鐵山公司 (IRM) 2004 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to your third quarter 2004 Iron Mountain earnings conference call.

My name is Brian, and I will be your coordinator for today's call.

At this time all participants are in a listen-only mode, and we will be facilitating a question and answer session towards the end of today's conference.

If at any time during the call you require assistance please press star followed by 0, and a coordinator will be happy to assist you.

I would like to remind you that this call is being recorded for replay purposes.

And I would now like to turn the presentation over to your host for today's call, Mr. Stephen Golden, Director of Investor Relations.

Please proceed, sir.

Thank you.

Welcome, everyone, to our third quarter 2004 earnings conference call.

Today's call will follow our regular pattern.

After I have completed some announcements John will discuss the Q3 financial results, he'll then turn the call over to Richard for some state-of-the-Company remarks, and we will take Q&A before brief closing remarks.

Before we get started, I would like to remind everyone that our annual investor day will be held on Thursday, November 18 at the Waldorf-Astoria in New York City.

If you have not registered for this event, you may want to do so through the investor relations page of our website at www.ironmountain.com.

As is our customs on these earnings calls, we have a user controlled slide presentation, also on the investor relations page of our website.

Please turn now to slide 2.

Today's earnings call and slide presentation will contain a number of forward-looking statements, most notably our outlook for the fourth quarter and full year 2004 financial performance.

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

Please refer to today's press release or the Safe Harbor language on this slide 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, operating income before D&A, or OIBDA, is a metric we speak to frequently, and one we believe to be important in evaluating our overall financial performance.

We are now providing additional information and the reconciliation of this non-GAAP measure, the appropriate GAAP measures as required by Reg G at the investor relations page on our website, as well as in today's press release.

With that, I'd like to introduce John Kenny, our CFO, for the financial review portion of today's call.

Thank you, Stephen, and before I begin, I think it would be remiss of me not to extend my not-so-sincere condolences to Stephen and the other Yankee fans that happen to be on the call.

That will be the extent of our gloating.

Let's just get into the agenda.

Slide 3 is my agenda for this morning.

It's the same line up we normally follow, with a review of the quarter and year to date P&L items, then a revenue discussion, and a look at free cash flow and related items.

I will finish with revised guidance for the balance of the year, incorporating acquisitions closed to date.

So on to slide 4, which compares results for the quarter to Q3 of 2003.

Revenue was up 20 percent to $459 million.

Internal growth was 7 percent while acquisitions contributed nearly 11 percent and favorable foreign exchange fluctuations added about 3 percent to growth.

Gross profit and operating income before depreciation and amortization grew at slower rates, as margins retreated from the record levels of the prior year.

We had expected and forecasted full year margins to decline from these 2003 levels as we increased our investment in our customer facing organizations of sales, marketing, and account management, and as we doubled our European business with the acquisition of Phase [ph].

We experienced a gross margin decline of 80 basis points in this period, the majority of which arose from our U.S. paper business where service margins declined.

Core service revenues remain soft and as we entered the seasonally slow second half of the year, service and courier labor expenses grew disproportionally (ph) to service and courier revenue, with higher fuel and energy costs also contributing to reduced margins.

We expect the U.S. paper business unit to return to its historical margin levels through cost controls, improved labor management and other measures we have implemented.

It is important to note that our storage revenues saw steady growth and that storage margins within that business are up slightly from 2003.

Regarding overhead, our increased investment in sales, marketing and account management cost 110 basis points of revenue year-over-year in the quarter.

Higher compensation due to increased head count and higher commissions due to higher aggregate performance by more sales people accounted for the majority of this investment.

On a related note, we saw higher expenses in the area of recruiting and relocation associated in part with this build up.

Elsewhere, operating income before depreciation and amortization benefited from a small gain on asset disposition versus a $2 million loss in Q3 of 2003, as well as a reduction in our allowance for bad debts due to our improved AR aging and the reduced risk associated with uncollectible accounts receivable.

The net effect of all this is that operating income before depreciation and amortization was 127 million, or 27.7 percent of revenue for the quarter.

D&A for the second quarter -- for the third quarter was in line with expectations.

Let's move to slide 5.

Slide 5 looks at our Q3, 2004 results for the P&L line items below operating income and compares them to 2003.

Interest expense is up 40 percent over 2003, primarily due to the one time non-cash accounting charge of $8.7 million we recorded in the third quarter required by the recharacterization of the interest rate swap associated with the real estate term loan we paid off during the period.

This is an issue we had specifically provided guidance for on the Q2 call.

Although the charge is noncash, it represents the current fair market value of the swap.

That is, the net present value of the expected monthly cash payments over the 3 year remaining term of the swap.

I should note that we left the swap in place.

And it is important to note that we will continue to enjoy the economic benefits of fixed rate debt in a rising rate environment over the life of the swap.

Unlike the many early extinguishment charges we have taken through other income or expense over the past few years, this one time charge was recorded in interest expense.

Going forward, proper hedge accounting requires that the changes to the fair market value of the swap be recorded against interest expense.

Accordingly we also recorded $300,000 of additional interest expense in the quarter.

Absent this issue, interest grew 17 percent year-over-year due to increased borrowings for acquisitions and investment in joint venture partner buyouts.

Moving to the other income and expense line.

You can see that we had other income of $300 million or 1 cent per share for 2004, versus a net expense of $10 million or 5 cents per share in 2003.

To be more specific, in 2004 we recorded 3 million of net gains due to foreign exchange rate movements as we mark our foreign debt and intercompany balances to market.

In 2003, foreign currency exchange rate movements resulted in losses of 5 million.

We also recorded 5 million of debt extinguishment charges in Q3 2003.

With respect to the major foreign currencies, our hedging strategy is in place for the British pound and is working well.

