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Iron Mountain (NYSE:IRM)

Q4 2010 Earnings Call

February 24, 2011 8:30 am ET

Executives

Brian McKeon - Chief Financial Officer, Principal Accounting Officer and Executive Vice President

Robert Brennan - Chief Executive Officer, President and Director

Stephen Golden - Vice President of Investor Relations

Analysts

Philip Stiller

Andrew Steinerman - JP Morgan Chase & Co

Vance Edelson - Morgan Stanley

Eric Boyer - Wells Fargo Securities, LLC

Gary Bisbee - Barclays Capital

Kevin McVeigh - Macquarie Research

Operator

Good morning. My name is Bonnie, and I will be your conference operator today. At this time, I would like to welcome everyone to the Iron Mountain Fourth Quarter 2010 Earnings Call webcast. [Operator Instructions] I would now like to turn the call over to Mr. Stephen Golden, Vice President of Investor Relations. Please go ahead, sir.

Stephen Golden

Thank you, and welcome, everyone, to our 2010 fourth quarter earnings conference call. Joining me this morning are our CFO, Brian McKeon, who will review our financial results; followed by Bob Brennan, CEO, remarks. When Bob is finished with his comments, we'll open up the phones for Q&A. Per our custom, we have a user controlled slide presentation on the Investor Relations page of our website at www.ironmountain.com.

Referring now to Slide 2. Today's earnings call and slide presentation will contain a number of forward-looking statements, most notably, our outlook for our 2011 financial performance. All forward-looking statements are subject to risks and uncertainties. Please refer to today's press release, 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 be materially different from those contemplated in our forward-looking statements.

As you know, we use several non-GAAP measures when presenting our financial results. Adjusted OIBDA, adjusted earnings per share and free cash flow before acquisitions and investments, among others, are metrics we speak to frequently and ones we believe to be important in evaluating our overall financial performance. We provide additional information and the reconciliations of these non-GAAP measures to the appropriate GAAP measures as required by Reg G at the Investor Relations page of our website, as well as in today's press release.

With that, I'd like to introduce our CFO, Brian McKeon.

Brian McKeon

Thanks, Stephen. Slide 3 highlights the key messages from today's review. Our Q4 results were in line with our expectations, capping off a solid year of financial performance for the company. Revenue gains were constrained by continued softness in core service activity levels and lower eDiscovery revenues. Despite these impacts, we continue to drive strong financial results, supported by international growth, expansion of hybrid services and continued productivity gains supporting gross margin improvement.

For the full year, we achieved 4% revenue growth, 9% growth in adjusted OIBDA and double-digit growth in adjusted earnings per share and free cash flow. Please note that our reported EPS for the fourth quarter of $0.16 per share included a $0.14 per share impact related to the finalization of the digital goodwill impairment charge initially recorded in Q3.

Our 2010 results build our strong long-term track record of financial performance. Our focus in recent years has been expanding our leadership position, while optimizing returns in the businesses we’ve built. We continue to advance a disciplined approach to operations management and capital allocation that supported a 440 basis point improvement in adjusted OIBDA margins, and a nearly 1,000 basis point improvement in free cash flow margins over the last four years. These improvements are sustainable and set the foundation for long-term success.

Our confidence in our business model and outlook supported our board's decision to increase our dividend by 200% in December. We intend to build on this track record in 2011. We plan to continue to drive solid free cash flow and adjusted EPS gains, supported by disciplined capital spending and lower interest costs. We're targeting moderate revenue growth despite expected constraints from continued soft core service activity trends and lower eDiscovery revenues. We'll be refining our revenue and adjusted OIBDA outlook today to reflect our updated expectations.

Let’s now turn to Slide 4 and begin the review of our financial results. Slide 4 looks at our full year operating performance compared to 2009. As noted, our Q4 results concluded a solid year of financial performance with profitability and cash flow generation reaching record high levels. Revenue increased 4% to $3.1 billion. Gross profit increased 8% to $1.9 billion, reflecting a 210 basis point improvement in gross margin for 2010 compared to 2009. These results are supported by continued benefits from North American productivity initiatives, solid international operating performance and higher recycled paper prices.

Adjusted OIBDA grew 9% for the full year of 2010 compared to the same period in 2009. Strong gross margin gains, controlled overhead spending and lower incentive compensation expense, which added about three points to growth, drove the increase.

Solid operating performance and lower interest expense drove a 17% increase in adjusted EPS compared to 2009. Capital spending was $268 million for 2010, including $14 million for real estate. Strong operating profit gains and capital spending efficiencies drove an 11% increase in 2010 free cash flow, despite a $52 million increase in cash taxes.

Let's now turn to Slide 5 to review our Q4 results. Slide 5 compares our results for this quarter to the fourth quarter of 2009. Q4 results were in line with our outlook. Enterprise revenue growth was 1%, down slightly from Q3, reflecting a moderated benefit from higher recycled paper prices. Enterprise revenue gains were supported by sustained 2% growth in storage revenues and by expansion of hybrid services. These gains offset continued softness in core service activities and lower eDiscovery revenues.

From a segment perspective, North American Physical posted 1% internal growth, supported by a consistent 1% storage growth, hybrid service gains and benefits from higher recycled paper pricing. These gains were offset by continued soft core service activities.

