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Executives

Stephen P. Golden - Vice President of Investor Relations

C. Richard Reese - Executive Chairman, Chief Executive Officer and Chairman of Strategic Review Special Committee

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

Analysts

Gary E. Bisbee - Barclays Capital, Research Division

Andrew C. Steinerman - JP Morgan Chase & Co, Research Division

George K. Tong - Piper Jaffray Companies, Research Division

Thomas Allen - Morgan Stanley, Research Division

Kevin D. McVeigh - Macquarie Research

Andrew J. Wittmann - Robert W. Baird & Co. Incorporated, Research Division

Shlomo Rosenbaum - Stifel, Nicolaus & Co., Inc., Research Division

Nathan Brochmann - William Blair & Company L.L.C., Research Division

Iron Mountain (IRM) Q2 2012 Earnings Call July 26, 2012 8:30 AM ET

Operator

Good morning. My name is Lindsay, and I will be your conference operator today. At this time, I would like to welcome everyone to Iron Mountain's Second Quarter 2012 Earnings Conference Call. [Operator Instructions] Mr. Golden, you may begin your conference.

Stephen P. Golden

Thank you, and welcome, everyone, to our 2012 Second Quarter Earnings Conference Call. Joining me this morning are Richard Reese, our Chairman and CEO; and Brian McKeon, our CFO. After their prepared remarks, we'll open up the phones for Q&A. Per our custom, we have a user-controlled slide presentation at the Investor Relations page of our website at www.ironmountain.com.

Referring now to Slide 2. Today's earning call and slide presentation will contain a number of forward-looking statements, most notably our outlook for our 2012 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 EPS 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 reconciliation 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 Chairman and CEO, Richard Reese.

C. Richard Reese

Thank you, Stephen, and good morning, everybody. And welcome to our second quarter investor conference call. We had good operating results for the quarter. I'd characterize them frankly as good results in a slow world. I'll go through and give you some update on the trends and what's going on, and then -- and I'll have a few comments about the REIT process, which I'm sure you're all eager to wait to hear.

The headline is you're not going to hear everything you want to hear about their REIT, because it hasn't changed a lot, but we will at least give you some color and some update. And then Brian will go through the detailed numbers and, as usual, we'll take your questions. With a little luck, we will attempt to make this call shorter than average, because I think things are fairly clear and it's summertime.

So let's get started. As I've said, I think we're having good execution in the organization, and the businesses are performing well against our plans. We're doing not only on a tactical or an annual operating basis, but you should be comfortable that we're also advancing our long-term strategy to continue building out a very durable storage annuity business. So we're making progress on both fronts and finally trying to balance all those to deliver the short-term results while keeping an eye on the future. And I think the company and the team is doing a good job at that.

As I've said, we'll update you on the REIT process, where the only significant news, which we did announce in our press release, is that we have submitted formally our request to the IRS for a private letter ruling. And as you know that we are going to be relatively silent and absolutely not speak to any details on that while we let them do their work and so forth.

So let me talk a little bit about the operating results. Storage, which is the key driver and everything we focus on in our business, had good 6% constant dollar revenue growth, which was about 4% of that, 4 points out of 6 was internal growth and the balance from acquisitions. Service trends remain consistent within the past year or 2. There were some puts and takes, but constant dollar service growth was about flat excluding the impacts of the lower paper -- recycled paper prices. Recycled paper prices in the quarter were the major issue to us, with a 37% decline from last year, and it reduced reported service revenue growth by a negative 4% but also total revenue growth by 1.5 points.

North America, as we had planned and as we communicated, sustained good strong margins of 42% and adjusted OIBDA levels while posting 2% internal growth of storage. But total revenue growth in North America felt the brunt of recycled paper trends, hard to say, as North America accounts for about 85% of our total recycled paper volume. International had strong storage growth at 13% in constant dollars, which was 8% internal and the balance from acquisitions. They had some slight softness we experienced in International and service trends, which we suspect is part of the slowdown globally, particularly in the U.K. and in Europe and their economies. But those trends were only slight. And as I said, overall as a company, our service revenues were about flat.

Internal growth in International, particularly storage, trended up slightly due to the higher-than-average customer acquisition activity. This was just a good, strong quarter. And although the dynamics in International are strong, this will move around a bit. So we're not forecasting these numbers. You can't draw a line forward from these numbers. These are great numbers, but I don't predict they will reoccur over and over every quarter. You will see some come back to this level in the future, but it's going to move around just a bit.

In line with our operating strategy, during the -- and we've spoken before during the quarter, and we've announced most of these. But just to recap, we acquired records management businesses in Hungary as a fold-in to our existing business and Brazil to solidify our market leadership position, as we've previously announced. Both of these markets have strong outsourcing trends and are very consistent with our strategy to build market leadership in faster-growing emerging markets.

We also increased some ownership stakes in some joint ventures we had previously set up in Switzerland and Turkey, consistent with our long-standing joint venture strategy where we typically enter in new markets on an International basis sometimes with a less than 100% or even less than majority control. But as the businesses evolve and turn into real businesses, we seek to buy out partners or buy up, in effect, become over time to eventual ownership, and we executed a couple of those during the quarter.

International also continued to make significant progress against their benchmark target that we set 1.5 years ago to increase our margins by 700 basis points, and they generated 150 basis points of improvement during the quarter. They are on track for the full year growth of about 200 basis points, that's what their plan says, and they're on track for that. And looking forward to the end of the year, assuming they hit their plans, which we fully expect, since we announced this increase of 700 basis points, we will have reported and generated about 500 basis points or nearly 70% of the way towards our improvement target. And to remind you, we still have one more year to go to complete that target.