Iron Mountain Europe's credit facility allow us to borrow locally, and Iron Mountain Inc.'s sterling denominated bonds offset gains and losses associated with our intercompany debt.

In connection with the payoff of the real estate loan I spoke of earlier, our Canadian subsidiary borrowed locally and repaid a significant portion of their intercompany loan due to the U.S. parent.

We use those proceeds to repay the real estate loans.

This repayment against the Canadian intercompany loan will reduce the impact of fluctuations in the Canadian dollar going forward.

And lastly, as a reminder, all of our per share amounts reflect the 3-for-2 stock split that became effective July 1 of this year.

Now, moving on, slides 6 and 7 are the year-to-date versions of the previous 2 slides.

Without citing all the specific numbers, I will speak to the overall comparison.

As shown as slide 6, for the first 3 quarters, revenue grew slightly faster than in Q3.

Margin performance was more in line with the previous year, as 2003 saw meaningfully higher margins in the second half than it did in the first half.

Slide 7 carries the income statement through to net income.

Without the refinancing related noncash charge, interest would have grown by 19 percent.

For the year-to-date, the earnings impact of other income and expense items is not material, as in both periods the combination of foreign exchange effects and refinancing charges wind up netting out to small expenses.

So for the year-to-date, net income is up 14 percent and earnings per share is 49 cents for 2003 year-to-date, versus 43 cents for -- for 2004, excuse me, year-to-date, versus 43 cents for 2003.

A slide 8 is titled total revenue growth rates.

For the quarter we reported total revenue growth of 20 percent.

Storage grew at 18 percent and services grew at 23 percent.

As many of our recent acquisitions were shredding companies, whose entire revenue is classified as service.

Largest among these was the Proshred acquisition, which close in July and gave us a pan-Canadian footprint.

Moving to slide 9 we can have a closer look at internal growth.

Slide 9 displays our internal revenue growth rate for the quarter from a core and complementary revenue perspective.

Core storage, representing 58 percent of our total year-to-date revenues, grew at 8 percent in the quarter.

This is within the 8 to 9 percent range we have discussed all year.

Strength in our international businesses and our digital services led the way in storage revenue growth.

Core services, representing another 29 percent of total revenues, grew at 6 percent.

Down slightly from the growth rate of the second quarter due to softer results in our U.S. paper business and Europe, offset by continued strong performances in shredding and digital services.

Total core revenue internal growth was 7 percent.

In Q3 we saw a small rebound in complementary services revenue, which grew 2 percent in the quarter.

Product sales were up over last year and we had some one time special projects completed in Q3 that more than offset the loss of the multi-year Canadian special project that came to an end in the fourth quarter of 2003.

Looking at the year-to-date growth rates we are within our forecasted ranges of 8 percent to 9 percent for storage, 6 to 10 percent for core service, and negative 5 to positive 5 percent for complementary services.

We expect to remain within those ranges for the balance of the year.

Let's move to slide 10, titled capital spending in investments.

This shows our CapEx spending year to date, relative to the prior 3 years and also displays our 2004 full year projections.

Spending in the third quarter of 2004 included 46 million for growth and maintenance CapEx in our core businesses, $4 million for real estate, and $7 million for our digital initiatives.

For a total CapEx spend of $57 million.

CapEx in the quarter was as expected, including the higher spending in the digital arena, driven by higher revenues.

We expect to finish the year toward the lower half of our previously announced range of $210 million to $240 million.

Slide 11 looks at free cash flow before acquisitions for the 9 months of 2004, versus the same period in 2003.

As we have consistently stated, free cash flow is best evaluated on a full year basis, as the timing of normal periodic events can skew interim period results.

At the 9 month mark, we are ahead of last year's levels.

The year to date $31 million use of working capital, which is essentially in line with Q2, but higher than at this time last year is the product of several factors.

Many of which are timing issues.

We believe that this number will decline during the fourth quarter as it has in past years.

Please remember that CapEx for this year includes CapEx relating to the restructuring of Hays that will not recur.

Additionally, the 2004 year to date free cash flow number is burdened by the interest associated with the buyout of some of our joint venture partners, most notably Mentmore, PLC, our former Iron Mountain Europe partner.

Acquisitions and other investments through 9 months totaled $254 million.

The largest transaction included in that total is the buyout of our European joint venture partner I just referred to for $112 million.

The remainder of the investment was for a number of transactions with the bulk of the consideration going to the international and shredding arenas.

The largest of these were Proshred and DISOS.

DISOS is the German business we bought earlier this year.

On the domestic front, a number of smaller deals added 4 new markets to our records management business, and the others enabled us to make meaningful strides in establishing our shredding footprint in the United States.

We expect to complete the acquisition of Connected Corporation early next month.

This is a cash for stock transaction that is valued at $117 million.

We will be acquiring approximately $6 million of cash at closing, which will help to fund anticipated merger related expenses of approximately $8 million, which will flow through our income statement over the next 2 years.

Additionally, Connected has a net operating loss carry forward that we value at approximately $12 million.

At roughly 3 times current revenues, we view this as a fair price for a strategic acquisition in this space.

Slide 12 is debt statistics.

This shows the progression of certain debt metrics over the last 2 and 3/4 years.

As many of you know, we have been fairly active in the high yield markets over the last 2 years, and even into the beginning of 2004.

In addition to being net present value positive, our refinancing activities along with the general decline in interest rates, have lowered our weighted average interest rate 80 basis points to 7.8 percent since 2001.

We are currently 93 percent fixed with respect to interest rates and have a debt portfolio maturity of more than 8 years.

Our bond ratio is currently at 5 times EBITDA, due primarily to the borrowings for the acquisition of the remaining 49.9 percent of Iron Mountain Europe.

Remember the bond ratio is fully charged for the domestic debt associated with this transaction but does not receive any credit for the foreign operating income before depreciation and amortization.