Our International Physical segment generated 3% internal growth. Storage internal growth remained solid at 6%, supported by strong performance in expansion markets. These gains were offset by core service revenue declines and partly impacted by weather conditions. Reported revenues for this segment grew 2%, net of a 2% negative impact from foreign currency exchange rate changes.

In our Digital segment, reported revenues declined 3% in the fourth quarter. Gains in backup and archiving services, reflecting our Mimosa acquisition, were offset by the divestiture of our domain name management product line and declines in eDiscovery revenues. Lower billing levels for eDiscovery in 2010 and the associated impact on deferred revenue recognition will continue to pressure overall Digital revenue growth in 2011.

Solid profit gains were supported by a 190 basis point improvement in gross margin. Higher storage gross margins reflected improved pricing and lower facility and insurance costs. Continued benefits from productivity initiatives also drove higher service margins.

Adjusted OIBDA grew 4% to $239 million, an increase of 11% compared to the prior year, reflecting strong operating performance and benefits from lower interest expense. Reported EPS for the fourth quarter was $0.16 per share, including the $0.14 per share impact of the $29 million non-cash charge for the finalization of the digital goodwill impairment initially recorded in Q3 of 2010.

The structural tax rate for the fourth quarter was 39% in line with expectations. Including the impact of discrete tax items primarily related to the goodwill impairment charge, the effective tax rate for the quarter was 54%.

Let's now take a closer look at our revenue growth on Slide 6. Slide 6 breaks down our overall revenue growth. It shows internal growth by major service line, as well as the impact of acquisitions and foreign exchange compared to our 2010 full year outlook.

For the full year, internal growth was 2% and reported growth was 4%, consistent with our expectations. Total revenue growth from Q4 was 1%, driven by storage internal growth gains. Overall, core revenue growth trends remain relatively consistent in Q4. Complementary revenue growth moderated in the quarter and strong hybrid revenue growth and narrowing gains from higher paper prices were partially offset by lower project revenues and eDiscovery sales.

The internal growth rate for core storage revenues for the quarter were sustained at 2%. Global records management net volumes increased modestly in the quarter, as destruction levels remained at relatively higher levels and new sales increases were offset by modest declines in other incoming volume.

Pricing trends remain consistent as well with net pricing gains of about 2% in North American records management. A key factor moderating growth involves continued softness in core service activity levels, reflecting impacts from current employment levels and general economic trends. Our updated outlook for 2011 reflects an extension of recent core service trends.

Let's now turn to Slide 7 to review our full year performance on a segment basis. Slide 7 shows key metrics for each of our four segments compared to 2009. North America drove higher profits and strong cash flows in 2010. Adjusted OIBDA in our largest segment increased 12% on 3% reported revenue growth, supported by gross margin gains and controlled overhead spending. Controlled capital spending to over 200 basis point improvement in segment CapEx as a percent of revenues.

Our International segment continues to post solid revenue, adjusted OIBDA and cash flow gains supported by growth in expansion partners. Internal growth for the year was 4%, driven by continued strong storage internal growth of 6%. Adjusted OIBDA grew 7% in line with revenue gains. We're targeting solid improvement in international margins in 2011, as we continue to build scale across our International business and drive operational excellence initiatives in the developed markets.

Gains in our Physical business helped to offset a challenging year in our Digital segment. Economic pressures and recent challenges, specifically in our eDiscovery business, constrained growth and lowered digital profits this year. As noted on our Q3 earnings call, we proactively reassessed the value of our digital goodwill in that quarter, which resulted in a preliminary goodwill impairment charge of $255 million related to our Worldwide Digital segment. We finalized our work on the digital valuation in the fourth quarter and recorded an additional $29 million charge to the impairment. This charge impacted our reported Q4 2010 EPS by $0.14.

As Bob will discuss in more detail, we've advanced significant efforts to better integrate our digital services into Iron Mountain to accelerate growth and cost efficiencies. We do expect to be working through tough comparisons in 2011, particularly in areas such as eDiscovery, which will constrain overall digital service revenue gains, but we believe we're on the right track towards strengthened revenue trends and profit performance from our Digital business lines. Overall, the strength of our portfolio provided the foundation for another solid year of financial gains.

Let's turn to Slide 8 to review our performance in a longer-term context. Slide 8 highlights the track record of strong financial performance Iron Mountain's achieved over the last four years, a record that we tend to continue building on for the long term.

While economic factors have recently constrained top line growth, we've continued to deliver strong profit and cash flow performance. Over the past four years, while continuing to expand our business foundation and capability, we've driven consistently strong adjusted OIBDA and adjusted EPS growth well ahead of revenue gains. Additionally, our disciplined approach to capital allocation has supported a 40% improvement in capital efficiency, which along with profit margin gains, has driven free cash flow from 2% of revenues in 2006 to 12% in 2010.

These improvements are sustainable. They reflect the strength of the business model we've built and our growing capabilities in organization. The financial strategies we're advancing should support sustained solid long-term growth in adjusted EPS and free cash flow. We intend to improve our revenue growth trajectory while continuing to improve adjusted OIBDA margins and sustain capital efficiencies. We also intend to drive additional tax efficiencies and manage our balance sheet in a disciplined way that enhances per share returns.

Let's turn to Slide 9 to discuss our progress on this front, starting with a review of our debt statistics and cash management initiatives. Substantial gains in cash flow generation has enabled the continued strengthening of our balance sheet. We improved our debt statistics steadily in recent years. Currently, our consolidated leverage ratio was 2.9x at the low end of what we feel is a very manageable 3x to 4x leverage level for our company.