That margin came -- increasing came from sort of 3 big buckets. In Western Europe, sort of the International business, it was really about a lot of overhead initiatives, a lot of reengineering of cost structures and process, most of which are designed to improve our operating efficiency and effectiveness all at the same time. In Latin America, we've been focusing on our direct labor and utilization, what we call operational excellence. It's the same strategy we started in North America some years ago and then rolled it to Europe. Now we're rolling it into Latin America, and that's showing good margin enhancement, improvements. And of course, it's easier to get good margin when you got good growth. And the International businesses, as I said, have had good, strong growth. So it's a combination of those 3 that have generated that. Team's doing a good job. We expect them to continue doing that and to hit their margins.

We also saw some flow-through of some margin accretion efforts did in our corporate functions, because we started investing a little over a year ago, and some improvements where we wanted to improve our internal service to ourselves as well as reduce costs. And those investments had a price tag, both in terms of OpEx as well as capital, and they're starting to flow through. And we saw about 40 basis points of margin generated by the projects we started a little over a year ago. So I think we're in really good shape on the margin front, and frankly, given the markets we operate in and so forth, I think we're doing quite well on the revenue front right now.

A little bit of update on our strategy just to remind those that either forget or haven't been listening or new to the story, whichever the case may be, it is our goal to continue to build a very durable storage-based annuity business, as I've said in the beginning. In doing that, we have already optimized and have a very good return on investment, North American business segment, which we believe can grow in the low single-digits and maintain their margins. That is not as easy to do as it sounds. In low-growth environments, maintaining margins is very hard to do. But the team is focused on doing it and so forth. And it's a business that we will continue to invest in, and there -- around -- on the edge, there are ways of raising the growth rates a little bit. And we will keep focused on that, but it'll be a very measured kind of a process over a long period of time, because the strategy is not to build a super-high-growth business. The strategy is to maintain a really strong business there, and we're very comfortable we can do that.

Whereas International, our strategy has been over the last 18 months as we shifted the focus of the strategy away from a portfolio build-out market presence strategy to really a portfolio return strategy. And we have been driving returns on invested capital up to the point that the entire portfolio has returns in excess of a weighted average cost of capital. And when we complete the program and the margin improvement programs, these businesses as a total portfolio will be generating very strong returns. And I'll remind you that in that portfolio, some of them already have North American-like returns, quite a bit of them do. But we still have some business International that are in their [ph] early stages of development where the returns are either negative to very low. But they're faster-growing, and they will grow their way into better returns, and they will optimize their way into even better returns, as we've done all around the world. And we're on a good path to do that, and I think the team is focused on that and executing well. Part of that strategy is expanding in emerging markets through acquisitions as well as new customer acquisition work to capital leadership. We know that market leadership drives out-of-line or extraordinary returns of invested capital, and that is our goal for the entire business.

So as I said, we're executing on all levels of our operating strategy, and we feel very strong about our ability to continue to build out a very doable storage-driven business over time. Another element of that strategy, though, that relates to it that, as you know, in June, we announced is a new, focused capital allocation strategy. It is a strategy in which we've committed to return excess capital that this operating strategy will generate to our shareholders. And of course, as part of that capital allocation strategy, which is one that brings a lot of discipline, is using a tactic to pursue a new or alternative structure operating as a REIT. And you know, we've announced our intention to do that. As I've said, we believe that a REIT provides substantial benefits to our shareholders, first, for efficient capital distribution. But it also comes with a burden of extreme capital allocation discipline. And we think that, that burden is acceptable, both as a management team and as a shareholder, to take in return for the efficiency that we would get out of this structure and so forth.

So we're embarked on both a strong operating strategy to build a very sustainable long-term cash generation energy engine, by the way, one that we've been doing for a long period of time. We have reached the point, though, in which instead of consuming capital to build this business, we are in the very nice position of having significant excess capital. And as I've said, we've gone through the work to understand and believe that the right thing to do is distribute that capital to our shareholders, regardless of whether the tactics ultimately pan out to be a REIT or not. The strategy is one of disciplined capital allocation.

So let me talk a little bit about the REIT. As I've said as I started, a couple of things. This is not a subject that we're going to give you a lot on. To be frank with you, we don't have a lot to give you, more than we've already told you. We've been out on the road talking since we have made the announcement early June, and so for those -- and I would expect that most of you who got a chance to see us or hear us, there's not a lot that's changed . And frankly, what we also told you was as it did change, we're not going to give you blow-by-blow or play-by-play color on this, that and the other and so forth. If it turns out that the IRS approves us, obviously, we'll tell you. If they reject us, we'll, obviously, tell you. If we were to find a reason it couldn't work, we will, obviously, tell you. But we're going about trying to execute on becoming a REIT. We're taking a positive hypothesis approach, which means that we filed for approval from the IRS. While they do their thinking and their work and so forth, we're moving forward with a process to restructure our business to separate entities into the QRS/TRS structure and to have ourselves ready to be a REIT as of January 1, 2014. We've said it before and I'm going to reiterate, it's -- and the more we look, the more I'll have to say this is it's a lot of work. And as you know, we forecast $100 million to $150 million of work to get there. Obviously, we expect the payback to be worth it.

