鐵山公司 (IRM) 2003 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Iron Mountain conference call.

At this time we placed all lines in a listen-only mode with a question and answer session to follow.

Should you require operator assistance while on this call, key star then 0 on your tone-dial phone and we'll be happy to assist you.

As a reminder this call is being recorded for replay.

Now I would like to turn the call over to your conference and Iron Mountain's Chairman and CEO, Richard Reese.

Thank you and good morning, everybody.

Welcome to our Q2 2003 investor conference call.

Today we'll follow our usual format.

I point you to www.ironmountain.com where you will find user control slides under the Investor Relations page.

As you know today's earnings call and slide presentation will contain a number of forward-looking statements most notably our outlook for the third quarter and full year 2003 financial performance.

All forward-looking statements are subject to risks and uncertainties.

Please refer to today's press release or slide number one of today's presentation which is available on our website, for a discussion of the major factors and risks that could cause actual results to differ from the forward-looking statements.

Today I review in general the individual businesses and talk a little bit about the Hayes acquisition and then I'm going to turn it to John who is going to go into depth on the details of the financial statements as well as a broad discussion of a growth and variety of other issues.

And we've got a lot of ground to cover today.

We'll go after that, obviously to question and answer.

I'm going to dispense with our normal commercial to leave some time to make sure we get all the questions in.

The business group as you saw from the press release at 10% and internal growth rate for storage revenues continue to trend up.

Our sales force production increased in the second quarter, but as you know revenues lack sales activity a bit.

I'll discuss this in more detail as I review each business.

Although we experienced slower and in some cases negative growth rate in some of our complementary services, the fundamentals of our business remain sound and the slower growth rate is generally related to customer's decisions to hold the line on discretionary spending, decisions that are beyond, in general, our control.

And most of these unfortunately with things they are not easy to see in advance.

We are learning particularly on the comp services side, as we've said before the revenues move around and they clearly moved around on us this quarter as we saw customers really trying to scramble and change their behavior a bit and hold back.

We will talk in more detail and John will give you even more detail, talk customers -- which in the long run is good news but in a short run is not -- reduce their destruction activity and certainly our terminations activity in emergence business.

So the service revenues we normally realized with boxes exiting, we didn't realize because the boxes didn't exit.

On the margin side, gross margins continued to improve ending the quarter at 54.9% versus 52.6% for the second quarter last year.

And EBITDA margins were a solid 28.6% in line with Q2 of last year.

As we previously stated, we do not expect to creep EBITDA margins significantly this year, as we're investing in new sales and sales support positions to support new services for the Enterprise account segment.

The business generated free cash flow before acquisitions and investments of $26 million for the first half of the year in line with our expectations.

And beyond the operating results, we completed two highly successful refinancing transactions and closed the acquisition of the Hayes IMS business which I'll speak about shortly.

Now let me run from going to the high level to talk a little bit about our major lines of business and I'll start with our North American RIMS or Records Management Services business.

That business continued to creep margin in their performance.

They grew margin 180 basis points over the first quarter this year.

Operationally they are humming and doing a good job.

The sales force continue to gain momentum as they achieve 99% of their quota for the quarter of new sales of new storage business and that is an increase where they were 73% for Q1.

And so on a year-to-date basis, they stand at 87%.

They are forecasting to be at 100% on a year-to-date basis by the end of Q3.

On the shredding product line, a new service line for them, the same sales force is at 96% quota on a year-to-date basis.

In fact, that also saw an increasing or rising trend from 79% in Q1 to 105% in Q2.

This is, I would remind you, the first year we have had that sales force sell this new service and frankly it is catching on and they are doing a bangup job there.

This operating division has also made significant progress and expansion of our secure shredding business line in the U.S.

Our strategy is to create a national service provider or footprint by a combination of acquisition and Greenfield start-up in the same markets we provide record storage services.

We reached our coverage goal last quarter and we are now focusing our efforts on penetrating these markets. would like to thank the operating division for the tremendous job they did.

They did more than two times the number of Greenfield start-ups than they planned to do over the last, oh, six to nine months.

They've really gone after this and done a great job of making that happen.

The records business unit experienced a slowing of growth, as I said, in the beginning of cartons destroyed as part of routine destruction programs.

It is believed that this is likely attributed to customers delaying the current pure charges that they would realize were destroying their records.

And in that case, their habit is to delay them because they would rather not take them this year and actually take the destruction charges later and just pay the storage which is a much lower number in the current period.

The other thing we experienced with customers, particularly our larger customers, is an interim policy decision to stop all destruction activity until they are certain they have a compliant records retention program.

All the issues I've spoken about before, things like Sarbanes-Oxley and so forth are getting people's attention, but their first reaction is stop.

Don't do anything.

We'll come back and deal with that later.

Let's make sure what we're doing is compliant.

And we're certainly seeing those kinds of edicts coming out of our customers.

Also we're reducing, or the division is reducing the amount of units leaving us due to terminations and permanent removals.

This is the successful result of our efforts, after we completed the system conversions post to Pierce merger to focus on better customer service.

And in fact, we've been doing that.

All of our statistics tell us that has taken hold both in terms of quality surveys and in terms of lost business.

And our reduction of people leaving us, which has never been a major problem in this business, but as you know a customer held is more valuable than a customer sold.

And we've worked real hard on that and I think have been successful on that.

But the result is on the current period is you don't achieve the permanent removal revenues on the service side, which has never been a goal of ours to do.

But those numbers are down significantly.

All of this contributed to lower growth to revenues associated with these services.

And to a modest increase in creep storage growth from existing customers.

We expect internal growth of storage to continue to trend up.

It may be the case that destruction services revenue will lag for a while as companies do come to grips with compliance issues, but they will eventually catch up and move toward.

We plan to work hard to keep terminations low so it will be our goal to get that revenue service line, It will never hit zero, but as low as possible.

We will keep working hard to not only keep it down but frankly reduce it, if we could.

Given the internal growth rate to date, as you'll see in our press release, and John will build up and show you more details later, we have lowered our forecast of internal growth for the entire year from 6 to 8%.

It is mathematically impossible given the performance of the first two quarters that we're going to hit our original target.

We're trying to be realistic and deal with what we're seeing in place out there in the marketplace.