Slide 13 is a debt capitalization slide and as of September 30th, and details the components of our debt structure where you can see the effects of the last 2 years' refinancing activities.

Let me move on to conclude with guidance.

This is slide 14, 2004 guidance.

Today we are adjusting our full year 2004 guidance to reflect our recent operating results and acquisitions closed to date.

That guidance is depicted on this slide.

Our updated guidance does not include any potential impact of the Connected Transaction, as that deal has not yet closed.

We do expect to close this transaction in early November.

As a reminder, Connected reported 18 million of total revenue for the first 6 months of 2004, and the business is currently profitable.

Connected's business model is characterized by strong operating leverage and low capital consumption.

The company actually expenses all of its R&D.

Over the long term, Connected will produce high margins and generate meaningful free cash flow.

That being said, this deal will be dilutive to operating income before depreciation and amortization margins, and to earning in the near term, due in part to integration costs which will run for the first 2 years and interest expense associated with the transaction and higher amortization from purchase accounting.

We will be providing more details on this transaction and its impact at our upcoming investor day in 3 weeks.

Thank you, and with that I will turn it now over to Richard.

Good morning, everybody.

Today I will make comments on a couple of issues.

First I will talk a bit about the operations and give you a little color and reinforce some of the things John said, and then I am going to talk a bit about a few of the strategic things that have been going on and finish with a little discussion of the Connected transaction and then, of course, we will take your questions.

On the operational front this quarter saw us continue to make progress on many fronts.

Our business is 20 percent larger than last year.

And on such a large business, this -- such a large base of business, this is significant growth.

Most of our businesses performed as we expected with one exception and that exception in our opinion is an isolated issue but here again, one that we do need to do some work on and we will.

As John discussed we failed to execute well in our U.S. paper business and allowed our direct variable costs to rise faster than related services -- related revenues.

We have taken steps to have our field teams focus on the issue and expect the gross margins to return to our normal patterns over the next few quarters.

Additionally, our sales and marketing organizations have been ramping at an accelerated pace, part of which was our plan throughout the year and in particular in this quarter.

We operated according to our headcount and base compensation expense plan, however, our new sales performance has been accelerating through the year and in the quarter we exceeded our plans on a year-to-date basis.

This good sales performance resulted in commission payments that exceeded our plan.

Increases in sales performance has a negative impact on margin in the current period, as variable compensation is a multiple of the monthly recurring revenue for the period and typically exceeds the actual revenue recognized in the period.

This sales performance has had a great impact on the shredding and digital services lines of business.

The impact on storage revenue is hard to detect in the short term due to the size of the base, but continued performance creates momentum that harbors well for the future of the storage.

Additionally, we expect that we will see a continuation above planned commissions for the fourth quarter, but, of course, we expect to continue to overplan selling, and our compensation plans have significant payment accelerations to reward this overplan performance.

So as we said, and as John went through in our North American paper business, we had a couple of things hit us.

Activity is up.

We're selling well, selling hard.

But we are paying more for it in terms of commissions because that's the way our plans are written.

We think that's fine.

On the margin side, it was a matter of us really not getting out and adjusting fast enough.

We hit the seasonal time of year in which service labor -- or excuse me, service revenue typically gets a little soft, and it did.

Our field organizations were really focusing on work and not on margin and took their eye off the ball, but I have seen this happen before.

I have actually -- maybe 2 or 3 times in my 20 years.

I guess you would think we would learn, but we missed this one.

Our teams missed it, but we are all over it, and it will come back in line as we said.

Now let me move on and talk to you about some of the strategic things that are going on in the business to give you some context for everything.

We entered the year with an aggressive agenda for investing in growth.

We have been executing on this plan on many fronts, and I want to talk about those major fronts, and give you a sense what has happened and been going on.

First on our secure shredding business.

This business is growing rapidly, both internally and through acquisition.

We believe that we now have achieved the position of the largest integrated service provider in North America, and this is allowing us to capitalize on the needs of our large customers that desire a single compliant vendor to service their multi location shredding needs.

During the quarter, we acquired a multi-city shredding company in Canada, and in one transaction, created a national platform in Canada.

The business is on path strategically and is operating profitably.

Now, the shredding business I said is doing well.

To support that business as well as all our other businesses, as you know, one of our themes has been building a world class selling organization.

And as I just discussed, we've been investing a significant amount of margin in growing and developing a major distribution force in the information management business.

We believe that the path we are on will lead to significant competitive advantage in both our physical and additional business lines.

We have proven that we can build an effective sales organization, however, we believe that we have significant upside in terms of additional efficiency.

That will become our focus for next year.

So this year, it's been about getting it up, and as the year went on, we had an aggressive hiring plan, and they met that plan.

We actually were behind the plan a bit for the first couple of quarters, but caught up in the third quarter in terms of hiring.

In addition to that, the sales force itself has produced significantly more new revenue than last year and is above their plan.

And as we said earlier, we are on a path to make it work in an effective way, and I think we have proven we can do that.

Now the next element of what we are after is efficiency and that's where we will turn to next.

The next thing we've been investing is in international expansion.

As you know, it's about footprint and so forth.

By and large in most of the world, except for Asia, which we've talked about before, that work is pretty much over.

But the general focus of our acquisition strategy for this year has been on 2 things: the international business and on the shredding.

And actually, we've closed in the last quarter and recently, 2 businesses.

The one in Canada and shredding I've talked to you about as well as one in Brazil to expand our international footprint.

We'll continue to seek transactions to build our footprint, but don't expect significant activity in this area for the balance of the year.

In addition to that international direct acquisition, though, we've also been buying out the interest of several of our international joint venture partners on an opportunistic basis.

These are not transactions that we were required to do, but transactions that were made available to us.

So far, we've completed 4 transactions both in Europe and Latin America in investing $176 million, and we have pending 2 additional partner buyouts which total approximately $20 million.