We've made significant progress. We've established a task force office headed by Jeff Lawrence. Jeff, as many of you know, is our Treasurer, but he's also been a long-term mountaineer and he has managed prior to this many of our major -- anytime we've had major change projects, such as Y2K and things like that, Jeff has been the go-to guy. He's got extraordinary skills and knowledge of the business, so he knows where every -- all the pieces and parts are. He's organized a team of over 25 full-time people, most of which came up -- we pulled out of other jobs and we're staffed behind them. We've almost completed that REIT staffing behind them, because we see that they're going to be this for a couple of years. We went and tried to pull people that are high-potential strong performers, and basically, making sure that they understand that this is a career-enhancing process. This is the project that you want to be part of, and I think we've chosen quite a bit of good talent to help us do that. That number of people would be augmented over time. I mean, quite frankly, to give you a picture of it, we've had to take another floor in our corporate office building just to house what we expect this workflow to be. And we'll get to be over time significantly more people, some part-time, some full-time. In addition to that, we have a group of outside advisors, primarily but not solely PWC [ph], on the actual technical conversion side because they have direct experience of doing this and direct experience, same team, same people of doing it for nontraditional REIT conversions, which is what we are and which is where the real complexity comes, okay? And IBM and other technology partners, but primarily IBM, is helping us over a lot of the systems work. They -- at the core of this transition is a lot of accounting and IT work and -- with a strong dose of legal and contract work. And it requires us to put in some new systems to get more granular detail on some of our details and systematize them and so forth. Net-net, all of this work we will do will make us a better business. And it would be hard work, but it -- plenty doable if we were doing it for one country, but we're going to do it across the majority of our big businesses around the globe. So I only stress all of that just to give you an appreciation of we're on it, we're not waiting. That is why we're spending money pretty fast. So far, the money that we put in the quarter was not that big. But stay tuned, those numbers will get bigger as we try to separate out and make sure you see the operating side of the business versus what we're spending to achieve this target.

So as I've said, I think we feel real good about where we are, both in terms of the process of the REIT, I feel real good about how the business is operating at this point in time. I wish the world were a little faster. I'm not used to this slow pace, it drives me batty. So with that, let's turn it to Brian. He'll go through the details, and we'll come back to take your questions.

Brian P. McKeon

Thanks, Richard. Turning to our presentation, Slide 3 highlights the key messages from today's review. We delivered solid performance in Q2, in line with our expectations, reflecting consistent business trends. Storage -- strong storage revenue growth and International performance again drove our overall results. We achieved 6% constant dollar storage revenue growth in the quarter, supported by internal growth that routed 4% and benefits from our recently completed acquisitions.

Storage gains continue to be solid globally despite soft economic conditions, demonstrating the durability of our business. International storage grew 13% constant dollar, augmenting the solid 3% constant dollar storage growth posted by the North American business.

We continue to expand our International business while driving higher returns, consistent with our 3-year strategic plan. Adjusted OIBDA margin in the International segment increased 150 basis points on 8% constant dollar revenue growth. Our International business is performing well, and we remain on track to achieve our International margin targets in 2013. Overall, our operating results remain solid and in line with our expectations.

Revenue and adjusted OIBDA grew 2% on a constant dollar basis. As noted in previous calls, sharp declines in recycled paper prices are constraining our operating gains this year. In Q2, lower year-on-year paper prices reduced revenues by $11 million. Excluding these impacts, adjusted OIBDA was up 7% on a comparable basis in Q2, reflecting continued storage gains and benefits from International margin expansion and overhead cost controls. On a reported basis, FX changes also constrained reported results. Excluding these macro factors, underlying business trends were consistent with prior quarters. Storage revenues continue to grow steadily, and hybrid service gains are offsetting soft core service activity levels.

We remain on track to achieve our full year financial goals, and we're reiterating our underlying revenue and adjusted OIBDA outlook for the full year 2012. We're maintaining a consistent outlook for constant dollar revenue growth while lowering our projections for reported results by $15 million at midpoint to reflect current FX rates. Our adjusted OIBDA, free cash flow and adjusted EPS ranges are unchanged from our previous outlook. These estimates reflect our underlying operations and exclude costs associated with the Special Committee and REIT conversion. We'll be tracking these costs separately as we work through the conversion process.

Let's now turn to Slide 4 and review our financial results in more detail. Slide 4 compares our operating results for this quarter to the second quarter of 2011. Please note that we'll be referring to our operating results throughout this presentation. Operating results exclude costs and other expenditures associated with the 2011 proxy contest, the Special Committee and REIT conversion costs.

In Q2 2012, we incurred $3 million of costs related to the Special Committee work compared to about $10 million of costs related to the proxy contest in Q2 of 2011. We're excluding these items, which are expected to be significant over the next several quarters, in order to better present the underlying performance of the business. The primary line items that will be impacted are adjusted OIBDA, adjusted EPS, CapEx and free cash flow. For your information, slides reconciling operating results to our reported results for key metrics are included in the appendix.

As noted, Q2 operating results were solid and in line with our expectations, reflecting consistent business trends. Enterprise revenue growth was 2% on a constant dollar basis, with reported results pressured by unfavorable foreign exchange rate changes. Overall, revenue performance reflected strong constant dollar storage growth -- revenue growth of 6%, which more than offset the impact of lower recycled paper revenues, which reduced total revenue growth by 1.5%.

From a segment perspective, North America posted constant currency revenue growth of minus 1% as consistent 2% storage internal growth was offset by a 6% decline in service revenues, including the impact of lower paper prices. Excluding paper price changes, North American service growth was down modestly.

Gains in project and data protection revenues and benefits from fuel surcharges offset decreased core service activity levels and lower revenues from shredding and fulfillment services. Our International segment posted 8% constant currency revenue growth, supported by 13% storage growth, reflecting sustained gains in Europe, continued double-digit growth in Latin America and Asia Pacific and benefits from our recently completed acquisition in Brazil. These gains were again augmented by strong hybrid service revenues, which offset impacts from lower paper prices, and lower revenues from product sales and shredding services.

Gross profit was $439 million in Q2, yielding a gross margin of 58.4%, down 110 basis points compared to the same prior-year period. Storage gross margins increased 100 basis points, reflecting lower occupancy costs. Service gross margins were down year-on-year due to decreased recycled paper revenues, the previously disclosed reclassification of certain overhead expenses to costs of sales and the growth of relatively lower-margin businesses, including our hybrid services. Adjusted OIBDA was $239 million or 31.8% of revenues, up 40 basis points compared to Q2 of 2011. Strong performance in our International business and the benefits from corporate overhead cost initiatives more than offset negative impacts from lower paper prices.