Additionally, we have not been successfully at closing any significant large special projects in recent quarters.

While we had several of these working last year, this type of project revenue is lumpy and is difficult to forecast.

Our routine special projects, and those are the ones sold by our account managers on average day in and day out, frankly continues to keep on pace.

But these are relatively small transactions, but the kind of projects that will generate a half million to a million dollars per project.

We had a few of those working last year.

Some of those were just dropped on our lap by customers in certain events.

So far we haven't had that serendipity come to us this year.

That also contributed to slowing of the complementary services type of revenue.

The new Enterprise sales and service division, which is really part of this product segment of records management which we're creating to focus on our large Enterprise accounts and to sell new digital records management services, continue to make progress.

Revenues additional services are growing.

But revenue realization is not as fast as we had hoped.

Decision cycles on major proposals continue to be pushed out.

However, the pipeline for these services continues to build.

And the fact that pipeline for large opportunities is up about 30% over the quarter.

We still believe our sales force is on path to book their quota for Enterprise services by the end of the year.

But as we said last quarter, we were behind planning hiring these people, new people, but we did catch up as of now and our staffing levels are at target.

So as we told you last quarter, we spent a little less wrapping up this group and, frankly, we're behind in the time frame, not only wrapping them up, we didn't spend the money.

We've now caught up and are spending the money.

We're going through the training and building the pipeline and we are seeing revenue close.

But all in all, add those factors together and that is behind our annual plan right now.

Our offsite data protection business, that is our business that supports our customers in their disaster recovery program, continues really on pace in their core business.

The core storage and services business remains right on path.

They have been seeing and continue to see impact from customers reducing or better controlling their IP spending budgets.

Customers are focusing more on the disaster recovery program therefore rationalizing their programs, both to save money in the short run and improve coverage of their programs in the long term.

This division has been experiencing increased loss of customers related to business closers, particularly in the high tech area and customer data center consolidation.

These trends have been in place for a few quarters and have contributed to the general slower growth and core revenues that OSDP has experienced for the last few quarters.

This quarter saw no change in these trends and the core revenue remained in the line with past quarters.

Average sum of OSDPs complementary service lines did swing during the quarter.

Most significant was a reduction in actual dollars sold for data products by 16%.

And I stress that is a reduction.

That is going backwards 16%.

As you know for our business almost nothing ever goes backwards.

This is a case we're selling new products, primarily tapes, actually went backwards over the same quarter last year.

This result we believe was two factors.

First, the industry in general is down.

As we talked to our suppliers, they tell us that pricing, media products and units shipped are both down significantly, not just through us but through all of their channels.

Second, we refocused our selling efforts and our related compensation structure on this product line and we refocused it away from revenue and owned to margin.

We got exactly what we wanted to get.

We got results we sought where revenue went down 16% while margin dollars actually went up 3%.

So it hurts our internal growth but is actually better for our bottom line and we will continue to focus this group on margin in this particular product line because that's what it is all about.

In general, the OSDP sales force is performing well at 111 percent quota on a year-to-date basis for the physical services.

This year we restructured our sales force and hired new sales specialists for our electronic vaulting services.

At the beginning of the year, because we wanted to place more focus on selling this new product line, this change created some loss of momentum for the product line, but we appear to have recovered the momentum and the electronic vaulting services are picking up.

The division is ahead of plan on EBITDA and continues to manage well in a tight environment and we think we'll come in -- in fact, we think both will come in for their bottom line for the year.

Now let me turn to the international businesses.

All of them continue to perform at all fronts.

Revenue growth rates remain in the high teens and margins are expanding.

Our strategic position in all of our major international markets we operate in is strong.

Latin America is strengthening and Argentina is coming back.

Europe performed well for the quarter even though many of the teams are heavily involved in the analysis of the Hayes IMS transaction.

Even in addition to completing the Hayes transaction during the quarter, we also closed on a transaction in Ireland.

This transaction is currently being integrated into our existing Irish business.

Now let me turn and talk a little bit more specifically about the Hayes transaction just to give you a quick update.

We talked about it a few weeks ago in our conference call.

So let me turn and talk a bit.

First, as I said before and we've said over and over the Hayes transaction was not a must-have acquisition for us, but it is certainly nice to have.

That's exactly the way we feel.

The strategic fit is great.

It closed two weeks ago.

And so far not only are there no surprises, I can tell you, looking on the inside, we like it better from the inside than we did from the outside.

Two weeks in, the returns are good and we see more upside opportunity, we see more cost-saving opportunity and we see better margins in the future and we see even a more effectively lower price than we would have expected going in.

Now, I'm going to point you to slides that are at the end of your slide show and don't suggest given you are on the Internet that you fast forward through them because you'll be there for a week catching up at the speed of the Internet.

But I'll just talk you through them.

I apologize we put them at the back of the show by mistake.

There are two or three slides, two of which are maps, only just to show you what our European footprint was prior to the Hayes acquisition and the next one is, what is our footprint post to Hayes acquisition.

And what it will show you is, we entered two new geographic markets in Germany and, by the way, strengthened the two we were already in.

Two new geographic markets in the United Kingdom and totally completed all footprint work for the United Kingdom.

We entered Belgium -- is a new city.

We entered Norway as a new market.

We more than doubled our business in the Netherlands and we've been able to expand in a product line that we were relatively small and candidly, relatively weak in called Global Energy Services.

Hayes is the global leader in that space and we were the weak number two there.

That is a specialized records management business that surveys in major oil and gas exploration companies.

And in that case you store a significant amount of multimedia information related -- better known as geodata and you do a lot of database work relative to it.

And Hayes brings to us, not only significant market presence but brings to us brand new technology in an area where our technology in that particular market segment was extremely weak and this really does avoid us a strategic issue we had to deal with of either investing in serious technology for that market or getting out of the market.

And this solves the problem, we are integrating together into a global energy services business.

We're pretty excited about the opportunity, having talked to some of our biggest customers recently, we see some good opportunity there.

We've got work to do but good opportunity ahead.

The last slide I'll point to -- you can look at it later -- is just to give you a little set up trying to quantity the European market opportunity.

What we've done is given you market size data as part of the Hayes transaction.

We created both internally and externally with economists and consultants, tried to create data on major markets in UK and continental Europe just so we would have a sense and quantify what we had known from an inside view.