Our debt portfolio at December 31, 2010, remains long and fixed. Our weighted average interest rate was 6.9%, and we were 87% fixed at year end. Maturity is less than seven years with no meaningful repayment obligations until 2014. In September 2010, we used excess cash to redeem $200 million of our 7 3/4% senior subordinated notes due in 2015.

In January of 2011, we used cash on hand and borrowings under our revolving credit facility to fund the redemption of the remaining $231 million of these bonds. These transactions will reduce our net interest expense by approximately $20 million in 2011, supporting continued growth in adjusted earnings per share and free cash flow. Pro forma for the January bond call were about 80% fixed with respect to interest rates.

We're well positioned in terms of cash and financing capacity. At quarter end, liquidity was more than $1 billion with $259 million in cash and $763 million in additional borrowing capacity. In January of 2011, we used cash on hand and $180 million of borrowings to fund the bond redemption I just mentioned. Our cash management strategies evolved in important ways in 2010.

Let's now turn to Slide 10 to discuss the advancement of shareholder payouts as part of our financial approach. Our track record in growing our cash flows and strengthening our balance sheet, combined with our confidence in our ability to grow our business profitably, supported our decision to initiate a shareholder payout program in 2010. This program is comprised of two important elements: a quarterly dividend and an authorization to repurchase shares.

Our dividend currently stands at $0.75 per share on an annual basis, following the announcement in December of 2010 that our board had increased our quarterly dividend by 200%. This dividend provides a solid foundation to our payout program. We're paying a dividend that is currently yielding above 3%, and we expect to increase the dividend on an annual basis as we continue to expand our free cash flow.

In 2010, we also announced that our board had authorized a total of $350 million for the repurchase of our shares. In the fourth quarter, we acquired 773,000 shares of our stock for approximately $17 million. For the full year 2010, we repurchased 4.8 million shares for approximately $111 million. This leaves us a balance of $239 million for additional share repurchases under our existing authorization. We intend to invest excess cash flow in share repurchases as part of our financial strategy, and are committed to managing our balance sheet in a disciplined way to enhance per share value for our investors.

That concludes our review of 2010 financial performance. Let's now move to Slide 11 and discuss how we intend to build on that progress through a review of our 2011 outlook.

Slide 11 highlights key factors supporting our outlook for 2011 financial performance. We're maintaining a measured outlook on revenue growth while continuing to drive solid profit and cash flow gains. We're targeting 2% to 4% revenue growth this year, with gains supported by progress on new sales, hybrid services development and international expansion. As I'll discuss in more detail, our updated outlook is for 0% to 2% internal growth as we extend recent trends in core service activities and reflect expectations for lower eDiscovery revenues.

We're targeting solid underlying gains in adjusted OIBDA, supported by continued focus on productivity improvement in our North American field and support operations, and progress in strengthening international returns. These gains will enable us to advance about $20 million of the investments in sales and marketing capabilities in support of accelerated new sales growth. On a reported basis, our outlook is for adjusted OIBDA growth in the 0% to 3%. This outlook assumes a return to normal incentive compensation levels in 2011, following lower than normal payouts in 2010. This impact will lower adjusted OIBDA growth rate about 3% in 2011.

Finally, we expect to drive continued solid adjusted EPS and free cash flow growth, benefiting from disciplined cash management. Adjusted EPS will benefit from lower interest costs, reflecting recent refinancing activities. We're also projecting benefits from our lower shares outstanding at the end of 2010, reflecting our share repurchase program. Our free cash flow outlook is also supported by projections for lower interest in capital spending. Continue projecting improvements in capital spending as a percent of sales reflect benefits from capital allocation flows, lower volume growth, moderate pricing gains and favorable impacts from the expansion of less capital intensive services.

Let's turn to Slide 12 for a look at our expected revenue growth rates for 2011. The table on Slide 12 breaks down key drivers of revenue growth in 2011. Our outlook is for 2% to 4% Enterprise revenue growth. As noted, we're targeting internal growth in the 0% to 2% range. This growth outlook is in a similar range to recent trends, adjusting for the about 1% growth benefit we saw last year related to the strong recovery in recycled paper pricing.

Storage growth is projected in the 2% to 3% range with expectations for strengthening performance as we work through the year and benefit from new sales initiatives. We're projecting core service growth in the 0% to 2% range, as benefits from higher recurring hybrid project sales offset recent soft trends in areas such as transportation activity. We're planning for declines in complementary revenues this year in the range of 5% to 10%. This primarily reflects expectations for lower revenue in eDiscovery, the lapping of a large product in Europe and tougher comps in recycled paper. Acquisitions in FX at current exchange rate levels should contribute about 1% to 2% to Enterprise revenue growth this year.

Let's turn to Slide 13 that summarize our 2011 outlook. Slide 13 summarizes our full year 2011 financial guidance. We've adjusted our enterprise revenue outlook to be in the range of $3,175,000,000 to $3,240,000,000, up 2% to 4%. This is moderately lower than our preliminary outlook shared at Investor Day, primarily reflecting our updated view on 2011 eDiscovery revenue and an extension of continued soft trends in core service activity. As noted, we're targeting improved revenue performance as we work through the year. Our toughest revenue comparisons for complementary and core service revenues will be in the first quarter.