When completed, we will have increased our ownership of our international businesses from approximately 50 percent share to approximately 98 percent share.

As you will remember, we used partnering structures to allow us to expand on multiple continents to give us local knowledge and share the risk.

Our partners have helped us create value, and we have developed our businesses to the point where we are ready to go alone.

This also allows us to capture all of the upside value we believe we have in these markets.

So, you know, we made major strides in the international side of our business, both in terms of expanding the footprint, but also now in actually buying in our full ownership of that footprint, which was part of the plan and the strategy all along.

Now the fourth leg of where we have been investing significantly this year is in our new digital services.

And we continue to invest in these services.

We have made significant new customer wins and revenues are increasing at the rate of 35 percent in fourth quarter over trailing third quarter.

For the year, we expect to report greater revenue than our original plan and to run at the planned loss rate, which is putting about 100 basis point's drag on our operating margins.

We realize that many of you would like more insight in this business, and we plan to provide more detail into both our strategy and a forecast for the future possible financial performance at our investor day presentation in New York on November 18.

For those not able to attend, the information will be available on our website.

And related to that digital expansion, let me segue into a little discussion about the Connected Corporation acquisition that we've announced, because Connected is a major extension and a major part of that strategy.

As you know, we recently announced the acquisition of Connected and Connected is headquartered in Framingham, Massachusetts, which is only about 6 or 8 miles from where we sit today.

Connected is the leader in the archive, backup, and protection of distributed data.

And by the way, by most studies, 60 percent of the corporate data is distributed data.

It is the bulk of where most of the data is and the hardest data to get out on behalf of customers, as they try to protect themselves by backup and become compliant through archives.

They have the best technology to get to the desktop and collect and store the data with a minimum footprint.

Their products reduce the cost and complexity of IT infrastructure for enterprises, while providing complaint backup in archives.

The technologies have been developed at a significant cost and is patented.

They have been successful at taking this technology to market in the form of a hosted service, as well as a licensed software product for in-house use.

They market both directly through channel partners and through channel partners.

Revenues this year for Connected will be approximately $36 million, and they turn profitable for the first time this year. 60 percent of their revenue is recurring, coming from both hosted services and software maintenance fees.

We have worked with Connected for a few years and know that they have a very strong organization that fits with us culturally, shares our vision for the future of archives and backup, and that can help strengthen us in some core disciplines in product management, product development, and channel partners.

We expect the transaction to close next week and have already started to jointly plan the integration strategy.

We do not expect significant cost synergies, as we value their organization and we will integrate it slowly with the rest of our digital businesses in order to not lose the momentum that both organizations already have.

Connected adds to our growing business in distributed data backup protection, and together we have the best product set and market position to lead this growing market.

We will give you more insight and introduce you to some of the Connected people, by the way, into this important transaction again at our investor day.

As I said in the beginning, we have been executing our plans for expansion on multiple fronts.

And it is an ambitious plan.

As I just reviewed, we've made a lot of progress on all of them.

We're creating value, but we're also moving very fast, growing a large business at greater than 20 percent is hard work.

Although we are proud of our accomplishments, we know that we need to continue to execute well.

For this reason, we will slow our investment activity down a bit and focus on making sure that we get the most from the investments we are making.

It is time in our strategy to consolidate our activities a bit and maintain focus on some blocking and tackling.

This does not mean we will not make more acquisitions, nor continue to examine interesting strategic opportunities, but next year will not be a repeat of the major moves we made over the past 16 months, starting with the Hays acquisition, and frankly, sort of ending here with the Connected acquisition, and a lot of activity in between of building a significantly bigger business off of a very big base.

The Company has moved a long way, but it is time for us to slow down a bit.

Absorb a bit, and make sure everything is working well.

So that's where we are.

We will stop at this point and take some questions.

[Operator Instructions].

Thatcher Thompson, CIBC World Markets.

Good morning, Richard and John.

Quick question and I was listening as close as I could, but, John, you mentioned the U.S. paper base records business is where the margin compression happened this quarter, where you were below plan.

Can you tell us again what precisely happened?

What you do over the next couple of quarters and what you are targeting to get it back to?

What happened was that as we have been discussing, core -- our core service revenue in the paper business has been a little soft but it always gets effected seasonally in the third quarter.

So anyway, in the face of that kind of revenue profile we simply didn't manage our variable costs well.

And so service and courier margins were about 9 percent less in Q3 of this year than like, they were in Q3 of last year, and on a 70, $75 million per quarter run rate, that translated into 6 or $7 million of margin short fall.

Most of that is in you know, is in labor, and the place to attack it is in overtime and temp labor and use of third parties.

A little bit of it is in energy and fuel costs, but really it's about labor management.

We put plans in place to address it and we are monitoring those plans and we believe they will work well.

It will probably take into the -- it won't turn it around entirely in the fourth quarter because the fourth quarter, also due to holidays is not a robust service quarter.

But our service revenue tends to jump into the first quarter of the year with the normal business cycle, and the first half of the year is our most robust service revenue time, so we would expect to see it come back in that time frame.

Okay.

And one other question.

You mentioned the rising commissions, I am just trying to understand how that worked.

It sounded like a good news/bad news story -- or bad news/good news.

Yes, what this comes down to is the fact that we had aggressive hiring plans, and our hiring really ramped up in the second and third quarter.

And new people coming in either have guaranteed commissions, or -- and the people that had been there and are seasoned, were performing over plan and there are accelerators in those plans.

So, I think it was a combination of that sort of momentum and frankly some less than perfect budgeting that caused us to have a 3 or $4 million surprise, if you will, on the level of commissions.

It is a good news story long term, but in the short term since we pay multiple of monthly recurring revenue in commissions, it's net negative to margin in the short term.

