverage is calculated on a trialing 12-month basis. Second, the capital recycling underway. We've got a sale leaseback portfolio in the market now of industrial properties. And in a second property, we're about to start marketing. So I feel very confident in the 100 million dollar plus that was built into our guidance currently. We could do more. There is a lot of demand out there for industrial real estate. We're trying to be prudent and sort of prune the portfolio the right way. The third thing to call out is the data center leasing because the way our covenants work in our credit facility is we get credit because it's a trialing 12-month basis. On development properties, we get credit for leases that have been signed. So because you put the capital out to develop it upfront, so you get all 12 months of EBITDA credit related to those leases. So that also helps get to the, you know, around five and a half times.

Okay, great. That's helpful. Thank you.

The next question is from George Tong of Goldman Sachs. Please go ahead.

Good morning. This is Blake on for George. Thanks for taking my question. Looks like organic volume growth in other international was supported by growth in new sales in the quarter. Can you discuss specific storage volume trends that impacted new sales in other international? Are you saying increasing demand in emerging markets or anything else there would be great?

Good morning, Blake. Thanks for that. No, I think overall, not just I would say in emerging markets, but if we look at our commercial pipeline in our records management business globally, it's very healthy because obviously that's what we look for to give us our confidence going forward into the further quarters. So just generally, I would say across the globe, we have a pretty good commercial pipeline over the next 12 to 18 months. Specifically on emerging markets, yes, we continue to see that and it's usually in markets like India, for instance, where there's still a very large, what I call unbended opportunity. I think I might have mentioned previously there's a specific customer in India that we just want a part of their business. Historically, it was all in-house and it was over 20 million cubic feet. This is a single customer in India. So if you think about North America, which is 500 million cubic feet in total, there's a single customer in India that has over 20 million cubic feet in-house. So that just gives you the scale of the type of pipeline that we're building or line of sight to future demand that we have in some of these markets. So we continue to be quite encouraged by what we're building.

Great. Thank you for that. Also, previously, you had discussed specific initiatives of the global operations team, including transportation cost efficiencies. Can you discuss progress on these initiatives and what your expectations are for the remainder of the year?

Yeah, Blake, again, it's built into our guidance. I won't talk about specific results of the initiatives, but yeah, we've got a number of initiatives going on, and both to improve efficiency in North America transportation when we look at our data management business and fleet and the records management business, efficiencies on the labor side, particularly focused in Latin America, where labor productivity, we think we've got some improvements there as we take some of the labor standards that we've employed here in North America, some of the efficiencies where, just to give you a specific example, in Latin America, we've traditionally staffed each project team separately, where in North America, we sort of cross-train people better and we can use them across projects. We're putting that same initiative in place in Latin America, which will help Latin America service margins as well. So there are a number of things going on. I think we've got, if we total up each initiative from the global operations support team, there's well north of 50 different things that they're working on to keep taking costs as part of our continuous improvement initiative. I think having it global now lets us really cross-breed ideas faster and implement them faster across the organization.

Great, very helpful. Thank you.

The next question is from Andrew Steinerman of JPMorgan. Please go ahead.

Good morning. Looking at slide 14.1, you raised your organic radio growth storage range from a quarter ago, it was 1.75 to 2.5, and now it's 2.2 to 2.8. What factors give you confidence to take up the range? Meaning, what are the most important factors to take up the range? Is it lower destruction, higher revenue management, higher backlog? Just give us a relative sense of what are the most important factors that improved over the last quarter.

Andrew, good morning. You almost answered the question for me. It's pretty much three of your four. So if you think about it, first of all, we're looking at the commercial pipeline when we move forward. We're looking at the pipeline in terms of how long we've been speaking to the customer. Destructions are, they've kicked down slightly. Last year, I think they were up, destructions were up. If you look at this year, they're trending back to what I would call more normal levels. I wouldn't say they're down unusually, but they've come down from last year. That's the second aspect. The other thing is, we're getting, especially in North America, we're getting more joy from our pricing initiatives. We've actually rolled out pricing initiatives to customers where we were a little bit shocked before, and those seem to be sticking pretty well. It's a combination of revenue management, especially specifically in North America, and then looking at destruction levels going back to what I would call more norms, and then looking ahead at the commercial pipeline.

Right. Could you just give a reason why you feel like destructions are normalizing now, and what gives us confidence that that's going to stick?