We're targeting adjusted OIBDA of $941 million to $971 million. This represents reported growth of the 0% to 3%, including incremental sales and marketing investments. We're increasing our free cash flow outlook to $375 million to $410 million, reflecting solid operating performance, lower interest expense and estimated capital expenditures of about $245 million for the year. We increased our CapEx outlook slightly to reflect recent acquisition activity and refinement to our spending plans. The capital outlook includes about $20 million from real estate. Our outlook is for adjusted EPS to grow between 5% and 13% to a range of $1.21 to $1.30 per share, assuming 200 million shares outstanding. This reflects our shares outstanding at year end, which are about 2% below average 2009 levels.

We would like to highlight a change in our approach to financial guidance this year. In order to reinforce our focus on full year financial progress and the progress that we're making against our strategic agenda, we decided to eliminate specific quarterly guidance. Instead, we'll provide qualitative information to indicate how our business is trending in the near term. We'll continue to provide annual guidance, which we'll update as necessary on our quarterly earnings calls.

Turning to Slide 14. You can see our expectations for the PL below the adjusted OIBDA line for the full year 2011. G&A expense is consistent with 2010 levels and interest expense is down about 10%, reflecting the bond redemptions we completed in September and January. We're expecting our structural tax rate to be about 39% for 2011.

In summary, 2010 was a solid year of financial progress, building on our strong track record of performance. Strong execution drove record profitability and free cash flow despite moderating revenue growth. Our business platform is solid and we remain confident in our long-term potential, and we look forward to building on our strong financial performance in 2011 and beyond.

Thank you, and now I'd like to turn the call over to Bob.

Robert Brennan

Thanks, Brian, and good morning, everyone. 2010 was another solid year of financial performance for Iron Mountain, as we posted our 22nd consecutive year of storage revenue growth. We reached record high levels for adjusted OIBDA and free cash flow. We also continued to strengthen our balance sheet and confidently advanced our first shareholder payout program. Brian has reviewed the details of both the quarter and the year, so I'm going to talk about Iron Mountain from my vantage point and share my thoughts on where we are, how we're doing and how we think about creating value.

Let me start by reminding us what a great business we have. Iron Mountain is global leader in information management services. We have operations in more than 35 countries, expanding five continents. We are the global leader in storage and management of paper records, the off-site storage and management of backup data and in secure document shredding, which we call the Box, Tape and Shred businesses. We provide superior security, storage and access through an integrated global service model and a footprint that is unmatched by our competition.

These physical services comprise 89% of our total revenues and are all built on a strong foundation of recurring revenues comprised of storage and related services. We call our recurring storage and service revenue streams core revenues. Core revenues form a durable annuity revenue stream that is sustained over time. In 2005, these core revenues were 87% of our total revenues. And five years later in 2010, core revenues remain at 87%. This great business is built on a financial model that has four pillars.

The first is that we have a recurring revenue growth stream that flows from existing customers. It's augmented by growth from the continued penetration of the unmended market.

The second pillar is that our revenue comes from a very diversified and stable customer base. We provide service to over 150,000 customers in more than 90% of the Fortune 1000. We've got very low churn, typically in the 1% to 2% range, and that has been the case over time. We have strong penetration in key factors such as financial services, legal services and healthcare. And we continue to build out new sectors such as retail and government.

The third pillar is that our value proposition enables us to achieve attractive adjusted OIBDA margins and expanded free cash flow. Our North American Physical margins were 36% in 2007, and they were 44% this past year. I point this out because we fundamentally have the same business globally, and we're well positioned to drive higher returns across the rest of world geographies. This dynamic supported growth of 9% in adjusted OIBDA and 11% growth in free cash flow this year.

The fourth pillar is that our capital investment is driven most significantly by growth investments. This key element of our business allows us to maintain disciplined controls of our capital allocation, ensuring we continue to earn attractive return on incremental investments.

Now these four pillars have remained consistent over time. Recurring revenue, a stable customer base, consistently growing free cash flow and growth-driven capital investments. This fundamental has emerged as we move towards the focus on organic growth, increasing the returns on capital. We're demonstrating the underlying attractiveness of our business and capitalizing on the investments made during the acquisition phase of the company's development to deliver steady improvements in ROIC, which reached 7.7% on an after-tax basis this year. Steadily improving ROIC performance is supported by centralized capital controls and rigorous ROI-based investment decisions.

Iron Mountain is the global leader with a significant competitive advantage in a business where we have structurally attractive fundamentals. So let's talk about how we got here. We've built our global leadership position by executing a long-term strategy of three distinct but overlapping phases. In the first phase, we acquired companies. At our peak, we were buying a company every three weeks. This period was characterized by high growth and high capital investment to acquire companies and then integrate and bring them into our operating standards. We focused our organization on acquiring a broader footprint to achieve strategic advantage.

In Phase 2, we continued to acquire companies and focused on building our sales capabilities to penetrate the local and national markets where we had been acquiring companies. The margins contracted during this phase because we knew it was important to build out the selling capabilities, and there was infrastructure requirements as well to run the businesses we had bought. We continued to roll off of the industry in the second phase and also began to pursue operational excellence. And it's during the last few years, that we have continued to capitalize on this opportunity, where we've been carefully targeting SG&A investments to achieve higher realized returns.