And it hasn't -- but it will have, I think, a meaningful impact, particularly on our new lines of business in shredding and digital and it should have a smaller impact on storage long term.

Okay.

Thank you.

Chris Gutek, Morgan Stanley.

Just to follow up on the last couple of questions -- or last question on the margin short fall.

I mean if the primary problem there is labor expenses, are you saying explicitly that you are looking at some headcount reductions or something else to get those labor costs back down?

Well, it starts with, we work a -- what you might call a bit of a variable work force.

On top of your base of your employees, you wind up using overtime and temporary labor to do on the margin work.

So it starts right now.

Overtime and temp labor gone.

Already.

Done.

And then you look at your work force.

But I do not believe that we will be in a position of any -- and we are not contemplating layoffs, because it's not that big of a problem.

The business will take care of itself and self correct.

And then to the extent that some of the pressures from energy -- obviously, energy prices -- I won't say obviously, but seem unlikely to come down meaningfully in the short term.

Do you have flexibility to push through fuel surcharges or anything like that?

Yes, and we are looking at what is the right strategy.

As you know, we are generally able to on a -- every quarter basis roll through approximately a fourth of your customer base.

It doesn't quite work out that way.

But we are constantly rolling through.

You know, it's the contract's Evergreen and looking at prices, and we will look to make sure that as energy prices keep rising, that we're able to recoup that.

Okay.

And then, John, --

But there will be a lag.

You eat it now and it takes awhile to get it to flow through, but we will be able to get it to flow through.

Okay.

And then, John, was the bad debt expense again negative like it was in Q2?

Yes, well, I think in the quarter, it was a little over 2 million negative.

Okay.

And then finally just from a high level strategic perspective, I guess, Richard, when you look into 2005, looking at how much money the Company spent on acquisitions over the last couple of years, I guess from my perspective, we haven't seen as much of a slow down in acquisition spending as I might have expected.

What are you kind of thinking roughly, in terms of a budget for next year?

I assume you will stay opportunistic, but any rough sense for the spending?

I will let John give you some facts, and then I'll talk a bit about it maybe.

If you look back at '01, '02 and '03, our total acquisition spending in those 3 years was 48, 73 -- 49, 73, and 48 million.

Now, in the last year, I cited -- that is to say '03, I did exclude the Hays transaction, so if you exclude a $333 million Hays transaction, the baseline routine acquisitions were between 50 and 75 million.

With that fact on the table, I will let Richard throw the dart.

Well, look -- look at our strategy.

We are sticking to the strategy.

We are doing exactly what we told you we would do.

Those that were at investor day last year, go look and go listen.

That is why I did this quick review, just to give you -- put some things in context.

On the acquisition front, there aren't any more Hayses out there.

We're not buying significantly in the box business, although this year we had some interesting opportunities, but they are relatively small.

I think if we did 100 million of routine acquisitions a year it would be a big number, and in fact it's probably going to be less than that would be my guess.

It's just the target is not out there.

You know, you make -- you can trade in a lot of little companies, but the target -- it just doesn't add up to a lot of big business.

And that's why I want to reinforce the message I just ended with, with look, we have run hard, swallowed hard.

We have done a lot of stuff in this business.

It is a lot bigger business than it was a even a year ago.

It is time to regroup and make sure it is all working well.

We understand that, but we've gotten it done and connected as we will talk about at investor day, I think people will come to really understand that it is a beautiful marriage and the circumstances are right, the timing is right to fit our strategy.

Our strategy also says though -- and part of our long term strategy is that we want to continue growing cash flow, and in particular free cash flow, and we will do that.

Okay.

Great.

Thank you.

Tim Byrne, Robert W. Baird.

Thank you for taking my questions and good morning.

The JV buyout figures, John, were those in the acquisition numbers that you shared with us in terms of the spend on acquisitions on slide -- what is it? 11?

Yes, so, as I said of the 254 million of total, 112 was just to take out our European joint venture partner.

And then there were a couple of others, one in the Benelux region and one in central Europe.

Okay.

And I think the answer to this is yes.

But I will ask.it explicitly, Richard, the little hiccup we have here in gross margin doesn't at all change your outlook of clear line of sight of 30 percent OIBDA margin by 2006.

Well, I mean the truth is we actually hit it last year.

In the physical business, yes, I would suggest that some of what's going on in the digital business, we'll have to pull that stuff apart and we're not ready to give you a real forecast on that.

Hopefully, by investor day, as I said in my comments.

I know everybody has been dying saying, Look, come on, guys.

You are spending money on this digital stuff.

When are you going to tell us what it can do?

I think we have a perspective and we do intend to share that, but in the physical business, yes, we're not -- we're sticking by it.

Okay.

So for the -- ex digital, you're standing by the 30 percent, but for the total business depending on the impact of digital, it may be lower than that?

Yes.

Okay.

I mean, look, but let me just do the easy -- the math for you.

Digital is consuming 100 basis points right now, and that's not going to be forever.

That is going to turn we think -- well, we're sure.

One way or the other, that's going to turn.

So it's just not going hard to get that whole thing there in time.

It sounds like the momentum on selling for digital is picking up, too.

What do you attribute that to?

Three reasons could you be your selling is actually getting better, the sales cycle is getting better -- shorter or you know, customer interest is up dramatically.

Can you give us some sense of what you think is driving the uptick?

I think it's a combination of customer interest up and we are getting better at it.

We've had to learn it from scratch.

This was not a market when we started a few years ago.

But all of the confluence of Sarbanes-Oxley and all of what's going on out there.

Customers are learning that digging deeper.

They are starting to understand information management -- or starting to understand they don't understand it in certain cases, and all of that is helpful to us in a variety of ways, and we are learning how to take better advantage of it.

Great.

And last question.

John, where do you folks stand on your Sarbanes-Oxley compliance?

