鐵山公司 (IRM) 2005 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

And welcome to the Iron Mountain, Incorporated Q2 2005 earnings conference call.

My name is Carlo, and I’ll be your coordinator for today.

At this time, all participants are in a listen-only mode, and we will be conducting a question and answer session during today’s conference.

If at any time during this call you require audio assistance, feel free to press star, zero on your touch-tone telephone and a coordinator will be happy to assist you.

As a reminder, this conference is being recorded for replay purposes.

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

Please proceed, sir.

Thank you.

And welcome, everyone, to our second quarter 2005 earnings conference call.

Today’s call will follow our regular pattern.

After I’ve completed the announcements, John will discuss the Q2 financial results.

He will turn the call over to Richard for some state of the Company remarks, followed by q and a and brief closing remarks.

Before we get started, I would like to thank everyone who came out to see us at a Conference and Road Show during this past quarter.

We had several successful events in New York, Chicago, the West Coast, and in Europe.

As always, we enjoy seeing everyone and thank you for your continued support.

At this time, I would ask you all to mark your calendars as our 8th Annual Investor Day will be held on Wednesday, December 7th, 2005 in New York City.

Details of this event will be forwarded along as they become available.

As is our custom, we have a user controlled slide presentation also on the Investor Relations page of our web site at www.ironmountain.com.

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 2005 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 depreciation and amortization, 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 and the appropriate GAAP measures as required by Reg G at the Investor Relations page on our web site, as well as in today’s press release.

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

Thank you, Stephen.

Slide 3 is my agenda for this morning.

We had strong financial performance this quarter with no remarkable events, so I want to move quickly through the review of the results, and spend a bit more time on our outlook for the second half of the year.

To get started, let’s move on to slide 4 and review the headlines for today’s call.

The important takeaways are as you see there.

We had very strong performance across the board financially.

We exceeded all of our Q2 financial targets.

Our free cash flow before acquisitions was $54 million, more than double the performance of the first half of 2004.

And so based on our performance and our outlook we’re raising our 2005 full year guidance.

Let’s now move on to slide 5, and begin to look at the details.

Slide 5 compares results for this quarter to Q2 of 2004.

I’ll be discussing revenue and gross profit here, and save my comments on OIBDA for the next slide.

Revenue was 512 million for the second quarter, an increase of 15% over the second quarter of 2004.

Internal growth for the quarter was 8%.

Acquisitions contributed nearly 6%, with favorable foreign exchange fluctuations making up the balance of the total growth in the quarter.

I’ll discuss revenue growth in greater detail later in my remarks.

Our consolidated gross margin improved 50 basis points compared with Q2 of 2004.

The 55.4% level we reached this quarter sets a record gross margin for Iron Mountain.

Labor productivity gains and reduced facility costs as a percent of sales in the quarter were partially offset by increased product costs of sales associated with our Electronic Vaulting Service and data product sales.

D&A was up 11% for the quarter compared to last year, with the absolute dollar amount roughly flat to the first quarter of this year.

In anticipation of a favorite question, depreciation was $41 million for the quarter, and amortization was $5 million for the quarter.

Remember that the Connected acquisition which closed last November had a higher level of intangible assets than our typical acquisition and, therefore, generates higher amortization.

Let’s move on to slide 6 for a discussion of our OIBDA margin.

Slide 6 highlights the OIBDA margin dynamics at work.

We posted an OIBDA margin of 27.6% for the second quarter of 2005, which was slightly above our expectations.

We exceeded expectations through better performance and because some of the factors expected to put pressure on our margins, namely bad debt expense and Digital losses, were more favorable than initially anticipated.

The decline in margin for the 28.6% we posted for the second quarter of last year was due to several factors we have discussed on the past several earnings calls, which I will elaborate upon here.

First, as a result of the significant ramp in investment in 2004 our sales and marketing expenses ran about 50 basis points higher this year compared to the second quarter of last year.

This is to be expected as we began ramping our investment in Q2 of last year.

In absolute dollar terms our sales and marketing costs were roughly in line with both the fourth quarter of 2004 and the first quarter of 2005.

While we continue to invest in sales and marketing we are doing so at a much slower pace than in 2004, and we expect the margin impact relative to 2004 to continue to narrow throughout the year.

Second, our Digital services performed better than expected in the second quarter.

Losses narrowed in the business versus last year on a higher archiving revenue, combined with strong performance from Connected.

Additionally, we won an important piece of Digital business during the second quarter.

This piece of business calls for significant service revenues at the outset, leading to increased volumes in our Digital archive, which will yield meaningful recovery storage revenues for at least the next several years.

We recorded $1 million of service revenue associated with this contract in the second quarter, as it started late in the quarter.

But based on strong first half performance and this new contract we now believe that the Digital business will breakeven on the OIBDA line for the full year of 2005.