We’ve been achieving this operational excellence through specific initiatives around optimized pricing, transportation, workflow and purchasing, all the while setting consistent high-performance standards across our business and for our industry. This focus has yielded both competitive and financial gains, with adjusted OIBDA margins increasing 440 basis points, and free cash flow margins increasing nearly 1,000 basis points over the last four years.

As we evolved, we also expanded our service lines through M&A and internal investments to create a range of technology services that extend from our core Physical services and offer the same fundamental value proposition. These offerings include close-in adjacent hybrid services that help our customers remove inefficiencies from document processes, as well as services that support the management of digital data. The ability to help customers manage their records and data across information formats is a capability unique to Iron Mountain, and it supports the long-term growth of all of our services.

Now this three-phased approach that I've described has not been without its speed bumps and missteps, but we have managed to achieve our major strategic goals while also delivering strong, improved financial performance. This strategy built the global leadership position we currently have in box, tape and shredding services. We’re well positioned to help our customers manage hybrid record processes as document processes become more digital.

We're also a leading provider of Digital services with industry-leading offerings for backup, archival and litigation support. Our approach to technology services is one of a services strategy, and that Iron Mountain delivers the same value across all of our services in OnDemand platform, high security and compliance embedded into each of our services. They all offer a low capital, low risk option for our customers versus doing it themselves. Through these three phases, we've built a company with a strong sustainable competitive position. We've also demonstrated the power of our financial model through continued growth, expanding cash flows and a strong balance sheet.

So that's history. Let's talk now about current trends and how we're managing today. While our financial performance continues to strengthen, we are operating in a lower growth environment. I want to describe how we think about that and plan to address this current trajectory.

Growth slowed meaningfully during the recession. Prior to the recession, our growth was tracking steadily in the high single-digit range. Our growth has slowed to the low single-digit range. We see this change as primarily related to changes in the economy, which lowered overall levels of business activity and drove customers to increase their focus on cost control. Growth is also impacted by execution shortfalls in our Digital business unit.

Our decline in growth rate lagged the decline of the overall economy, and we expect that any recovery will also lag the general recovery. Despite these significant impacts, our business continues to expand. Our physical services grew 3% worldwide in 2010, led by international growth of 6%. Box revenues were up 2% last year despite volume growth being constrained by higher levels of destruction activity and pressured service activity levels. Tape revenues were up 3%. Shredding posted solid global revenue gains of 12%, supported by higher paper prices. Technology services, which include hybrid and digital solutions, grew 7% overall, supported by approximately 20% expansion in hybrid services and gains in digital backup and archiving. As we move forward, our focus is on driving new sales to help move our overall growth trajectory higher and position ourselves to long-term expansion.

In North America, we're applying our operating profits focus to our go-to-market capability and increasing our emphasis on the Box business, to complement the progress we've made in driving higher hybrid sales recently. We have significant unmended market opportunities for our box, tape and shredded services. We're investing in increased sales, marketing and product management capability to support new customer acquisition and segmented service line development. We're starting to build momentum on this front and are experiencing benefits and expecting benefit from the second half of 2011 that will position us for improving momentum going into 2012.

In our International Physical business, we intend to build on our solid momentum. We posted 6% internal growth in storage in the International business through investment in expansion markets, sales and marketing capability and of course, our core business in the U.K.

In our technology service offerings, we intend to build on our progress in hybrid service expansion and address key drivers of recent underperformance in Digital services. In Digital, our CloudRecovery in Digital archiving expanded last year, supported by our Mimosa acquisition. However, we experienced a rapid change in eDiscovery business, which declined 10% and pressured our profits. We also had management execution issues in part of our Digital business that caused us to fell well short of our profit plan. These factors caused our Digital segments to suffer a contribution decline of 45%. We’ve corrected these issues and reduced our cost structure in line with current revenues. The impact on revenue growth from eDiscovery will continue into 2011, but our cost actions will offset these impacts, sustain margins and position us well for profit gain as get growth back on track.

The key change element we have advanced is the integration of the full scope of services across our business. One of our competitive advantages is the ability to offer solutions across Physical and Digital formats in an integrated offering. This advantage really aids growth across our service lines, as we've seen just in the expansion of our hybrid offerings. We will apply these same principles to improve our Digital business.

Now in order to start our Digital business, we initially operated as a separate and somewhat redundant organization. Our structure served us well as we established our products and built capability. Now to take advantage of the products and capability we've built, we've decided it's time to integrate our Digital services more fully into our overall operations.

We started this process during 2010. Our first step was to integrate our separate sales forces under a common management structure. This is being followed by the integration of our service delivery organizations. This further integration of our business will produce more efficiency going forward and build upon the Iron Mountain strength of providing our customers an integrated approach to their information management problems regardless of location, regardless of format.

So that's how we're managing today and how we intend to drive growth and improve performance in the near term. Let me now describe how this points to our approach for creating shareholder value.

Value creation comes down to how well we manage the business and how well we invest your capital. We take this responsibility seriously. We're managing the business to grow free cash flow and grow returns on invested capital. In this context, you should hear that our primary investment focus is on growing our business organically and continuing to optimize the highly attractive business we've built. In terms of organic revenue growth, we'll continue to invest both capital and operating expense to grow our revenues. We know we have significant untapped market opportunities across our service lines.

Our 2011 budget includes significant incremental investments in sales and marketing to support higher growth. We're also investing growth capital directed at the expansion of our International Physical business. We know this business well. Its performance has been improving steadily and we have a clear line of sight to attractive incremental returns. Now if our investments in organic growth yield the returns as planned, we'll keep investing. And if they don't, we'll adjust our spending appropriately.