Yes, we are going to disclose all that in the Q. I guess suffice it to say that we're --we're very far along in our more mature businesses and the biggest challenge we have in total is in Europe.

Because we close, we doubled the business, a little over a year ago.

Consolidated -- consolidated all of our accounting operations into a new site in Scotland, but we're applying the same processes there with the same outside resources to drive to the right answers.

So at this point in time, do you foresee a challenge overall, getting to compliance by the required time frame?

Not in North America.

Potentially in Europe.

Thank you.

Bradley Safalow, J.P. Morgan.

Good morning, guys.

Just wanted to ask you a question on Europe, more so on the growth trends there.

Are you guys still trending in kind of the low teens organic growth rate there?

Yes, our -- our growth rate in, I guess, in -- in Europe consolidated is in the low teens.

But I would caution that part of our European operation, which is Hays, is not in the denominator of that calculation yet, because, as is our consistent practice, we have to own an acquisition for a full reporting period -- calendar reporting period, to put it in.

So, that will increase the size of the base and bring that down a bit, but long term, we foresee very good and solid growth in Europe.

Just so I am clear on the organic growth that you reported, Hays, which closed, I think July 1st of last year, if memory serves me correctly, is not in that number?

That's correct.

Okay.

And then, just to -- just to switch gears, in terms of your national account effort and also your deployment of a Seibel system.

Can you just give us an update on your hiring and where you stand in terms of the Seibel implementation, in terms of harvesting these cross selling opportunities?

Well, I guess it is sort of different questions.

The Seibel implementation is going well, and we've now rolled it out to, I think, the majority of the North American sales force, at about to -- and in fact, during this quarter we're training our account management group in North America.

By the -- roughly, end of the year, we will have probably 90-plus percent of the people on it.

In that ballpark.

Okay.

What won't be on it will be Latin America and Europe, but they will come in some time early-mid next year and what that means to us by the way is it costs a lot of money to do this.

So we're consuming quite a bit of money on training, is the big number, to get people up and so forth.

But, we now have a big win in terms of consolidated data.

You can get a good look -- we already have sales people giving us good feedback that says, I won this customer because I was able to go into the system and understand it.

We already do business with them in another city and simplify the purchasing process, etc, etc, and speed it up for close, so, it's starting to work there.

On the cross selling, we are continuing to evolve our sales organization to a more sophisticated structure, and it is working.

Everything we're seeing said it is working.

This year was the year in which we had our -- a historical paper sales force start to sell shredding.

It's the first year that they have gotten a second product and they are knocking the cover off the ball.

That's one of the reasons the commissions are up so high in that space.

And by the way, they're ahead of plan on their core storage business, too, but they are absolutely knocking the cover off the ball there, so we are starting to see that.

And the other element we are seeing is in our named account -- enterprise-type account programs, that is working.

We are getting depth in the customers.

We are getting better penetration.

So I think a lot of this stuff is working.

It just takes time to fold in and flow through.

And just one last question on the Seibel system.

How meaningful a spending level is that, as you get through the implementation next year?

What kind of benefit do you see as that rolls off in terms of margin?

Oh, well, it's a few million bucks.

In fact, my guess is in this quarter -- this quarter being Q4, it is probably one and a half million something like that in Q4 alone we'll spend for training, and we spent some last quarter, and so forth, and so on -- but so on an annual basis -- I don't know, 2 or $3 million at least.

My sense is there's a big upfront initial training piece to this.

But I don't think it goes away.

It's a tool that it costs money to maintain, and you over time implement --

It won't go to zero it might come down a bit.

Great.

I will turn it over.

Lionel Jolivot, Goldman Sachs.

Good morning.

I have 2 quick questions, first of all, in the pricing front, do you see any change in the trend or is pricing flat and are you seeing any differences between North America and Europe in terms of pricing?

The pricing is flat in North America, consistent with recent trends and no, there is no meaningful difference between here and Europe.

Okay.

And just second thing, you mentioned during the presentation that historically you have been relatively opportunistic when -- in terms of accessing the high yield market to refinance some of your bonds when it had a present value.

What is the your thought on the 8.25 at this point, because it seems to me that you can refinance them, and it would be a positive present value for your shareholders.

We would never preannounce such intentions in advance of a registration statement and so, if it makes sense, at a moment in time, we might consider it, but you know, we are -- we have good, lengthy, average maturity in our portfolio, and there will come a point in the cycle when we'll value flexibility as much as we will -- as much as we will maturity.

We will be though in all cases net present value driven, with the guiding principal being to create value for shareholders.

Okay.

And just last thing, you mentioned that you will probably be a little bit less aggressive with acquisitions next year.

What will you do with the extra free cash flow?

Do you expect to pay it on debt or are you comfortable with the current level of debt?

Well, yes, next year – you know, any excess cash flow we would have above our uses we paid on debt.

Okay.

Great.

Thank you.

Scott Schleffer, Tiger Technology.

My question was answered.

Thank you.

Douglas Pratt [ph] of NAEA Capital [ph].

Good morning.

Thanks very much.

I had two quick questions.

One, what is the revenue -- annual revenue roughly for Hays and for Connected capital, and also I got in a little late, so I'm apologizing if I missed this answer.

Bad debt expense for the quarter, what was that?

I will take them in reverse order.

Bad debt expense was a negative two and a half million for the quarter and Connected as we reported had first half revenue this year of $18 million.

And I think the legacy Hays business is about a -- it's about a 90 million pound business.

So I guess I can't do that math in my head, it is about $136 million year-to-date.

It's the 9 month -- that includes the piece in the U.S. and the gas and oil in this business in Texas.

I am sorry.

That was Connected?

No, Connected was a $36 million run rate business based on that first half results.

Hays 90 million pounds. $136 million year-to-date in U.S. dollars.