Adjusted EPS for the quarter was $0.36 per share, an increase of 9%. The improvement was primarily due to fewer shares outstanding following substantial share repurchases in 2011. Reported earnings per share of $0.24 includes $3 million of excluded items, $10 million of other expense and the impact of a higher effective tax rate due to foreign currency losses and discrete tax items. Our structural tax rate for the quarter was 40%.

Let's now take a closer look at our revenue growth on Slide 5. Slide 5 shows the components building to our overall revenue growth. Q2 and year-to-date growth is trending consistent with our full year expectations by a major service line. As noted, constant dollar growth was 2% in Q2, driven by strong storage gains.

Storage internal growth remained solid at 4%. North America reported consistent 2% internal storage growth, and International storage internal growth remains strong at 8%. Net global Records Management volume was up more than 1% on a year-on-year basis in Q2, reflecting continued strong gains in International, offsetting a modest year-on-year decline in North America. Pricing trends remain consistent, with a 2% net increase in North American Records Management.

Total service internal growth was minus 5% or down about 2% excluding impacts from commodity changes. These results were also consistent with underlying trends in recent quarters. Core service internal growth was minus 3% in the quarter as growth in the hybrid services and benefits from fuel surcharges offset lower shredding service revenues and moderate declines in activity-based core services. Complimentary service revenues representing about 11% of total revenues decreased 12% internally. Results were driven entirely by $11 million decline in recycled paper revenues, as expected. The impact in Q2 was greater than the impact in Q1 as 2012 paper prices have remained fairly stable against sharply rising prices in the first half of 2011. Assuming paper prices remain stable for the balance of the year, the gap should widen in third quarter before reversing itself in the last couple of months of the year.

Let's now take a look at our year-to-date results on Slide 6. Slide 6 looks at our year-to-date 2012 operating performance compared to the first half of 2011. Our year-to-date performance reflects consistent business trends. Reported revenue of $1.5 billion is up 1% on a constant dollar basis as continued solid storage gains offset impacts from lower recycled paper prices and soft core service activity. Lower paper prices and the SG&A reclass discussed earlier contributed to a modest decline in gross margins.

Despite these impacts, adjusted OIBDA grew 2% year-over-year on a constant dollar basis, slightly ahead of revenue growth. Strong International profit performance and corporate overhead cost initiatives are key factors in this improvement. We expect these factors to continue to support profit performance as we move forward.

Adjusted EPS was $0.67 per share, up 8% for the year-to-date. EPS benefited from about 15% fewer shares outstanding, more than offsetting higher interest costs incurred to support our $1.2 billion shareholder payout program that we completed earlier this year.

2012 capital spending is $76 million, excluding $11 million of acquired real estate. As a percentage of revenues, CapEx excluding real estate is 5.1%, in line with prior year levels. Capital expenditures historically increased in the second half of the year. We're currently on track to achieve our capital spending efficiency targets in 2012. Free cash flow for the first half of 2012 was $117 million compared to $149 million for the first half of 2011. The decrease is primarily due to higher interest expense in support of our shareholder payout program and higher cash incentive compensation payments related to 2011 performance. These results exclude year-to-date costs of $5 million in 2012 and $14 million in 2011 associated with the REIT conversion, Special Committee and prior year proxy costs. These year-to-date costs reduced 2012 reported EPS by $0.02 and free cash flow by about $3 million. Through the end of Q2, we've not made any capital expenditures or incremental tax payments related to the REIT conversion. We expect to make these types of payments in the second half of this year. I'll have more to say on this in the Outlook section of the presentation.

Let's now turn to Slide 7 to review our results by segment. Slide 7 shows key year-to-date metrics for each of our 3 key segments compared to the same period in 2011. Consistent with our 3-year plan, we're sustaining high returns in our North American segment while continuing to build momentum in our International segment as a significant driver of profit and cash flow gains. North America continues to deliver high profits and strong cash flows. In the first half of 2012, our North America business segment reported revenues of $1.1 billion, supported by consistent 2% storage revenue gains. Overall, North America growth was constrained by the impact of lower recycled paper prices. Despite these impacts, we sustained adjusted OIBDA margins of 42%. We also continued to achieve capital efficiencies, with spending at about 4% of revenues excluding real estate. These metrics support very strong cash generation from this business.

Our International segment continues to post solid constant dollar revenue growth and strong adjusted OIBDA and cash flow gains. As noted, adjusted OIBDA increased 15% excluding FX impacts, yielding 180 basis points of margin expansion. We're benefiting from cost improvement initiatives in Western European markets and strong profit performance in Latin America. Benefits from these initiatives and from continued solid growth across our International portfolio has us on track towards our business plan goals of 25% margins in 2013. Corporate expenses improved slightly compared with prior-year levels due to overhead cost control initiatives. Overall, we continue to drive solid operating performance across our portfolio.

Let's now take a look at our debt statistics on Slide 8. Strong consistent cash flow generation has enabled us to maintain a strong balance sheet. We're currently operating with a consolidated leverage ratio of 3.5x, comfortably within our target 3 to 4x leverage range. Our leverage ratio will likely increase over the next few quarters as we make expenditures in connection with the REIT conversion process.

We remain well positioned in terms of cash and financing capacity. At quarter end, liquidity was more than $600 million, with $170 million in cash and $455 million in additional borrowing capacity. Our debt portfolio at June 30, 2012 also remains long and fixed. Our weighted average interest rate was down to 6.6%, and we were nearly 80% fixed at quarter end. Maturity is about 6 years with no meaningful repayment obligations until 2014.

During the second quarter, we paid $43 million in regular quarterly dividends at a rate of $0.25 per share. In June, the board increased the dividend rate by 8% to $0.27 per share. We're managing our balance sheet and cash flows consistent with our strategy, and we're well positioned to fund our business plan.

That concludes our review of Q2 2012 results. Overall, we continue to drive solid financial performance, and we're on track to achieve our goals in 2012.