And the answer is, the entire market continental Europe is significant.

And in fact equal to a greater than what we believe the total U.S. market is today.

Our market share, the outsourced version in the U.K. is under 10%.

We're estimating about 9% today.

In continental Europe, less than 1% and now we have broad footprint, there are a few other places in continental Europe that we are not in and will continue working on getting in a few cities.

This really does slam the door in terms of solidifying our market position there.

And as I said earlier, it doubles our position in Europe.

Proforma for the Hayes deal, and before the Hayes deal, we were as an enterprise 90% North America and then after the Hayes deal, we are 82% North American.

North America just to remind you, in our mind, the way we do it is Canada and the U.S.

And so post to Hayes deal, or as we said today, our revenue mix is 82% North American, 17% Europe and the U.K., and 1% in Latin America.

As I said earlier, that 18%, the Europe, U.K. and Latin America businesses are all growing in the high teens.

The Hayes mix of business was more records management oriented than we were in Europe.

It was a 92% paper or records management based business and an 8% offsite data protection business where we were more like an 08/20 mix.

Proforma together we are at 87% rim business and a 13% offsite data protection business in Europe.

On an integration front, this looks a lot like the stories you've heard before.

As someone said, we've seen this movie a couple of times.

It will take about 24 months, soup to nuts, although big things will get done within the first 12 months and most of the big stuff will be out of the way in the first 12 months.

There are no new challenges so far we have not faced successfully so far.

We have a strong team in Europe in place chomping at the bit.

I have to tell you -- absent that team we would not have tried to take on this transaction.

I personally spent a lot of time with them before we -- every bit a penny in fact before we did any hard work on it, to make sure they were up for it and to a person they were ready to go.

And I think they are going to do a good job.

We're finding good talent in Hayes and we're going to integrate that talent together with our talent and I think we will come out of it a better company.

We will support the integration some from the U.S. on a technical basis from time to time but it is basically an integration driven by Europe and we're there to support them.

IC conversions of systems conversions typically take the longest time.

The majority of the revenue and work will be done in less than 12 months, but it will take 24 to get all that out of the way.

The organization design is in process and the high level done.

But we've got more details to get down to.

The major roles have been decided and most of them have been announced, but the integration of the two organizations, organizationally will be done in less than 60 days.

Accounting and support services will be moved and integrated within six months.

Customers have been contacted and we've had favorable early response from our large customers and programmed to go out and see all of our major customers and make sure they understand the technology we at Iron Mountain can bring to bear.

Unfortunately, Hayes did not have a strong technology base in their basic business.

Their technology base was strong in the oil and gas, but nothing else.

We want to get out to our customers to show them what we've got coming there.

And of course, we've already started the rebranding process and we're operating away from the Hayes brand into the Iron Mountain brand as fast as we can.

In all, we are pleased by the response of Hayes employees and its management.

They've been waiting for direction and a permanent home for someone who believes in their business and we provide that.

The general message for most of the managers, let's get on with it and get back to business.

We're happy to have a new home, just tell us who we work for.

Obviously, some of them want other opportunities and we're already able to accommodate that in many cases.

The acquisition closed in record time given the sales process and our teams on both sides of the Atlantic really did a great job of pulling the transaction which was a competitive auction and remind you not only competitive auction, one which we in parallel went through the Office of Fair Trade.

The teams did a great job not only in the transaction and the auction but the integration plan done at a rapid pace.

I'm proud of what they've done from a personal perspective.

This is a good sized transaction in which I certainly participated in but I didn't do as much work as I used to.

That's a greet feeling.

And I'm really proud of all the people and all the hard work they did.

And with that, my overview, I'm going to turn it to John to get through the numbers and so forth and then we'll come back and take your questions.

I thank you, Richard.

I guess we're going back to the top of the slide presentation on the assumption that some of you might not be able to view the slides in realtime.

I'll do my best to describe them fully.

However, some of them are reasonably complex.

The other thing I would mention is that I will try to refer to the slide title, but I may from time to time slip into talking about slide number.

And slide number is the number on the power point slide in the lower right-hand corner, not number of the navigator on your screen.

In any event, slide two is pretty self-explanatory.

It is an agenda.

My agenda is my usual format with an additional time allotted for more in depth discussion of revenue growth mixed in.

The next three slides beginning year-to-date financial highlights, slide number three, contain various P&L metrics.

Before I begin my detailed comments, I should say that our focus for clearance guidance remains operating income which is immune from some of the other income issues we'll discuss.

Operating income showed excellent margin expansion on a year-to-date basis.

There are three recurring nonoperational items which warrant some attention and which we'll point out to enhance the comparability of the results.

Rather than repeat myself throughout my commentary, let me address them in summary fashion right now.

There are no new items here.

These are things we've been dealing with.

And the first is that in 2003 we have $5 million of interest expense associated with our real estate term loans that was classified as rent expense in 2002.

This obviously has a positive impact on all metrics that exclude interest like year-to-date gross margins or operating income and EBITDA.

In all cases these are on a quarterly basis or year-to-date basis.

We're talking about an 80 basis point positive impact.

We don't want to take credit for that from an operating standpoint.

I want to point that out.

Second, we had transactions from time-to-time related to tangible property.

They resulted in this quarter in a $1.7 million loss.

Versus a $2 million gain in Q2 of 2002.

So this negatively impacts operating income and EBITDA in the quarter by 50 basis points.

And positively impacted operating income and EBITDA in Q2 and year-to-date 2002, the prior year, by 60 basis points and 30 basis points respectively.

On a year-to-date basis, we happen to have an identical gain for similar reasons in Q1.

So this line item gain or loss on asset disposition net to zero for the year.

Finally, there is a lot of action in the area of other income.

It relates to FX gains or losses and debt refinancing charges.

I'll remind you that last year that refinancing charges were treated as an extraordinary item and now they are another income.

So they are obviously above the net income line.

In any event, these are detailed in an upcoming slide, which is our reconciliation slide.

I'll touch on it briefly here.

The net -- the number of events in other income is $8 million this year to date and was $5 million last year.

For 2003 the positive impact on EBITDA was 130 basis points and 110 basis points for the quarter in six months ended June 30, 2003 respectively.