Well, first of all, these are relatively small movements, but they have sizable impact, because you're talking about small movements on a business of 700 million cubic feet. So little bit of change in that can make big differences. I think last year, we all have our own hypothesis, and we speak to customers all the time, but many times our customers aren't crisp in their response. But I think last year, probably, it was a combination of some of the GDPR cleanup. People were going in to bring themselves into compliance and destroying a lot of their documentation rather than trying to bring it into compliance. And then the other aspect is we did get some legal holes that got released in the financial service industry. So I think those two things alone probably attracted a bit of it, and it's the best feedback we're getting from our customers at this point. So our expectations, it will kind of trend at the more what I would call usual levels, you know, pre-last year, and you can see that kind of bleeding through this year.

Thank you.

Coordinator The next question is from Shlomo Rosenbaum of Stiefel. Please go ahead.

Shlomo Rosenbaum Hi. Thank you very much. Can you delve a little bit more into the pricing in North America? I think you described it, Bill, as getting more joy over there. What exactly is it charges there and put through straight off contracts? Is it something that you feel is a sustainable thing that you could do on a regular basis if you could just give us just a little sense of that?

Bill Okay. Good morning, Shlomo. So I think kind of two aspects. I mean, one is, you know, watching the story is about two thirds of our pricing actions come in the second half of the year versus the first half of the year. So we have that normal uptick. But specifically, what's different this year than last year, it is that, quite frankly, if we started rolling out revenue management, the ones you're always shy of is your largest customers, right? Because there, if there's any elasticity, you know, obviously, you feel it in volume in larger dimensions. I think the last couple of years have given us confidence as a team, and specifically more in North America, that we're able to roll out the same kind of revenue management or pricing discipline to our larger customers as we were to, you know, kind of our midsize customers. And that built on the confidence with the midsize customers. And as we've gone into this year, in the first half of the year, we've seen that we have been able to actually achieve that. So in a lot of this, I think I've mentioned before our pricing, a lot of it has changed management internally. In other words, giving our folks the confidence that, you know, that they can charge the right price for the service that we're delivering.

Bill Okay. And then if you would just, and the supplemental slide nine on the records management and developed markets. So there's a trend that tends to be going on from like four Q, where the volumes were declining sequentially, you buck the trend in one Q, and ticked up and then is down again in two Q. Why is that trending down even if if destruction seems to be moderating? I'm just trying to get a handle as you know, or is the trend continuing downwards? Are we stabilizing just trying to get a sense of what's on there?

Yeah, I think it's more of a stabilized trend. I mean, if you look at the specifically on the developed markets, the chart that you're referring to is, if you then go down into the detail, it's a draw a moderate, yeah, moderation in terms of new sales in Q2. But if you kind of look at over 12 month basis, that goes up and down. So when we look at that, and we look at giving our projections going forward, is we look at the commercial pipeline. So I think it is, developed markets will be, as we said, it'll be more on the negative side of neutral. So to speak, it'll be a slight downward kick, more than offset by revenue management. So we build that into our projections. And at the end of the day, what we're delivering is total organic revenue sales, or organic storage sales, feel really comfortable with that. But in terms of looking at the volume that your question that you're asking is, we then look forward at the commercial pipeline, we think it's going to be kind of in that range, kind of up and down.

Okay, if I could just sneak in the last one, that 20 million QXT customer in India, when is that already rolling in now? When is that supposed to roll in? That sounds like actually a pretty big deal. I

wish it was the whole 20 million. They're not outsourcing everything that they have, and they actually split it between two of us. Actually, we got more than half, so we got the bulk of it. So they didn't outsource the whole 20 million. I think over time they will. And that's already starting to flow into our Indian operation.

Okay, great. Thanks.

The next question is from Andy Whitman of Robert W. Baird. Please go ahead.

Okay, thanks for taking my question, guys. Stuart, I appreciated your comments on the acquisition of customer relationships, otherwise known in the industry as the pick up and move business. I guess as I look at this, I want to understand it a little bit more. I guess last year you guys spent about $60 million. This year you're on track for about $90 million for these types of customer relationship acquisitions. You mentioned that you pay a sales commission anyway, and so there's costs either way. What is the delta in cost, if you look at it on a per box basis or some normalized basis between the two as you compare them? I mean, $90 million this year, I mean, it's clearly driving growth. You said 60 basis points of volume, but how does that compare? It seems like it's more expensive than a sales commission, but why don't you help us understand that a little bit more?