Let's now turn to Slide 9 to review our full year outlook. Slide 9 summarizes our current 2012 operating outlook. The chart also highlights our expected expenditures related to the ongoing REIT conversion process. Today, we're reiterating our constant dollar revenue growth guidance and our projections for adjusted OIBDA, adjusted EPS and free cash flow. We are lowering the midpoint of our revenue projections by $15 million to reflect current FX rates, which weakened relative to the U.S. dollar since our last call. We're projecting 2012 reported revenues to be in the range of $2,990,000,000 to $3,040,000,000 at current FX rates, reflecting consistent 2% to 4% constant dollar growth excluding the impact of lower paper prices. We're maintaining our outlook for adjusted OIBDA to be in the range of $890 million to $930 million on an operating basis. Adjusted EPS for 2012 is expected to be in the range of $1.20 to $1.36, unchanged for the prior outlook. The calculation of adjusted EPS assumes a 40% structural tax rate and 172 million shares outstanding.

We now expect capital expenditures for the year to be approximately $225 million, including an estimated $30 million for real estate. The increase reflects a real estate lease buyout opportunity we recently took advantage of in Ireland. Our outlook for operating free cash flow continues to be in the range of $320 million to $360 million.

As highlighted in a recent announcement of our intent to pursue conversion to a REIT, we anticipate significant one-time operating capital costs associated with the conversion. Total operating expense and capital costs are estimated to be between $100 million to $150 million, with the majority deployed over the next 2 to 3 years. These costs relate to substantial system investments, legal and tax work, advisory fees and other miscellaneous costs to implement the proposed structure. This effort is under way, and we'll be breaking out and reporting on estimated impacts as we advance the process.

For 2012, in addition to the operating expense expectations discussed above, we expect to incur between $10 million to $20 million of incremental expense, $10 million of CapEx and about $80 million in additional taxes related to the depreciation recapture in connection with the REIT conversion. The impact of these items will be a reduction in adjusted EPS of $0.03 to $0.07 and free cash flow of $95 million to $105 million.

The current full year outlook does not include any projected impact from potential 2012 distribution of earnings and profits in connection with the conversion. A slide laying out our outlook for line items below adjusted OIBDA is included in the appendix.

That concludes our review. In summary, Q2 was another quarter of solid financial performance, and we're on track to achieve our financial goals for 2012. We continue to execute against our 3-year plan, sustaining high profits and cash flow in North America and driving strong growth and higher returns in our International business. And we're also advancing working connection with the REIT conversion process as long -- as part of our long-term approach to drive value creation for our stockholders.

Thanks, and we'd now be happy to take your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Gary Bisbee with Barclays.

Gary E. Bisbee - Barclays Capital, Research Division

I guess the first question, just on Europe, your commentary on the International segment was positive. But how should we think about the impact of what seems like it's been pretty evident deterioration over the last few months in the economic activity across the continent?

C. Richard Reese

Well, as you know, in our business, on the way down, we tend to lag. On the way up, we tend to lag. And I think we probably are seeing that. Storage remains strong and -- even in Europe and International in general. And I think storage will hold up okay, if not do fine through this. Service, we saw softness. Just as we saw it come down in North America, we saw it in this quarter. It'll find a new good [ph] point when their economy settles and sort of stay there. Whether we've hit that yet or not, I don't know. But net-net, as I've said in my comments, we've had some puts and takes. We've had some strengths and other pieces and parts of things, so overall, our services are about flat if you take recycled paper out. So on a global basis, I think we're feeling all right. I mean, we're not projecting it going to rise, don't get me wrong. But I think we're feeling all right.

Gary E. Bisbee - Barclays Capital, Research Division

And -- but just on that lag comment, so could things likely get worse next year? And I guess, is there any risk to the margin target for International? Or do you think you've got a pretty conservative case built into how you're thinking about it?

C. Richard Reese

Well, I don't think we have a conservative case. But I think we can deliver it, yes.

Brian P. McKeon

The margin improvement is really driven by things in our control...

C. Richard Reese

Yes, it's mostly stuff we can control.

Gary E. Bisbee - Barclays Capital, Research Division

Okay. And then just any update on how you're thinking about the succession plan for the CEO role?

C. Richard Reese

Yes, I'm trying to get out. No, look, we're -- it's a very methodical process. And we -- and look, the board is working quite hard and being pretty methodical about it. But look, the truth is I'm not putting the feet to the fire. I started down this path to help the company get a line around a strategy, which I think we've done really well, the business has. And part of that strategy was the capital allocation strategy. As I've said, we've done our year of homework, and we've come out the other end with a direction, and now we go about executing. I'm not running from the completion of that. So it's a matter of finding the right person when we find him at the right time, and until we do, I'll stay here and try to help the team get this stuff across the goal line.

Gary E. Bisbee - Barclays Capital, Research Division

Great. And then just one cleanup one. Can you give us a sense how much you spent on all these acquisitions in the quarter? And was the revenue contribution material, or were they all pretty small deals?

Brian P. McKeon

It's roughly $90 million in the quarter -- I'm sorry, $98 million. The bulk of that was Brazil and the Swiss buyout. This year, we won't see a lot of profit flow through just because the integration cost in Brazil will offset some of the benefit. But it'll be nicely accretive for us as we head into 2013.

C. Richard Reese

And by the way, the -- not always, but the nature of the kinds of acquisitions we would likely do international will be the kind of things where you buy now and it will take you 12-plus months to really see the synergy, because we're not typically buying new footprint. There will be some rare exceptions to that statement. But we already did the heavy lifting of putting the footprint in place. Now we're really try to buy major fold-in, tuck-in. And the big fold-in, tuck-ins take a little time to do right and continue growing fast and maintain and so forth. So we're taking our time on those.

Operator

Your next question comes from the line of Andrew Steinerman with JPMorgan.