For 2002 the positive impact on EBITDA was the 190 basis points and 80 basis points for the quarter in six months respectively.

While these items impact the various P&L metrics about which we speak -- and I know they are complex -- they are not representative of our day-to-day business operations.

We'll try to talk you through them to see through what the business is doing.

Back to slide three.

Slide three, which is titled, year to date financial highlights, reviews, the financial highlights, revenue, as you can see, increased 10% to $711 million.

While gross profits increased 15% to $389 million.

To put it another way, gross profit margins increased 240 basis points. 160 of these points were due primarily to lower rent, improved labor management and reduced products cost of sales.

Meanwhile, SG&A grew a little faster than revenue at 12% as we implemented our previously announced plans to invest more heavily in sales and marketing during the year.

While D&A grew 18% for the first half of 2003, it is right in line with our guidance and reflects some increased depreciation related to recent capital spending in the IT arena which uses shorter life assets.

Operating income grew 18% primarily due to revenue growth and the improvements in gross profit.

Interest expense was basically flat to last year in absolute dollar terms before you add the additional interest that I mentioned before that was related to the real estate term loans.

Let's move to slide four.

It is titled quarterly financial results.

It is a comparison, obviously of revenue, operating income, EBITDA and net income.

So the second quarter of 2003 versus the same period in 2002, like year to date, total revenue grew 10% to $359.3 million.

Operating income and EBITDA margins as reported are flat year over year at 19.1% and 28.6% respectively.

But, again, the three previously noted items masked what was an operating income margin improvement of approximately 40 basis points.

Generally, EBITDA margins improved by 80 basis points before including these three items.

A common theme to runs to net income.

It would also appear to be flat at $20.1 million.

However, Q2 2002, a year earlier, enjoyed the benefit of 6.3 million of other income items, as well as a gain of $2 million on asset disposition.

Whereas this year Q2 '03 had a loss of 1.7 million on asset disposition and only reported other income of $4.7 million.

Slide five is entitled year-to-date financial results.

It is a year-to-date version of the previous slide.

Similar dynamics are at work here as we essentially post a very strong margin improvement for the year-to-date period.

Slide six provides net income and per share data.

We have already addressed the net income on a quarter over quarter basis.

And our EPS on a year-to-date basis has increased 10 cents.

Due to increased revenues and margin improvement.

Slide seven, which is called reconciliation of nonGAAP measure is that it reconciles operating income to EBITDA before extraordinary items and to net income as well.

The important thing to note here are the major components of other income and expense.

Including the foreign exchange effects resulting from the strengthening of the Canadian dollar and British pound and the early extinguishment of debt associated with our recent refinancing activities.

You may recall last quarter we were very clear to guide people to an April refinancing event that would give rise to a $14 million charge in other income and certainly it shows up -- it was more than overwhelmed by a $18.6 million positive event as foreign exchange rates went our way in a mark-to-market of the inner company debt yielded a other income.

Let's move now to slide eight.

Slide eight does begin our discussion of revenue.

And shows reported total revenue growth.

Broken down into storage and service.

For the last 2 1/2 years.

Now, reported revenue obviously includes the impact of acquisitions and foreign currency translation which internal growth calculus explicitly excludes.

So on a reported basis, what you can notice here is the business is growing over 10% despite a challenging economy and a very -- relatively very modest acquisition program over this time frame.

Note also if you would, that storage growth rates have increased over 2002.

And Q2 2003 is also the only period on the chart in which service growth lagged the growth rate of storage.

Moving to slide nine, you see the exact same information presented on the basis of same store or internal growth.

Now, internal growth for the quarter came in at 6.1%.

With storage revenue growing 8.4% internally.

Q2 represents the second sequential quarter of improved storage revenue growth, a trend we anticipated.

It is probably worth mentioning that storage represents 58% of total revenues and generates better than 80% of our gross profit dollars.

Service revenues were especially weak in the quarter, growing at only 2.9%.

A disappointing and somewhat surprising result.

Before I address the reasons behind this result, let me put some dimension on this issue for you.

It has been our recent experience that service revenue has grown about 5% from the first quarter into the second quarter.

So sequential growth, Q1, Q2 in the last couple of years has been around 5%.

This year, service was essentially flat from Q1 to Q2, particularly if you adjusted appropriately for foreign exchange.

Had the normal seasonal pattern held, Q2 service revenue would have been about $8 million higher.

Likewise, had service revenue grown a little over 500 basis points faster to be right in line with storage revenue growth, we would have seen a similar result.

So any which way we look at it, look at our experience and look at what happened, we see an $8 million gap.

Lets go to the next slide now.

It is slide number 10.

And it is called components of internal growth.

Now, obviously slide ten is a more detailed review of internal growth for 2003 by the quarters, this slide cuts revenue into core and complementary by parsing service revenue or nonstorage revenue into these components.

While core service growth is trending slightly behind storage growth, clearly the biggest issue in service growth in the quarter arises from complementary services.

Complementary services are more volatile as they arrive from service events that are inherently more discretionary or episodic and lumpy in their nature.

Now, we have seen quarterly complementary service growth rates ranging from this quarter's low of negative 3% to over 20% within the last six quarters.

So we've seen some of this volatility in the past.

Let's go to slide 11, and we'll drill right down into the kinds of transactions and service things that gave rise to the weakness.

Slide 11 is called component of service revenue growth.

It is 42% of the total.

I want to talk about each of the components.

Handling, transportation and complementary.

Each of these revenue sources are roughly equal sides, about $200 million each on an annual basis.

We have consistently referred to the combination of handling and transportation as core services.

They represent the charges arising from the day-to-day movement of records back and forth to our customers and other recurring programmatic events, including routine destructions.

Core revenues are directly tied to the storage relationship, and therefore, are relatively stable.

Even in this quarter, that day-to-day customer behavior, over which we have very little influence in the short term was generally stable.

For example, storage saw very normal growth in the quarter.

And the bulk of the service revenue, the client we saw was again in complementary services.

The shortfall we experienced in service revenue arose principally from lower levels of activity in three specific areas.

Particularly data product sales.

Destructions and permanent withdrawals of archived records.

And large special programs and projects.

Our data products sales revenue is down 16% a year-to-date versus 2002, and down 27% in the quarter.

And this accounts for $2 million of the $8 million shortfall.