Yeah, and I think it's actually not very complicated. So on average, we've spent, I think probably at $60 million a year, and this year I would expect us to be around that as well. And that includes mostly boxes, mostly in the developed business, in the developed markets, a little bit of it in the shred business as well. So it gets sort of spread between the two. And as we've said before, typically we're bringing three to four million cubic feet a year in tuck-ins. When you're comparing the cost between bringing it in through a salesperson, you typically get a number of different costs. Because when you bring it through a salesperson, depending upon if it's at the customers today or the competitors, you get some different costs. So you've got the sales commission you have to pay, which you're right is a portion of it. If it's at a competitor, you're often reimbursing the customer for their permanent withdrawal fees that they've got to pay for the competitor, which can be pretty substantial. And so you compare that to a PUM V, we are typically paying around three times revenue. You actually don't get that much of a difference, but you get the volume benefit and efficiency benefits of doing it and moving it one time efficiently. And once you're fully integrated and synergized, you're at about a 90% margin. So the flow through that's really good. So you've got a payback of less than four years with integration costs, which has given you a cash on cash return of 25%. So our goal is to be transparent about it. We view it as organic. And because it is like a sales or some other competitive takeaway, we'll provide the information to investors, but it is part of organic growth. And we think about it that way as part of our organic capital spend as well.

Okay, that's super helpful. So in there, I heard that you're expecting actually $60 million for customer relationships. So I'm sorry, Tim, to quote you on my question there where I said it was 90. So that implies that the difference between the 90 that's in your slide 15 and the 60 you mentioned there is the customer inducements, which are basically those perm withdrawal fees. Is that the right way to think about it?

Correct. Yep. That's correct.

Okay, cool. That's what I wanted to understand. Thank you for your help.

The next question comes from Marlene Pereiro of Bank of America Securities. Please go ahead.

Hi, thank you for taking my question. I just had a quick question regarding, can you talk about funding the $395 million of incremental capital for investments and getting leverage to around five and a half times by year end?

Yeah, I think I touched on already, there's a couple of different ways to look at it. I mean, I touched on the leverage change from year to year end, both from the capital recycling. I think the thing to remember, Marlene, is that as EBITDA grows, that allows you to borrow against that and still reduce leverage. So if our EBITDA grows $100 million organically per year, you can theoretically, at five times, borrow $500 million and still reduce leverage from where we are at the mid-five level. So you can do both at the same time and fund those capital needs.

Great. So just to be clear, you do expect as communicated last quarter that you expect leverage to kind of get down to roughly that five and a half area.

Yeah, and I repeated that in my opening remarks as well.

Yep. Great. Thank you. Again, if you have a question, please press star, then one. The next question is from Kevin McVeigh of Credit Suisse. Please go ahead.

Hello?

Yes.

Yep. Can you hear me? Hey, Bill or Stuart. Nice job on the margin sequentials. The paper headwinds weren't as much as what we had modeled. Can you help us understand what you're using for the spot price, kind of where that came in in the quarter, and then how we should think about that over the balance of the year?

Yeah, Kevin, and just to, yeah, just appreciate the question because a number of questions about it. Let me start off with our initial guidance already assumed the paper prices would be declining. So our initial guidance, we assumed the paper prices would decline about $10 per ton from 2018. And on a price per ton basis, $10 per ton equates to about $6 million of EBITDA. So if you sort of say, okay, what's now inherent in our current assumptions, and Bill touched on his remarks when I did as well, if paper prices stay at current levels, and that's down about $40 per ton from a year ago, right, that $40 per ton is about $25 million impact year over year, right? And so if you think about it versus guidance, that's about a $20 million headwind relative to our guidance. Other thing just for people to remember as well, that we have really high quality sorted office papers. When we go into market to sell, we do sell it at a higher price than what people may be saying in the RECI index.

That's helpful. And then just, Stuart, what was it that kind of helped the margin recovery? I mean, I know in the first quarter it was kind of, you know, there was some unexpected cost around labor, things like that. What were you able to put in place that kind of helped boost the sequential and then, you know, the improvement that we'll see over the balance of the year?

Yeah, and remember, that's despite the $10 million of headwinds that we booked as well. And again, I mean, we came out of, when we talked about the first quarter call, we came out with a lot of confidence in terms of our ability to recover. The fact was that the labor issue that we had in first quarter was late in the quarter. We could have recovered in the quarter. And again, I think from an execution from our operations teams out there around the world, they're the ones who really get the credit. Both Bill touched on the revenue management programs we've got in place, cost takeout. There's a lot of work we have to do. There's a lot of opportunities for us in terms of levers in the company to move margins and to get more efficient. And we work on delivering those every day.

Got it. But was that maybe, I guess, can you give us some examples? Was it like maybe lower bonuses to drivers or was it, you know, just any thoughts on kind of-

Absolutely not. We're not taking this out of the backs of the mountaineers out there who are serving our customers every day. Got it. If you look, you can see labor efficiencies. Our labor actually year over year as a percentage of revenue is down. There is some price flow through. Again, most of that will come through in the back half of the year. And then efficiencies and just other cost of sales as well around transportation and some of the other areas.

Got it. Okay. Thank you.

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