Andrew C. Steinerman - JP Morgan Chase & Co, Research Division

It's Andrew. I want to ask a question about the slide that goes through global volume trends. I would have thought, given the storage growth being at 4%, kind of a nice, accelerated level that we haven't been at for a while, that chart that you have in the slide decks would also show acceleration. Could you go through the differences between what that slide is trying to portray and how it ties back to storage internal growth?

Brian P. McKeon

And so the slide actually is a -- it takes quarterly performance and annualizes it, Andrew. And so it's because we're trying to break it out across these key metrics that we found that that's the easiest way to show it. And that compares to when we talk about that growth, we're talking about year-over-year volume. So it's slightly different. I think the key theme here is more consistency than change in terms of the trends. If you look at the storage growth in the quarter, it rounded to 4%. It was a little -- it was 3.5%, actually. And we've been in that 3% range for the last -- since, I think it's 7, 8 quarters now. Some of the benefit was -- improvement was related to customer acquisition activity in International, just in terms of, as you know, kind of the old [indiscernible] terminology that we use when we acquire customers from other businesses, customer relationships we had, some of that flow-through from a timing of...

C. Richard Reese

And, Andrew, I think you sort of said it's just a good, strong quarter, how do we portraying? Look, we're positive about the business in the economy we operate in. It's a crappy world out there, okay? But we're not suggesting -- in fact, I am cautioning, that you don't take a strong storage quarter and try to project it forward that we're going to stay at these levels. I don't believe we will. I think we'll move up and down. We'll see this level again, I'm not saying that, okay? But it might not be next quarter or the quarter after. I think we're going to be hovering around the 3%, 3-ish range, give or take, 3.5%, 2.75%, hovering around there. And they round the different numbers, as you know. We'll be hovering around those ranges. And I think we can do that very well and so forth, but we're not talking about major acceleration here.

Operator

Your next question comes from the line of George Tong with Piper Jaffray.

George K. Tong - Piper Jaffray Companies, Research Division

I just want to get some color on your acquisitions in Hungary, Switzerland and Turkey. How did the acquisitions position you from a market share perspective, and when can you expect to achieve market leadership in those countries?

C. Richard Reese

In Hungary, it was a nice bolt-in and we already had market leadership there. It was just good economics. Switzerland, we've got leadership in everything except Geneva. And Turkey, we are a strong #2.

George K. Tong - Piper Jaffray Companies, Research Division

Got it, that's very helpful. And could you give us a sense of how -- just globally, how activity-based core services performed and how much hybrid services contributed to growth?

C. Richard Reese

[indiscernible] while I look [ph].

Brian P. McKeon

Yes, I was thinking -- hybrid services were a -- were up solidly on a global basis. It wasn't -- it was probably a point or so of contribution net to our overall service growth. And that helped to moderate the -- basically helped to offset the continued moderate decline we've seen in service levels in places like the U.S. And, as Richard noted, I think the International...

C. Richard Reese

Some acceleration in the International.

Brian P. McKeon

International was not -- International had been growing quite well, and we saw that moderate somewhat. So that could be a leading indicator.

C. Richard Reese

And as you know, we fully expect that our hybrid business, as it gets bigger and it's still growing well, will overcome other declines in the physical business. I'm not calling that turn yet, but this quarter, that pretty much happened. But again, I wouldn't say it's for sure it's going to happen next quarter or the one after. Still a little early to tell that we're drawing the lines yet, guys.

George K. Tong - Piper Jaffray Companies, Research Division

And then last question. You touched on this earlier but could you give us a sense of how the volatility in Europe is impacting core and complementary services? I know you're on track to achieving the margin expectations, but do you see any negative impact and deceleration in growth due to that?

Brian P. McKeon

We haven't for the last -- in terms of our business overall, I think it's held out very well. And I think the team [ph] feels good about the ability to sustain that. We are highlighting at the margin, we're seeing some deceleration level of growth in the service activity. But I would say the theme is more that we're holding up quite well. And I think we're going to plan the business prudently and make sure we're managing appropriately in an environment that could get softer for us. But I think it's more -- at this stage, more at the margin and something that we're keeping an eye on.

C. Richard Reese

Yes, and look, I'd tell you, sort of the key theme if you look at our total growth and so forth is our Shredding businesses, although they're growing on units and everything else, we see some price compression. So a good part of that. It used to be -- it still is a very aggressive price market. Although, in general, at the Street, that has modified itself a bit as paper prices have come down, which is what you'd expect. We are still rolling off some rather large multi-year agreements that were priced in a different market environment, and as they roll off, they get repriced. We'll -- that will run off, but the tail of that's coming, and it'll run off and so forth. But our -- but the Shredding business between that dynamic and the -- and, of course, the paper prices themselves is as much a drag on total revenue as anything, so forth.

Operator

Your next question comes from the line of Thomas Allen with Morgan Stanley.

Thomas Allen - Morgan Stanley, Research Division

Following up on your comments on paper prices. We've heard that expectation in the market is that prices should actually gradually improve over the course of the year. Are you hearing the same, and any additional color there?

C. Richard Reese

We've heard conflicting data. Some people say they believe at the demand level, it's strengthening, at the front-line demand level, it's strengthening. That would naturally lead to some increase, and others say not. So we don't have an opinion on that right now. But look, North America may strengthen while Europe doesn't. Some of this will be about where China goes, because a lot of this recycled paper winds up in China. And their economy -- you guys know better than I do the changes going on over there. So I think it's a little early to make a call.

Brian P. McKeon

There's a bit of seasonality in the business where the pricing goes down a bit in the back half of the year normally. We've seen sort of modest improvement on the sorted office paper rate. So we'll -- it's gotten relatively better, but this does get tied into the overall demand situation. So right now, we're -- the numbers that we're using basically reflect the debt that [indiscernible] will sustain.