It is our understanding that these results are generally in line with the industry's recent experience where shipments are down around 20% year to date.

We think we're riding a tech spending curve driven by the general economy there to some degree.

As Richard mentioned -- I won't belabor this -- it is interesting and encouraging to note that our OSDP division has been diving to improve the margins in this area and so our year-to-date gross margins in absolute terms are right in line with last year.

Despite the markedly lower revenue.

As regards special projects and programs, we have seen strong performance from our account managers and salespeople who sell a large number of projects of low average value.

These arise and are executed in a very short time frame.

We have however, experienced a [Inaudible] of the more episodic larger projects that we enjoyed last year and do not have good visibility to any such similar effects in the near term.

This area accounts for about $3 million of the $8 million shortfall.

The last issue regards archival records destructions and permanent withdrawals which includes customer termination.

And these issues also account for about $3 million of the $8 million shortfall.

In the quarter, revenue few from destruction of archived records that have reached the end of their useful or regulated lives was down 6% in absolute dollar terms from Q2 2002.

We have limited ability to influence customer behavior on this front in the short term.

And suspect certain organizations are putting on hold or scrutinizing more carefully this activity in light of impending regulatory changes and heightened awareness driven by high-profile corporate embarrassments around records issues.

Also in the quarter, revenue associated with records removal was down 18% versus Q2 2002.

There is an obvious related benefit to lower levels of these activities.

As they increase creep [ph] rate and if they persist over a longer time frame, will contribute to higher storage growth rates.

But I remind you that in general, the charges to destroy a carton or permanently withdraw a carton are equal to or greater to one year's storage revenue.

In the short term it is a bad trade on total revenue.

In the long term, it could be a momentum builder for storage.

Having taken these service revenue induced to year-to-date growth revenue -- as Richard mentioned, we're forced to take down our full internal growth target as I will discuss more fully in the upcoming guidance slide.

Slide 12 is called -- we will move to capital spending and investments.

As is normal, we organize our presentation into two major categories.

Capital used to drive the internal growth of the business.

And discretionary expenditures in real estate and our digital initiatives.

Capital spending for Q2 was $45 million for our core businesses.

And $11 million for our investments in digital initiatives and real estate.

These levels are right in line with our expectations and previous comments.

As to the full year, we reiterate our previous guidance overall and anticipate 2003 CAPEX will be in the same range at 2002 and that is $190 million to $250 million.

Please note that these projections do not fully incorporate the detailed capital needs of our recent Hayes IMS acquisition.

We've only owned it for two weeks.

As I mentioned in the call two weeks ago, we will have restructuring capex of about $15 million pounds or $25 million to be spent over two years.

We can't, at this moment with precision, predict how much will be spent in the next three months which will enter this year, we'll update you on that as it comes to be more clear.

Let's move to slide 13 entitled free cash flow.

It looks at the free cash flow year-to-date versus the same period last year.

The dynamics we have been discussing all along are clearly at work here.

And we generated meaningful positive free cash flow before acquisitions and investments.

That number was $26 million.

It actually just covered acquisitions for the period.

The important thing to note here, you'll recall in the first quarter, we had working capital as a significant use of cash.

And we mentioned that that was somewhat seasonal in nature and related to a lock box reengineering.

We said that would come back.

It has come back.

It is a slight source of cash.

As a result of that, and interest being more or less flat and EBITDA going up, our cash flow from operating activities on a year-to-date basis up 33% from last year.

Meanwhile, capital expenditures and customer acquisition costs were essentially flat resulting in a surge of free cash flow turning a negative $4 million around last year to a positive $26 million.

Slide 14.

Debt capitalization.

As many of you know we've been fairly active in the high yield markets this year.

Go back to December, we issued 7.75 bonds at par.

In April we sold more of those 7.75 bonds to raise about $312 million.

Those bonds were priced at a premium and reduced the yield to 7.07%.

At that point, those proceeds were used to redeem our 8.75 bonds.

And turn out approximately $75 million of floating rate debt under our revolver.

In June we issued $150 million of 6 and 5/8% senior subordinated notes through 2016.

And we issued those at par.

Proceeds of this issue were used to fund the Hayes transaction as well as to complete a partial call of $50 million of our 8 and 1/8 Canadian subsidiary senior notes and for other general corporate purposes.

Please note since the call on the Canadian notes didn't close until Q3 -- the tender closed on July 24, we will therefore incur a charge of about $6 million pretax to other expense related to the early extinguishment of this debt, so you will see that in the third quarter this year.

The columns on the slide depict our actual debt capitalization as of year end and quarter end.

And quarter end on a proforma basis giving effect to the Hayes transaction I discussed on the partial redemption of the Canadian note I also discussed.

One of the things to note is that we are basically free cash flow neutral even after acquisitions for the first six months.

And you can see net debt only moved about $20 million.

That's all related to financing activities, the expenses associated with issuing and calling notes.

So it is born out in the debt capitalization there.

After completing these financing in the Hayes transaction, our average cost of debt is approximately 7.65%, down 60 basis points from December, just 7 months ago.

We are approximately 80% fixed with respect to interest rates.

Let me close with guidance.

That's slide 15, 2003 guidance.

This depicts our latest guidance from the year.

We're increasing our revenue and operating income guidance to reflect the Hayes IMS acquisition which only closed two weeks ago.

We have embodied about a 45 to $50 million is our range for Hayes revenue.

For the rest of the year.

It's got margins in the 20- 22% area EBITDA margins that is and operating income of about 10% as we modeled it.

We are encouraged by the acceleration of storage growth but cautious regarding service.

There we anticipate therefore the total revenues of between $1.48 billion and $1.51 billion.

The impact of these changes on operating income are noted on the slide.

As I said earlier, our capital expenditure guidance hasn't changed.

And you can pretty much follow the hays impact offset by gain-and-loss on assets through all of these numbers.

And come to understand that nothing has changed on this page in any significant respect other than the internal growth guidance.

We're sitting here with a 7% internal growth for the first half of the year.

The second half of the year, please realize 60% of our revenue is storage.

And the growth rate on storage simply cannot move meaningfully in the near term.

We expect storage will come in with an internal growth rate of between 8 and 9% for the year.

And we're estimating services will come in between 3% and 7% yielding the 6 to 8%.