In terms of margins and capital efficiency, we will continue to invest to drive productivity improvement that support long-term margin gains and continued capital efficiencies. The majority of the margin growth over the next few years will come from our International business. We're going to use the same techniques and programs that increased North American margins by more than 800 basis points since 2007. And of course, we'll also maintain our focus on capital efficiencies across our entire business.

Acquisitions. We will complement investments towards organic growth and productivity with targeted acquisition investments. We will consider specific acquisitions that help round out our service offerings in areas like hybrid services, as well as fold-in acquisitions that help us drive margin on a local scale. Our primary focus will be on select expansion in international markets including the purchase of joint venture interests. In this context, we're excited to announce the recent acquisition of the remaining 80% in our Poland joint venture.

The key message related to acquisitions is that we will be targeted in our approach. Our focus is on small and midsized opportunities that are closed in and have a clear path to value creation. I don't foresee a significant transaction that would change our risk profile. Built a great business, and we're focused on investing to take full advantage of what we have built.

Balance sheet management is another key element of our approach to value creation. Continuing to grow revenues and free cash flow, we will continue to use various financial strategies to enhance returns for our shareholders on both the current basis and in support of share value appreciation. Our predictable and growing free cash flow gives us current cash from operations after fully funding internal capital needs and significant borrowing capacity to invest. The strength of our balance sheet and cash flows enabled us to confidently advance shareholder payouts as part of our financial strategy. We started our first ever dividend payment last year and recently increased the dividend substantially, reflecting confidence in our ability to grow and expand cash flows.

Given our strong operating cash generation and current acquisition outlook, we also intend to support share repurchases at prices that create value for our shareholders. We're in the early stages of this process and have purchased more than 2% of our shares since we started the program. Share repurchases, along with tax strategy and debt cost optimization, will help us drive solid adjusted earnings per share and free cash flow growth over time.

Summary. We intend to invest appropriately to grow and improve our business over time, increasing its future value while managing excess cash flows to provide current yield and create additional value.

So thanks for allowing me to go on a little longer than usual. I wanted to provide context about how we built market leadership, to discuss where we are and how we intend to create value. We remain committed to solid execution of an investment plan that will reward our stakeholders year in and year out. I appreciate the input and insights you offered Brian and me throughout the year. And now we'd both like to take your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Kevin McVeigh of Macquarie.

Kevin McVeigh - Macquarie Research

I wonder if you could talk just a little bit about the leverage ratios. We're down to 2.9% right now and I know we recently took the range down to 3% to 4%. As you think about that, Brian, going forward, can you help us kind of is 3% to 4% the new normal or do you envision given the strength of the free cash flow that, that's going to continue to trend down? Or how we should think about the dividend versus buy back within the context of the leverage ratio overall?

Brian McKeon

We have said that 3% to 4% is a leverage range that we're quite comfortable in. As you point out, it's right now at the low end of that range. In terms of how we're managing that, we obviously have increased the dividend pretty substantially. We think we're in a good level there. We're looking to increase that over time as we go free cash flow, but we think that we've established the dividend as an important part of our financial approach and we will continue to buy back shares. I think we have a significant amount available under our existing authorization. We see that as a key point of our financial strategy as well, and that will enable us to have another vehicle to create value and to manage the leverage ratios and acquisitions are part of that equation as well. So net-net, I think we're comfortable operating at or slightly below the low end of the range, and we may spike up over time depending on how we choose to deploy capital given the opportunities that we have. But right now, we're comfortable where we are and we'll continue to evaluate that.

Kevin McVeigh - Macquarie Research

The SG&A, it looks that ticked up a little bit in the fourth quarter and I know that was from some targeted initiatives. Can you just help us understand what they're related to? Was that kind of sales people in hybrid services or just kind of what that related to?

Brian McKeon

It is principally related to a combination of growth and productivity initiatives, but we had started to accelerate the investments in sales and marketing that we've been highlighting. And maybe Bob can talk a bit more about that.

Robert Brennan

Kevin, we've been bolstering our product management marketing and selling capabilities. You've heard me refer as the go-to-market effort over the past couple of years and we've made a lot of progress as we came towards the back half of the year. And embedded in my comments is the fact that 2011, we will continue to make significant incremental investments in this capability as we see it generate the right kind of progress. And we're seeing that kind of progress, so we feel pretty good about that.

Brian McKeon

We were also -- similar to what we did in North America, we do made targeted investments in the SG&A line and currently in our International business that will enable us to drive gross margin improvement over time, the operational excellence initiatives. So there's some of that as well. But net-net, the overall equation continues to work well for us and we're pleased to have delivered good profit growth this year and look to build on that next year.

Kevin McVeigh - Macquarie Research

And Brian, I know you kind of talked about targeted cost savings in North America as a result of those OpEx initiatives. Do you have any type of range for Europe or what we could expect over the next couple of years as a result of that?

Brian McKeon

We've spoken about the longer-term goal in our international operations to increase our adjusted OIBDA margins by 100 basis points or more annually. And we haven't gotten more specific than that, Kevin. But I can tell you that 2011, we're definitely targeting strong margin improvement in international and that's a key factor that's allowing us to advance incremental sales and marketing investment and address some of the lapping issues that we've highlighted.