Thomas Allen - Morgan Stanley, Research Division

Okay. And then on your global records management slide, it looks like you had the lowest level of destructions in the past 10 quarters. Anything going on there?

Brian P. McKeon

We did see -- it's a little different geographically. But actually, in Europe, we've seen a decline in some of the destruction levels. These things tend to move around a fair bit where you have some larger destructions that people may be planning, and you work through them. And so there is some volatility in that, but we've seen some contraction there that's helping...

C. Richard Reese

And by the way, the Europe destruction pattern is behaving the way the business historically always behaved except for the 2007, '08 financial crisis period, which is in slowdowns, people delay destructions because they're protecting their current year budget. So as the storage pickup -- storage charge, rental pickup for destroying the item is not as large as the -- in the current period, as large as the destruction fee, and they try to protect their budget. And I suspect that's what we're seeing there now.

Thomas Allen - Morgan Stanley, Research Division

That's helpful. And then if I could fit one more in. You bought the controlling interests in your Turkish and Swiss JVs this quarter. Were the acquisitions related to the REIT conversion at all? I mean, are you going to maybe accelerate kind of converting JVs into company-owned quicker because of the REIT conversion?

C. Richard Reese

No, no. The JVs themselves, by and large, the ones we have right now are in kind of the emerging markets, strong, extreme emerging market front. And -- which means they would be late in our cycle of REIT conversion, as in not this year or next or the year after. Over due course of time, we would want to deal with those sort of things. But we're not going to be pushed into doing that.

Brian P. McKeon

We're starting with what makes sense from a strategic point of view, a value-creation point of view, and then we'll factor in how to think about the REIT more as the tail on that kind of consideration. So these are good, strategic investments that we'd be doing regardless of the path we're pursuing as a company.

Operator

Your next question comes from the line of Kevin McVeigh with Macquarie.

Kevin D. McVeigh - Macquarie Research

Brian, can you remind us, on the core services side, just round numbers, what percentage is kind of related to the destruction and other type services just to kind of get a sense of the contributions to that revenue line item?

Brian P. McKeon

It's a smaller part, so I'm going to find it. But 5% we're seeing. So it's -- we have a long list of services that we provide there in core services, the bigger items are things like transportation activity. But destruction services contribute to that. Overall, the core services are a little north of 30% of total revenues.

Kevin D. McVeigh - Macquarie Research

Got it. And then in terms of timing on the distribution of the equity, is that something, Richard, we can talk about now? Or just any sense of -- I know the IRS is in the process of the private letter ruling. But just any sense of timing around when we can expect any update on that?

C. Richard Reese

Well, our view hasn't changed from what we've said in early June. And that view is that we would strongly consider, but we haven't 100% committed to, but strongly consider doing a major E&P purge sometime during this year. I think you would expect it towards the back end of the year. And there's a lot of mechanics to actually making that work since it would be a combination of cash and stock. But we're moving forward on that front as all others. That decision in itself does not depend upon the, necessarily, the private letter ruling, in fact.

Kevin D. McVeigh - Macquarie Research

Understood, that's helpful. And then are we going to have an Investor Day this year? Is that back on, or...

C. Richard Reese

Yes, we are -- we had hoped to have the precise date. We don't yet. We're nailing down the venue and we -- but we will have an Investor Day in October in New York City. And within a couple of days, we expect to have out the invitation with the exact date and time and so forth.

Operator

Your next question comes from the line of Andrew Wittmann with Robert W. Baird.

Andrew J. Wittmann - Robert W. Baird & Co. Incorporated, Research Division

First, I wanted to start off with a couple of technical questions. Just Brian, on the $10 million to $20 million of cost that you're experiencing this year, did you say that, that was outside of the $100 million to $150 million that you previously talked about in the June conference call?

Brian P. McKeon

Sorry if we confused on that. No, it's a subset of that, so it's within the $100 million, $150 million. We expect to incur $10 million to $20 million of OpEx this year and about $10 million of capital. The $100 million to $150 million is both the OpEx and capital. I think our estimates were -- was like 60% capital, which is largely the systems, and 40% OpEx. But we'll be breaking this out for you as we go, and actually, we'll start adding some tracking relative to the overall estimates for you as well so it's very clear how we're...

C. Richard Reese

And it will -- and that will get spread beyond January 1, 2014, because there's -- it's a strategy to get ourselves to the point where we can legally convert and operate. But it won't be as pretty as it likely -- we'd like it to be by that date, and we will continue working beyond that. So those expenses will flow on beyond that.

Andrew J. Wittmann - Robert W. Baird & Co. Incorporated, Research Division

That makes sense. Just in terms of that process, now that the team has been kind of assembled and started off on this path, Richard, just kind of curious. I mean, obviously, very complex. Can you just give us any positive or negative surprises that may have arisen that couldn't -- that could help or hinder your ability to hit that January 2014 date?

C. Richard Reese

No, I don't -- look, I -- we've gone to the detailed planning. I think we have 20-odd work streams all running in parallel. We've got program managers, project managers. We've really gotten it organized as just as a massive kind of project. But look, the tall pole on the tent, so to speak, is in the systems arena. And it's primarily in the arena of -- we actually have to change our charter of accounts for our entire accounting system and, in many ways, update some technology and/or convert technology, particularly some of the global platforms. And some of that, we made two-step because it's too much risk to do one-step. And when you're doing that much technology change, to be candid with you, our goal is to have all those systems operating mid-next year to give us 6 months of working out the kinks and making sure nothing happens. And our head -- our Chief Information Officer is sweating a lot right now. He and his team are doing good work, and they'll get it done. And so, no, we're not -- this is not something that I lay awake at night worrying about. But then again, I don't do this kind of execution. Brian does it, and his team and Jeff and [indiscernible], those guys do it. And they're sweating a bit and complaining to me not go off and do anything else, but that's not my nature either.