I should also mention with respect to the 2004 guidance, we plan to issue that at our annual investor day which is scheduled for November 20 in New York City.

I hope you all will be able to attend this important event.

Thank you I'll turn it back to Richard now.

Thank you, John.

I think we've talked quite a while.

We need to move now to questions-and-answers.

Operator, if you could please open up.

Certainly.

If you have a question, key star 1 on your tone-dial phone.

If you want to withdraw the question, key star two.

Again, star 1or questions.

Our first questions will come from Arnold Ursaner from CJS Securities.

Hi, good morning, John and Richard.

One quick question if you could -- actually two.

If you could be a little more specific on the impact of [Inaudible] on results this year, I know it's been a pretty good wind at your back.

The second question, the percentage of your boxes that normally are destroyed, what is that number and what did it run in Q2.

On the first point, had foreign exchange rates for the first six months of this year been identical to those that existed the first six months of last year, we would have $8.5 million less revenue.

So Canadian dollars really sored as have the pound and aided our reported U.S. dollar results.

The second question you had related to the units of cubic footage in storage that were destroyed.

Historically and then in the period.

Historically, about 4.5 percent of your cubic footage in storage is destroyed.

And the experience of the first six months of this year is a little bit under 4%, about 3.8%.

When you think about that, that's about a 70 basis point move on a 4.5% number.

That's very meaningful, about a 15% reduction in units destroyed.

And your margin typically on destroyed documents or destroyed boxes?

They carry very high margin, because they usually are large.

They are usually not onesy/twosy destructions, they are usually tens or hundreds of thousands of boxes.

So we do quite well on that work and we tend to charge full margin on the way out.

So I don't know specifically -- we don't track margins by specific --

I want to be careful on that answer, Arnie.

We make more margin on destruction and removal than we do on refile.

But it would be argued we make almost nothing on retrieval refile.

We don't make unusually high margins on the product line.

Okay.

Thank you very much.

And our next question will come from Harry Blount from Lehman Brothers.

Hi, guys, just a quick question.

I want to make sure I'm looking at things right here.

Just in terms of the Hayes acquisition, just in round numbers, it looks like that should add roughly $70 million, just a tad less, $60 to $70 million of revenue in the second half.

And given the guidance increase, it looks like you guys are basically assuming that the service slowdown is a negative drag of $25 to $30 million.

Am I doing that about right?

Your approach is reasonable.

But I think you're losing sight, Harry, of the fact that most of that revenue is in Europe.

And Europe has a different fiscal cycle than us.

Their year-end closes October 30.

You're only going to see four months of that.

You did mention that.

The 60, 70 is really like two thirds of that.

More like $45 million.

If you add the $45 million to our previous guidance, you'll see that we just -- we skooched down our base business -- our base business range a bit, you know, to reflect the weakness we saw in the first half.

Okay, great.

Thanks.

And our next question comes from Andrew Steinerman from Bear, Stearns & Company.

Hi, guys.

I'm going to focus on storage because I sort of agree that is sort of the anchor of this ship here.

And it is encouraging to see it move up for two quarters in a row.

We're looking at a level of 8.4 and last quarter was 8.2.

You gave a range of guidance of 8 to 9% which is suggesting that you're leaving open the possibility that storage doesn't accelerate from here, that it decelerates if you were at the low end.

What are you seeing out there in terms of your backlog, your sort of methodical acceleration here that makes you feel like it is still possible that we move backwards before moving forwards?

We expect to be in the top half of that range for the second half.

And that's based upon -- remember, the two things -- one I talked about and one I haven't yet.

But one -- I talked about the sales force performance and suggested by the end of Q3 the larger of the two in the records management business, which is where the boxes are, would be at 100% of quota.

We're pretty confident of that, because we talked before about the role, the so-called pipeline of built up demand.

That is moving in and it's moving very consistently.

And you can map it out and it will get us there is our belief.

Right.

These are known accounts.

But is there anything about the move in of the role that makes you feel like it's coming in but it is coming in slower than we would hope?

Once it started, some of it started slower.

If you remember going back, it started slower.

But once it starts, its generally in our control.

And you build up a program.

You're moving tractor trailers every day, day in and day out it moves on path.

So to summarize you feel like you moved from backlog to revenue and storage in the second quarter was healthy?

Yes.

And we got things started and we think they are going to continue rolling into Q3 and Q4.

That what gives us -- gives John the confidence.

Your question was, what gives us confidence so we won't be in the low end of that range?

Look, there is no guarantees in life.

I want to be very careful to say that.

You asked me a few years ago before I came to understand what comp services were, when the business was dominated totally by mostly storage type services, I would have said, you know, the whole thing can't move, but as you know in the last couple of years we've learned that we do have some service rides that customers can hold back on and they certainly do.

But on the storage side we feel pretty comfortable we're going to keep inching up unless some radical changes we don't see.

Thanks, Richard.

Yep.

And Franco Turrinelli from William Blair & Company has our next question.

Hey, John.

Hey, Richard.

Help me understand the margin impact of the more than expected services revenue.

Well, services revenue generally carries about 25% gross margins, but it is something that you can react to, because you can cut overtime, you can reduce your use of temporary staff.

And our field units are highly incentivized to meet absolute dollars of EBITDA target.

So they are out there with their incentive compensation on the line working harder than they thought they would have to.

But trying to bring the bottom line in for the year.

I also would note that, you know, a couple of -- in a couple of areas, in particular the product margin area we talked about in data products, that bottom line folded up in the face of weaker service.

Or weaker revenue, gross revenue.

I guess what I'm driving at, John, is that there seems to be nothing -- or what I think you are saying is there is nothing unusual about the margins in this quarter as a result of that $8 million quote shortfall in services revenue you discussed.

That's just good reaction by our field --

Well, I think people manage well against it.

Richard, can I ask you a couple of questions on the Hayes side.

I think you had indicated in early commentary that Hayes had not maybe invested as much in their sales force as you would have done.

Maybe you could give us an update on that.

And then these numbers that you show us for the market, is this total -- for the U.S. you've talked about vended vs. unvended, could you just kind of clarify those numbers.

The market is comparable to what we've been showing before.

It is total market opportunity, not vended or unvended.