Robert Brennan

Actually, Kevin, Brian and I just got back from visiting the international team and the way that they're getting after this with execution is very encouraging. And it helps that North America paved the way over the last four years, so we have a playbook here.

Operator

Our next question comes from Vance Edelson of Morgan Stanley.

Vance Edelson - Morgan Stanley

For starters, what do you think is driving the modest declines in incoming volumes from existing customers? Seems like the economy picked up a little more pace during the fourth quarter, so I'd be interested in hearing your thoughts on that. Is it just the late cycle nature playing out or is there anything else there?

Robert Brennan

Vance, we lagged coming in, we lagged coming out. We've been -- that showed in our results, we are seeing stabilization. And we expected any benefits that we, in the economy will benefit our business, although it will be on a lagged basis. We're not planning for those benefits, but we feel pretty good that we're on track as we start the year.

Brian McKeon

Vance, sort of the key thing is that it's more similar than different. We always have some movement on the margin in different areas, I would say, where net-net, the volume has been within the similar range in Q4. It has been kind of in a similar zone for a couple of quarters. We feel good about the progress that we're making to influence the new sales side, and we think we're on track and look at targeting improved performance as we work through the year.

Vance Edelson - Morgan Stanley

And as a follow-up on an earlier question, sounds like there are more benefits ahead from productivity initiatives and there will also be more investments to that end as well. Where would you say we are in that overall process? Has most of it run its course or have we barely scratched the surface? If you could just give a feel for where we are in that process.

Brian McKeon

We tried to break this down a little bit at Investor Day in terms of where we'll drive margin improvement over time. And in North America, we continue their work to get better and we shoot to have our profits grow faster than our revenues. But we have seen substantial benefit from productivity initiatives, and we've recognized that obviously in our financial performance. International, we're in much earlier innings in terms of what we believe we can achieve there. We are going to balance that over time with continued investment towards growth. The International businesses is growing quite well. We continue to have strong storage gains and very optimistic about the potential in that business. And that'll be the -- that earlier innings will be a bigger driver going forward, as Bob highlighted.

Robert Brennan

You're right, Vance. You do have to invest to get the productivity and you have to invest to get the growth, and we're careful to make those investments. And as they pay off, we continue to invest and if they don't, we adjust our investments accordingly.

Brian McKeon

We're obviously in a moderate growth zone currently. As we increase our growth rate, improve our growth, which is our intent, we should be able to get more benefit out of overall overhead leverage as well. It's just when we're in a more moderate growth range, it's a little tougher to do that.

Vance Edelson - Morgan Stanley

How should we think about maintenance CapEx levels in terms of when we might get there, if ever, what those levels might look like? Could you provide some color on that?

Brian McKeon

Sure. We're enhancing our capital disclosure in our 10-K, which will be available in a couple of days to provide a more granular look at where we invest capital. And the bulk of our capital view is growth oriented. That includes capacity expansion, it includes investments that we make in improving our products, as well as some targeted investment in new products. We invest in things like operational efficiencies. So I think the true maintenance capital required in a business is low, but we continue to grow as a business and improve our product offering. And we're comfortable with our outlook, which we've said over time, we think we can sustain capital spending in the range of 7% to 8% of sales even as we improve -- that's excluding real estate, even after we improve our revenue growth, our outlook for 2011 is roughly 7%. So we think we can sustain the good capital efficiencies that we've driven and drive cash flow higher.

Robert Brennan

Sustainability is a key theme you'll hear from us, Vance. And fundamentally, if you step back, that's a result of us investing and having a better competitive position in our industry than really anybody and those investments pay off a good bit. Sustainability is about making them and continually increasing your competitive position.

Operator

Our next question comes from Gary Bisbee of Barclays Capital.

Gary Bisbee - Barclays Capital

How are revenues overall from existing customers trending if you combine the higher destructions and the lower incoming volumes? Is it down at a mid-single digits rate or how should we think about that?

Brian McKeon

We continually try to highlight the overall volume and records management was relatively flat. So we are seeing continued higher levels of outgoing volume, net-net some destruction activity offset by incoming volumes. So that's been the trend for the last few quarters and we came from a place where we're growing mid-single digit before the economic downturn, so we are targeting improvement as we move forward.

Gary Bisbee - Barclays Capital

Can you break that out between new sales and existing -- it sounds like existing customer volumes must be down quite a bit. But you've got a new sales effort that's offsetting that and getting that to flat?

Brian McKeon

New sales are a relatively small driver of the volume growth in the short term at the margin, right? It builds as an annuity over time. So the existing customer volume in the quarter was down slightly. But if this is net-net, new sales are not a huge driver of our volume growth at the margin.

Gary Bisbee - Barclays Capital

Can you tell us how large the eDiscovery business is? Just what’s the scale relative to other businesses in Digital? And if that continues to go lower, I guess I'm curious what cost actions you're taking? You said you're going to be able to maintain margins, I believe, for this year?

Robert Brennan

Yes. It's just below a $50 million business, Gary. Fundamentally, we have taken cost actions relative to our cost reserve to provide service on a given matter. The other thing that we've done is really integrated under Harry Ebbighausen's leadership into our overall business, as I mentioned in my remarks. So there are things like when we see customers pulling hard copy records being able to isolate them and understand if they're subject to litigation, that we're -- I'm comfortable with the progress that we're seeing in our execution on that front. It was a combination of the pricing in the market plummeted very quickly as a result of secular trends in that space, and we weren't quick enough from an execution perspective to write our cost structure. We are writing that cost structure and I think we're doing a much better job identifying and pursuing new opportunities. So I'm confident that, that would stabilize that business. Although because of the way that we booked the revenue, the effects of the down of 2010 will flow into 2011.