Brian P. McKeon

To your question, no surprises. We thought it was a lot of work, and that's turning out to be true. And we'll -- we've got a really good team working on it and committed to getting this done.

Andrew J. Wittmann - Robert W. Baird & Co. Incorporated, Research Division

Okay. And the -- just thinking about the capital base and some of the capital needs that you have this year, Richard, can you kind of just update our thinking? It sounds like you mentioned the $600 million of liquidity that you have today. That would be, I guess, all of your cash and all of your credit facility. Can you talk about kind of what you're seeing out in the market to maybe fund any hole that you might have in the capital base to do the E&P in some of these other investments?

Brian P. McKeon

What I -- we have discussed it's likely we're going to go to the market at some point to help fund that, and we'll update you as we move forward on that. But we will likely want to put some more kind of financing in place...

C. Richard Reese

Yes, and our sense is the market environment is quite good right now.

Andrew J. Wittmann - Robert W. Baird & Co. Incorporated, Research Division

When you -- you mentioned in your comments here that your guidance does not impact any -- or does not reflect any impact of the E&P distribution. Is that really the financing terms of that E&P distribution? Is there any other impact that it would have to your P&L, or is it the cost?

Brian P. McKeon

It would include the -- obviously, there is a cash outflow. But keep in mind, too, if we did a majority of our E&P distribution this year, which is -- which has been our plan that we signal. There would be a number of shares that are issued, right, that go along with it. So we...

C. Richard Reese

Per-share metrics would change, your interest cost would change and so forth.

Brian P. McKeon

It effectively works like a stock split. But we haven't plugged any of that into the outlook, and we'll obviously get you more details as we firm up plans there.

Operator

Your next question comes from the line of Shlomo Rosenbaum with Stifel Nicolas.

Shlomo Rosenbaum - Stifel, Nicolaus & Co., Inc., Research Division

Just to piggyback a little bit on the last line of questioning. Just to be clear, you're thinking of funding -- you're going to fund the gap with debt, not equity, right?

C. Richard Reese

Yes, that would be our current intention, recognizing that we're going to do, likely, 80% of it in issuance of the stock, yes.

Shlomo Rosenbaum - Stifel, Nicolaus & Co., Inc., Research Division

The question is in order to get into the REIT structure, the whole that you have in terms of the capital, that's going to require you to raise capital. You're planning to do that with a debt offering or more bank debt, but it is not going back to the markets for an equity offer.

C. Richard Reese

Correct. We don't need equity. We don't need equity. And I'm never going to say we won't go to the markets for equity. You tell me the price, and I'll tell you if we'll go. But as we sit here today, we don't perceive going to the markets. It's not in my -- our thinking at the moment for equity. I would tell you, though, just to be clear, just to close out that subject for you a little bit. As we do M&A, we may use some equity and transactions to the extent that the deals are highly accretive to our shareholders, okay? We might do something like that. But that's not going to be major, it's not going to be big numbers.

Brian P. McKeon

Yes. And as we talked in our announcement, over time, we think it will make sense to operate at lower level -- leverage levels. And so equity may be part of our future plans, but it's not a requirement for us to get into the structure. We're well positioned to get to -- to fund that conversion.

Operator

Your last question comes from the line of Nate Brochmann with William Blair & Company.

Nathan Brochmann - William Blair & Company L.L.C., Research Division

I mean, one of the things, obviously -- I mean, I know the economy hasn't been helpful in this in terms of the service revenues always consistently being a pain in your side every quarter. Is there any light at the end of the tunnel in terms of what turns that around or in terms of just finally reaching such easy comps that it doesn't get any worse?

C. Richard Reese

Well, I think we're seeing that's an area of North America. And the decline rates are slowing, okay? And it'll drift in the right space there. And it's hard to know what -- where Europe is going, I mean, quite candidly. But Europe does not -- we don't have quite the risk profile in Europe. Our business there is much less active in the physical side, because we don't have a big medical business. And still the #1 driver of that decline is a health care trend. It's not the economy. The economy is the second driver of that decline. And which is, primarily in North America, an issue totally. So the fact that we don't have the big driver in healthcare will mean it's not going to impact us that much. It's likely be on the margin kind of stuff.

Nathan Brochmann - William Blair & Company L.L.C., Research Division

Okay, that's helpful. And then just one quick question, too, in -- part of the margin improvement in North America, you've mentioned in the press release the lower occupancy cost. Is that because you're already starting to consolidate some facilities there? Or is it just lower lease cost and lower property values, et cetera?

Brian P. McKeon

We're always working to optimize the utilization our network. We have improved that a bit. And I think that's reflective of the work that we're doing on that front, as well as utility cost. I think we're down a bit as well in the quarter. But it does reflect the work that we're doing to optimize the real estate.

C. Richard Reese

So thank you very much for giving us this hour. We appreciate your support and so forth. As we did mention earlier, we will be out. There's 1 more -- 1 or 2 more conferences we'll be at. We'll be at the Barclays Conference in a few weeks in New York. Next week, they're telling me. I got to look at my calendar more carefully, I guess. But we are driving towards an Investor Day in October, and we'll be out shortly with a precise date and location, so hopefully you can put it in your calendar. We would expect at that Investor Day to talk quite a bit about what we see forward, finishing out our 3-year plan. I think we've started about 18 months ago making sure you see that we're on track there. We'll expect to be talking a little bit about how we're going to build a more durable business. Hopefully, give you -- likely give you some access to some of the key managers that are doing it. And then, of course, we will be talking not about the REIT process, because we'll be in the middle of it. We won't know anything, and if we did, we wouldn't tell you anyway. We will be talking about, though, what Iron Mountain might look like as a REIT a bit more than we have and so forth. So I think you'll hopefully find that a useful time to come and spend a morning or so with us.

Again, thank you, and we hope you will all have a good summer. And we'll see you later.

Operator

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

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