I didn't put up our views of the vended or unvended which are in some places we got better views than others but it is substantially less than the U.S.

In certain cases, less than 5% is our sense to that.

In terms of number of salespeople, it roughly goes like this.

Sales and account management personnel, all of whom are customer facing.

Hayes had about 55 out of their employee base of roughly an equal amount of revenue to us.

And we had pre Hayes we had 89, so we had 144.

And a large number of that 55 had been on board less than 6 months.

Because they had ramped down, ramped up, ramped down as they would fill up and were not consistent in how they invested.

They would fill up cities and go out of the market a while and ramp up and down.

It will help us bring significant head count.

I will tell you we don't have enough salespeople in Europe given the opportunity.

And we are going about trying to work on that as we do this integration, too.

Thanks, Richard.

Yep.

And our next request will come from Chris Guteck from Morgan Stanley.

Thanks, good morning, gentlemen.

A couple follow-up questions.

John, I think that you mentioned the creep was up sequentially but I don't think that you qauntified that.

Do you have the actual number?

or the first half of this year, creep was at a rate that would annualize closer to 4 than the 3.5 area where it's been running.

Great.

And can you give us an update on the restructuring of the domestic sales force in terms of operation of the account managers and national sales team.

Where are we in that process?

It is a fluid, ongoing process.

We've done it.

And the account managers are performing as we said in terms of the routine project work.

They are actually doing what we asked them to do.

The Enterprise sales group, as I said earlier, we were behind in hiring.

But we're now up to staff now.

I was just talking to them this morning.

And I think they are pretty confident looking at their pipeline and looking at some of our product stuff, for the year, they will hit their targets from a book perspective.

I'm not sure if we realize all of that in the year.

And the sales force on both of our core North American businesses, the records management, as well as the offsite data protection business are as I gave the numbers earlier, Q1 they were behind quota.

OSDP is now ahead quota on the year-to-date basis.

And the records management business will be at, they believe, at or ahead of quarter for the third quarter.

So the momentum is going in the right direction.

We are continuing to look at some other areas.

I should say, though, I said earlier we made the statement we don't have enough salespeople in Europe.

Given the size of business we certainly don't.

We have a lot of work to do over there, which this Hayes gives us the opportunity and the scale to do to actually get better at marketing.

And one of the key themes you'll hear us talking about over the next year or two is where we're starting to really invest our money is in marketing.

This was a company that historically had sort of single-focused product line sales forces.

And now we're asking sales forces to cover multiple product lines like the storage sales force and the records management business is now covering the shredding business.

And they are doing a good job in it.

But they had to learn it.

We need to give them more support to make those learning curves faster and so forth.

And we see opportunities to slice and dice some of our new services across different sales forces.

Increase their book of portfolio and products to carry and so forth.

In order to do that, we feel like we built a good sales force.

In order to support it and do it right, we're going to invest more and build in marketing.

That's the key theme of what we are working on around here right now is how to do that.

And what money to spend where first and so forth.

Great.

A quick question in the digital business.

It sounds like the business is ramping up a bit slower than you were hoping.

I'm curious why you think that's the case and especially given some of the regulations from the SEC and elsewhere that would seem to create a compelling need to customers outsourcing services?

Do you think it is the regulations haven't really kicked in yet or do you see from the customer's perspective maybe some concern that maybe Iron Mountain's skill set in this area isn't quite what it needs to be?

What do you see the reason why the business is ramping up so slowly.

Well, I think a couple of reasons.

Primarily I would say these are big-ticket items.

These are part of policy decisions that take a lot of thinking and a lot of people's input in certain cases.

These are long decision cycles.

We're experiencing long decision cycles on the big-ticket items.

We're actually doing pretty well for small mid account stuff.

You just don't see their impact anytime soon.

You've got to build up hundreds, if not thousands for those to impact.

We see long decision cycles.

And we don't see that shortening.

And if anything, it is getting longer.

The regulations are kicking in, in that people are thinking about what to do.

If you break the market apart -- take email for instance, break it apart, you have a direct regulated email market that the SEC has regulated for broker dealers.

That market is strong and kicking in but still not everybody is doing it.

They are still trying to figure out the right way and most cost effective way and That market is attracting competition, obviously.

And we've seen every software company that does anything related to storage and data has jumped into the archive space.

So you see they have more choices to insource or outsource and we still believe a significant number will outsource but not everybody.

In the corporate email or the so-called enterprise email market where the regulations, at least in some people's minds are not as clear, people are taking time to make decisions.

And, frankly, what I see out there is the marketplace is looking for leadership.

They are looking to be in the middle of the pack.

One of the things we're doing working hard on is helping them understand where the boundaries are in terms of compliance, what are the right things to do and help define the pack and I think hopefully we'll be successful at doing that.

Having said that, I still see lots of opportunity out there.

As I said earlier, we're not realizing the revenue as fast as we would hope.

I don't know if our hopes were unrealistic or if we're not quite doing, you know, the job we should do.

I don't see a reluctance of people to buy from the Iron Mountain brand at all.

There are times in which in certain cases we lost bids because our pricing wasn't competitive enough.

And we're learning that and would adjust it if necessary.

And times which we've gotten bids because not only were we competitive but our technology was good.

But we've got some interesting products.

And I think we'll still get good results out of them.

Great.

Thank you Richard.

And Douglas Pratt from Wells Capital will have our next question.

Thank you.

Two quick questions.

One -- and I missed the early part of the call so maybe you went through this.

It looks like there was an adjustment to revenue last year of a couple of million dollars.

If that was the case and what was that?

There have been no retrospective adjustments to revenue.

It's $327.7 million was originally reported?

You might be referring to late last year a change in how we booked data product sales.

We had historically booked them on a net revenue basis.

We were essentially an agent and taking just a fee, not taking possession and having people drop ship around us.

Our product profile expanded and our method of selling changed.

And we went to gross revenue.

I see.

Which added $18 million for the year.

Probably about $4 or $5 million to each quarter actually.

No change to earnings, no change to cash flow, no change to anything really except margins.

Okay.

Thank you.

Also, what was bad debt expense for the quarter and also for last year's second quarter?

We've had great collection results -- is this for the quarter?

Our bad debt was about a half million in the quarter in '03.

And it was a little over $4 million in '02.