Gary Bisbee - Barclays Capital

Can you give us a sense what your exposure to energy prices is? I guess I'm thinking gasoline or diesel for the delivery trucks and shredding trucks and electricity. Should we think about the recent spike in prices being a big impact in your gross margins or is it a pretty small percent of revenue?

Brian McKeon

It won't have much of an effect in that -- first of all, overall energy costs are about 2% to 3% of our revenues and we actually have fuel surcharges as part of our business model. So when the -- at least the energy cost is split pretty evenly between utility cost and transportation cost. And for the transport piece, when the prices rise, we have an offsetting fuel surcharge. It doesn't help profitability, it doesn't hurt. It just helps us to mitigate that.

Operator

Our next question comes from Andrew Steinerman of JPMorgan.

Andrew Steinerman - JP Morgan Chase & Co

Usually, first quarter is a good sequential quarter from the fourth quarter. I guess people clean up their records, and there's just more activity in the first quarter versus the fourth quarter. And obviously, that was not the case for Iron Mountain in the first quarter 2010 and 2009 because of the recession. But if you can make some qualitative comment about sequential revenues first quarter 2011 versus fourth quarter on storage and service, we'd appreciate it.

Brian McKeon

Yes, I think we tend to look at these things year-on-year, Andrew. I think we are expecting to have some tougher comparisons in areas like complementary revenues in Q1 and that we're lapping some of the paper prices come down from some of its peak. So we're not going to have the same benefits that we did last year. We've got some special projects that we're lapping there and the kind of extension of the core service trends we've seen recently compared will continue to be a factor in moderating growth. We intend to continue to march forward with expanding our storage revenues and expect kind of similar seasonal effects. So that's how we're looking at them.

Robert Brennan

The purge effects that you're referring to in Q1 really come later in the quarter, then it's not a January 1 kind of thing. So we wouldn't even have a line of sight to that at this point.

Andrew Steinerman - JP Morgan Chase & Co

Right. But you do agree with me that first quarter generally, historically, with the exception of the last two years, has shown good sequential lift from the fourth quarter. And I just was wondering if there's anything that you're seeing aberrational this year given the previous two years?

Brian McKeon

We're planning for similar seasonal trends.

Operator

[Operator Instructions] Our next question comes from Eric Boyer of Wells Fargo.

Eric Boyer - Wells Fargo Securities, LLC

Can you just go over the expectations for net pricing gains in 2011 versus '10? I think you said 2% in North America Physical for 2011, if I have that right?

Brian McKeon

It's North American records management. And the net pricing has been turning at about the 2% range, and that's our expectation for this year as well.

Eric Boyer - Wells Fargo Securities, LLC

And then I understand you have an offsetting fuel surcharge for some of the transportation services. But I was wondering when you look back at prior gas price spikes, did it have any impact on falling incremental services revenue as the cost go up for clients or is that cost increase so small, it really isn't much of a factor?

Brian McKeon

It did. A couple of years back, it added some at the margin to our core service growth about 220 basis points -- $20 million. And we'll highlight that for you as we work through the year if that becomes a material factor.

Eric Boyer - Wells Fargo Securities, LLC

And did you say lower incentive comp was a 3% benefit in 2010? Just want to make sure I had that right.

Brian McKeon

That's correct. Just 3% 2010, and we're claiming for normal levels this year so that's factored into our outlook.

Eric Boyer - Wells Fargo Securities, LLC

So that would be like a 3% headwind year-over-year then? '11?

Brian McKeon

That's exactly right.

Operator

That question comes from Ashwin Shirvaikar of Citigroup.

Philip Stiller

This is Phil Stiller, in for Ashwin. Just following up on the first quarter question for -- I know last year you had some impacts from adverse weather. And given the heightened storms this year, just wondering what you're expecting on that front?

Robert Brennan

It's an impact in parts of the country and we saw it on some service activity volumes. Snow removal costs that -- it spikes, but it's very much on the margin. I'm actually -- I like the way that we're starting the year and we're on track to really build on the performance that we had in 2010 in 2011. So I feel pretty good about the start.

Philip Stiller

I know you guys just commented on the pricing for the storage, but can you comment on what kind of pricing trend you see in terms of core services?

Robert Brennan

It's pretty consistent. We take a measured approach to this. In 2009, we really start to get after this with discipline and we're taking a very measured, consistent, sustainable approach to pricing.

Philip Stiller

And then lastly, I know, Brian, you alluded to some tax rate planning that you're doing. You're kind of expecting the tax rate to be flat this year. Just wondering when we could start to see some benefits from that and what are your kind of longer-term expectations for that?

Brian McKeon

We think over time, we can reduce structural tax rate 200 to 300 basis points and that will continue to benefit as we expand. We'll see those benefits as we continue to expand our international profits. So there's a number of factors that we build into the one year outlook. But over time, we do think we can drive additional efficiency there.

Robert Brennan

Well thank you all this morning for allowing us to explain our 2010 performance and the financial progress that we really made building on our strong track record. We look forward to reporting to you again in April and speaking about the progress that we're making here in 2011. Enjoy the rest of your today.

Operator

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

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