So, it's probably -- right, 240 million total run rate of the two combined, something like that?

If you say so.

It's ballpark.

Okay.

Quick follow up on the bad debt.

More like 220.

On the bad debt, I know last year, you actually drew down your debt reserve about $2.5 million.

It sounds like you are on a run rate to draw down this year by 3 to 4 million.

At what point do you feel you start -- number one, why have you been drawing down bad debt reserves and at what point do you think you start adding to those again?

Well, first of all, there is no plan, It is something you evaluate quarter by quarter based on your ageings and your view of -- your view of collectibility.

Basically we have -- our ageings have improved and we simply couldn't justify the reserve based on what we view as a very low collectibility risk relative to the level of the reserve.

And we will continue to evaluate it.

You may recall that last year in Q4, we had extraordinary margin performance because we lowered our reserve for bad debt by $6 million in the quarter.

And we have, obviously, analytical techniques, you know business unit by business unit to look at aegings and collectibility and past, and look at specific reserves and past bad debt performance.

So our approach to this is highly analytically based and highly consistent from period to period.

When you talk about your cash flow numbers, do you adjust for that bad debt expense, since that's obviously a noncash item?

Yes, it is part of the reconciling items that are noncash.

Okay.

Alright, thanks very much --

Our cash flow is right off the cash flow statement.

Okay.

The reason I ask is it's -- I mean, that was a big --a big, I mean, that had a big impact on operating income on the positive side, and if you adjust for that -- and, again, you may have discussed this earlier in the call.

I was a little bit late getting on.

I am coming up with about a 27.5 percent margin.

And EBITDA, including an add back for bad debt expense, or bad debt negative income versus 29.7, and that's sort of like a 3 quarter phenomena where we see that number going down.

And I --

Yes, but I think it's more appropriate to look at it on a full year basis.

Last year our analytics on this caused us to take a very -- a big piece of the bad debt reserve down in the fourth quarter.

Fully $6 million.

So on a full year basis, I don't think it will have a meaningful year-over-year impact on our margins.

Okay.

Well, thank you very much.

You're welcome.

Henry Nah [ph], Lehman Brothers.

Hi, John.

Hi, Richard.

Two questions here for you.

First one revolves around acquisitions.

You guys have stated numerous times that there aren't any big acquisitions out there in the records management business.

On the digital side of the equation, obviously, the Connected acquisition is pretty significant.

What are you guys thinking in terms of acquisitions for the digital business?

Do you see any targets out there?

Or would you consider them to be larger players, or would they be more of a smaller tuck-in type acquisition?

Well, yes, we are always looking out for things that can add to our strategic value of the business and to our cash flow, and in the digital space, there may be some things out there in the future, but it is not something we are aggressively seeking.

By and large, we will build additional business on internal growth, because that's what we have been investing to do and we're learning to do.

Connected brought to us, though, a -- an ownership for technology as well as a great organization and good revenue and customer presence and it's turned profitably with timing.

Everything works well, it had good financial metrics, 60 percent recurring revenue because they also were working a balanced portfolio of services and products.

So there was just a lot of things about Connected -- and remember, our strategy in the digital services was to invest money, to get into the space, and sort of watch the market and learn, and that's what we have been doing.

Waiting on the market to evolve.

And the market's evolving, it's here and the Connected space is both archives and backups, but their lead product right now is the backup space with distributed data.

They absolutely, hands down, are the winner in that market space, and we wanted to make sure -- we've been in the market space, with electronic vaulting long enough to know that it's going to be -- it is a good market space, it is going to be a good market space.

This allows us to now to confirm our ownership in our rights to be in the market forever.

Because we were licensing our way into that -- you know, through different partners and so forth.

So this had a lot of elements to it.

But we are not out looking to hunt for revenue in the acquisition space in the digital business.

It is -- time to time, things will come up that make sense, but it is not a key part of the strategy.

Unlike a key part of the strategy in the paper business.

Remember -- and for that matter, the physical offsite data protection business.

In that space, acquisitions was strategic because it built footprint.

It is a physical business.

You had to have geography.

You needed footprint, and that's what we have done.

In the digital business acquisitions, you don't need footprint.

You occasionally want to extend your product line or build some synergy in different ways.

So it is a different tool used in a different way in the digital business.

Regarding Connected a little more here, you've mentioned a couple of times that they've brought to you a technology that you didn't have before.

Is technology something that you guys are looking for?

From time to time in our space.

Absolutely.

Our value proposition to our customers is to help them be compliant in their storage and management of archival and backup data and to do it at lower cost, and technology can help you do it at a lower cost.

Connected is a good example of somebody who could do that.

But we also got something else out of Connected with market position.

You know, if you combine what we are already doing in the space, some with their technology and some with others, and what they're doing is -- we are the hands down leader in the backup and recovery of distributed data.

As I said earlier, that's where lots of that is.

Okay.

Great.

This question is probably more for John.

In terms of operating expenses.

It looks like you will probably have operating expenses in 2004 which are probably -- call it 90 to $100 million higher than they were last year.

Obviously, the Hays acquisition accounts for a good chunk of that.

How would -- I guess, John, how would you kind of break out the incremental operating expenses?

The delta $90 million of operating expenses this year versus last year?

Right.

Some of it's going to be for Hays, but how much would you kind of attribute to increased headcount, increased marketing activities and the like?

Well, someone just handed me a draft MD&A to try to answer that.

That's a tough one.

I mean, our -- our storage margins are in line with – or in some cases ahead of last year, of the -- and so, you know, I am sure that facilities which are about 20 percent of total revenues scaled, you look at the 9 months ended September 30th.

We actually had -- the absolute dollar change of our cost of sales was $115 million.

And labor went up faster than facilities, and that's because we are getting into the shredding business, which is less real estate intensive.