So do you think that $500,000, is it sustainable going forward, is it a good number for us to use on a quarterly basis?

Our bad debt expense historically has been about a half a percent of revenue.

Our DSO's are down meaningfully and we were very fully reserved as we went through our credit -- our collection centralization process last year.

And we're seeing the results of it.

Okay.

Great.

Thank you very much.

And Mr. Burn from Robert Baird has our next question.

Thank you for taking my call.

Question on the core records management business, I guess I just want to go back to the 8.4% internal growth.

If destructions had been more along the lines of a normalized rate, what would that number have approximated, and would it have met your internal expectations for the quarter?

The changes in the ending volume of boxes in a given period has very little impact on the realized revenue growth rates in those periods.

Let me put it to you this way.

If in a given quarter creep via any of its components, via any of its components changes a quarter or two, a half a point, within a period, you only see on an annual basis, you only see 1/8 of that effect in the period.

So it is di minimus.

It is very important for momentum over the long term, but certainly the trade-off between service revenue to send things out versus the tiny uptick in average number of boxes upon which you can apply storage charges is in the short term a very bad trade.

As a long term shareholder, you'd love to see a secular trend toward longer retentions and less terminations.

And we don't know if we're seeing that or not, but we're experiencing some of that in the present.

Okay.

And then I guess, on the core records business and then more broadly speaking saw -- my perspective, my question is, for the second half of the year for the core records business, do your targets remain the same?

Are they slightly better?

Slightly worse?

And then I believe I heard Richard, you say, you still believe this business can grow internally in the 9 to 11% region.

And this is a short-term phenomenon.

But knowing what you know now, you would would feel confident saying that again.

In the second half, we are not assuming the creep changes at all.

We're not assuming that our pricing actions change at all from your experience in the first half of the year.

We're simply assuming that our maturing sales force and the role they have set up in the beginning of the year materializes.

And we've got customer by customer expectations that are well thought out.

On the issue of what are the long term gross prospects, we've actually said that we thought our physical businesses would grow 10 to 12%.

I think we still believe they can grow 10 or better.

I'm not betting on 12 as I sit here today.

But I'm still willing to bet on 10 looking out 4 or 5 years and looking back.

Embedded in that is an assumption that the economy gets back on some more even keel.

My sense is, a little is happening, I think the whole U.S. economy is sort of restructured.

I think we're overcapacity in a lot of ways.

We just see a lot of our customers adjusting a lot of what they do and we're adjusting to that ourselves.

But let's assume that gets out of the way and we go back to a reasonable growing economy, I don't see why we can't grow ten or better.

And by the way, I'm still bullish that the whole company will grow greater than that.

I do believe that the new services, not only shredding but digital and others will kick in.

And I'm obviously bullish about international.

We just put a lot of money over there and we think that is going to kick in.

You look out five plus years it is going to be a major player to growth.

So I think we can continue growing our top line above 10%.

And obviously earnings and EBITDA will grow faster that that.

Thank you.

Yep.

And Jack Chung [ph] from Research Light will have your next question.

I was wondering if you could give priority in terms of your guidance for operating income and D&A?

Are you excluding basically any of the FX gains and also any of the charges from extinguishment of debt from your current guidelines?

Extinguishment of debt would hit other income and therefore touches none of the metrics we're guiding on.

The second point is that, at all points in time when we forecast this business, we're not economists, we assume forward FX rates are what they are at this moment in time.

And our operating income and D&A is simply our previous guidance adjusted for historical known events like gain and loss on assets, plus the contribution of the Hayes acquisition.

We never forecast acquisitions that haven't closed.

So it is FX neutral.

No unknown acquisitions.

And in all other respects is directly in line with our previous guidance.

Okay.

And just as a follow-up, in terms of the Q3 guidance, in terms of the operating income, that doesn't include $6 million of charges, right, that you were talking about from the extinguishment of debt?

No.

That's in other income that is below operating income.

The correct accounting for that type of charge is not in operating income.

The correct accounting is below the line.

Is in other income, which is lower on the P&L than operating income.

And just one last thing, just checking to make sure.

The minority interests in earning subsidiary is also below the line?

Yes.

Great.

Thanks.

And Maury Simpson [ph] from UBS will have our next question.

Yes, I was wondering, are all the facilities that you guys maintain are being carried on the balance sheet or financed off the balance sheet?

How is that being handled?

We directly own about a third of our real estate.

And we control the vast majority of our real estate through leasing terms or generally through terms in the lease to give us rights to purchase or right of first refusal.

I might suggest looking at the hour and I apologize we talked so long, but we can maybe take two more questions and then call it quits.

I know many of you will sit and listen to the replay don't want to sit and listen for an hour and a half.

So I really appreciate it.

So if there are more questions, I think there may be a couple more at least.

Why don't we take those and call it quits for the day.

And our next question will come from Nicholas Shareet [ph] from Sheckwig [ph] Capital Management.

I apologize if this question has already been asked.

Have you had additional discussions what meant more regarding your intentions on their equity interest in the Europe [Inaudible]?

No.

Actually we closed the transaction two weeks ago.

A variety of people went on vocation.

And we'll get back to some of that stuff in the near future.

Thanks.

Yep.

Are there any other questions, operator?

Yes, we have a follow-up question from Harry Blount from Lehman Brothers.

Okay.

Hi, guys.

Just one clarification, John, what were the cash taxes during the quarter?

Searching.

Hang on.

Okay.

$1.4 million.

Great.

Thank you very much.

Thank you, Harry.

And thank everybody for joining us today.

As we said, the company continues to grow and margins at the operating level are expanding.

We are continuing to invest this margin growth in many initiatives that will likely fuel increased growth in the intermediate term.

And as we discussed, some of these missions are ahead of plan and some are behind.

However, we remain convinced we're on the right path but there certainly is work to be done.

The Hayes IMS acquisition solidifies our competitive position in Europe and should prove to create significant value for our stakeholders and we remain excited about that.

I do want to remind all of you and invite you, any interested of you, to our investor day, our annual event we have this year is scheduled for Thursday, November 20 in New York City.

Details will be made available later this summer.

If you're interested, please mark it on your calendar.

We appreciate your continued support and we appreciate you're joining us.

We apologize for being a little long today but hope it was very helpful.

Thank you.