So, labor was up about 60 million and facilities were up about 30 million.

Transportation, which is leases, maintenance and repair, gas and oil, and that sort of stuff was up 12, 13 million and then the rest was product cost and other.

Now, that's -- I have just laid out for you the increase from the prior year in the cost of sales line.

In the overhead categories of sales, marketing and account management would lead the way with a combined increase of about 25 million, and IT grew only 7 million, and all other overhead grew 43 million.

I don't know what -- I don't frankly know what I make of that, other than it demonstrates, I think, an increased investment, sales, marketing, and account management, which is old news at this point.

A bit of a mix shift away from facility based businesses.

A leveraging of and not a meaningful increase in IT overhead and probably sort of a normalized increase in general overhead.

Great.

And kind of piggybacking on one of the prior questions, in terms of margins, you know, we have seen operating margins tick down here for a couple of quarters.

Any kind of target of when you'd expect margins to increase again, and are there any targets in terms of target operating margins?

Well, I think you may have to pull the businesses apart, and ask that question of the physical business separate from the digital business, and our targets would be those consistent in the physical business with what would yield you know, 30 percent EBITDA margin.

So something just north of 20, I would say.

Thanks guys.

I want to be mindful of time, because we heretofore have tried to commit to keep this call at an hour and we're an hour and 5 minutes.

It looks like we got 2 or 3 more people.

We will try to take 2 or 3 more questions and draw it to the end, if you don't mind.

Andrew Steinerman, Bear Stearns.

Hi, I'll keep it to one question.

CapEx as you mentioned did come down a midpoint to the range of perhaps $12 million since the last time you set it in July, but your expectations for digital spend and real estate came up.

Digital at the midpoint, came up about $8 million, and real estate came up about $4 million.

So it seems to me if although our CapEx is going down, digital and real estate going up.

There is some reallocation going on here.

What should be the interpretation?

We were presented with some options to purchase properties we lease.

We may o or may not take advantage of them.

As we discussed in previous calls, digital CapEx would be a function of its revenue level this year, and it's exceeding plan in terms of revenue, so we are tooling up to --

And we're tooling up and building into what we expect to be a significantly bigger year next year in the digital space.

Right, but given the IT activity, Seibel, etc, are you pulling away from there, or did you get everything done, all within this range?

No, no.

We haven't changed our agenda.

Okay.

We haven't changed the agenda one bit.

The only thing that's changed is some of it's accelerated faster than we thought.

Got it.

It's more a timing issue --

And all this will settle itself in over 6 months, timing-wise.

Thanks very much.

Nicholas Sartese [ph], Shankman [ph] Capital Management.

John, can you just touch upon your liquidity for a second?

You have 172 million drawn on you revolver and another 118 to spend on Connected Corp in the fourth quarter.

Are you comfortable with your availability post -- post this year, or much are you looking to increase it, and if so, what would be your preferred avenues?

Thanks.

Well, current availability is 143.

Under the U.S. revolver, you have to be mindful of that.

Our European business unit has 50 million pounds available on under their revolver.

Once we've closed the Connected transaction, our U.S. availability is estimated to be 32 million.

As is our practice, once we've run up our revolver from acquisitions, we tend to term debt out, and later today we will be launching a $150 million term loan add on under our U.S. senior credit facility.

This is an accordion feature, I guess -- it was preauthorized when we negotiated this facility last March, and that new facility is expected to close in -- on November 9th.

Remember what we did in the third quarter was we used revolver capacity to take out a real estate term loan that had 3-plus years left on it, and we did that to be able to tap our Canadian sub limit of our revolver in order to have an effective hedging strategy.

It is for that reason that we built this accordion feature in.

Nothing should be read into this other than a preplanned event to reduce tax and any income statement volatility in -- by hedging the Canadian dollar and so just moving money from real estate term loan back into the term loan B market.

Operator, we will take one more call, and then we'll sum up.

Arnold Ursaner, CJS Securities.

Can you give us a feel -- I think you've got a pretty aggressive expansion of your sales force.

Can you give us a feel for the percent of your shredding customers that are your storage customers, and if your sales force is successful, what do you hope the number will move towards?

I don't think we put a dent in our record, our hard copy customer base yet of any significance.

You -- realize that our shredding revenue right now is running at about, a little under $100 million run rate, and I would guesstimate that probably half the -- half -- more than half of that, we got via acquisition.

So if we acquired the shredding business of a box customer, it was a -- it just happenstance in the context of an acquisition.

So I think -- I think the best is yet to come in terms of taking shredding with our direct sales force to our existing customers.

I know there's a lot of interest, and we have a great opportunity with our major banks.

One major west coast bank just coincidentally came with an acquisition.

So sometimes that happens.

It's just in the normal -- the course of building the footprint out.

And again, to the extent your sales force initiatives are successful, new sales typically are about half of your growth, if you are, in fact, successful, shouldn't this be adding 1 to 2 percent to the growth overall?

Possible over time that that could happen, yes.

But right now, it is growing fast on a small base.

Thank you.

Thank you, everybody, for your continued support and joining us this morning.

I won't have many comments since we are over time.

I do want to remind you, probably for the third time in the call, to sign up for our 7th annual investor day on November the 18th in New York City at the Waldorf-Astoria.

It will begin promptly at 8:30, and we will let you free by noon.

We do -- we're working on the agenda.

We have tried to listen to -- we've done some surveys of investors to make sure we try to be responsive to your questions and so forth, and so as usual, we will come forth and bring us as much data as we got that we can make heads or tails out of, and tell you about it, and introduce you to a few people, and we will have some senior management and even some broad field management there for you to meet and just ask your own questions, and so forth.

So we look forward to seeing you all in New York in just a few weeks, and, again, thank you very much.

Ladies and gentlemen, this concludes today's conference call.

You may now disconnect your lines and have a great day.