Richard will give you more color on this deal in his remarks, and I will discuss the financial impact in more detail when I review the guidance for the balance of the year later in my presentation.

Finally, consistent with our guidance that bad debt expense would return to normal levels in 2004 we recorded 20 basis points of bad debt expense in Q2 ’05.

In the second quarter of last year bad debt contributed 30 basis points to margin.

So, we are seeing a swing YOY for the quarter of 50 basis points.

Offsetting these factors was an improvement in other overhead of approximately 80 basis points.

Let’s move to slide 7 which looks at our Q2 ’05 results for the P&L line items below operating income, compared to 2004.

Interest expense grew 11% in Q2 versus last year, reflecting increased borrowings for acquisitions, primarily the Connected transaction.

This quarter we recorded $300,000 of additional interest expense due to the mark-to-market of our interest rate swap which was formerly attached to the real estate term loan we paid-off in the third quarter of last year.

We will be repeating this process until the swap expires in about two-and-a-half years, so we may see some slight volatility in our interest expense over that time period, depending on what’s going on in the general interest rate environment.

Moving to the other expense line, you can see we had other expense of $5 million or $.02 per share for both Q2 ’05 and Q2 ’04, all of the $5 million of expense in ’05 was due to foreign exchange rate movements as we marked our foreign debt and inter-company balances to market.

As a reminder, all of our per share amounts reflect a three-for-two stock split that became effective in the second quarter of last year.

I’m going to move real fast now through slides 8 and 9, with limited commentary, as these are the YTD versions of slides 5 and 7.

They depict the same dynamics as those of the quarter.

So, let’s move on to slide 10.

Slide 10 displays total revenue growth rates.

And for the quarter we reported total revenue growth of 15%.

Internal growth was strong for the quarter, coming in at 8%.

Acquisitions, primarily the Shred-Pro and Connected transactions, contributed nearly 6 percentage points to overall growth.

Finally, favorable YOY foreign currency fluctuations comprised the balance, or just less than 2% of our total internal growth, total revenue growth.

Acquisitions will become less of a factor as the year progresses since our largest 2004 acquisitions were completed in the second half of last year.

Moving to slide 11, we can have a closer look at internal growth.

Slide 11 displays our internal revenue growth rate for the quarter from a core and complementary revenue perspective.

Storage, representing 57% of our total revenues, showed consistently solid growth of 9% for the quarter.

Improved storage growth rates in our core businesses compared to the first quarter and continued strength in our Digital services were the highlights of this quarter.

In our North American business, box business, volumes were stable with the recent past and we enjoyed modest net price increase.

Core services, which represents another 30% of total revenue, grew at 7% for the quarter, towards the high end of our guidance.

Core service revenue in our North American paper business grew in line with the growth rate of storage as retrieval, refile activity and courier revenues showed improvement.

Secure shredding remains strong, and we saw strengthening in our offsite data protection business, as well.

Total core revenue internal growth was 8% for the quarter.

In Q2 complementary services revenue grew 4% versus the second quarter of 2004.

Increased revenues from special projects in our North American physical and Digital businesses offset the expected lower revenues from our public sector business in the U.K., which is coming off of an extraordinary record year.

Importantly, data product sales surged and contributed 500 basis points to the overall complementary service internal revenue growth rate.

Based on our performance in the first half of 2005 we certainly expect to end the year with a total internal revenue growth rate at the high end of our annual forecast range.

Slide 12, capital spending and investments.

This shows our CapEx spending YTD relative to the prior three years.

CapEx in Q2 2005 included 56 million for growth and maintenance CapEx in our core businesses, 4 million for real estate, and 14 million for our Digital initiatives, for a total CapEx spend of $74 million.

There are several important points to be made relative to CapEx, at this time.

First of all, included in the 16 million of spending for Digital services is about 11 million for servers and other equipment to respond to demand for e-mail restoration and archiving.

The majority of this equipment will initially be used to perform against the new Digital business we signed during the quarter and will subsequently be re-deployed to meet future demand in this arena.

We are considering implementing a sales leaseback arrangement for a significant portion of this equipment in order to lower our overall cost of capital and to maintain a flexibility.

Second, we expect to complete the sale of two properties during the second half of 2005 for net proceeds of approximately $16 million, which will further reduce our net CapEx for the year.

I mention this because although we generally sell some real estate every year, it usually doesn’t amount to much money.

We have proceeds from the sales of assets of 7 million, 11 million, and 3 million for 2002, 2003, and 2004, respectively.

All of the amounts on this slide are shown gross and do not reflect the proceeds of any asset sales.

Finally, we are raising our CapEx guidance for the year to reflect the strength of our first half performance and our expectations for future revenue growth.

I’ll discuss the new revenue guidance later in the presentation.

Now, slide 13 looks at free cash flow before acquisitions for 2005 versus 2004.

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.

However, you can see that cash flows from operating activities was up 61 million or 47% over 2004, and that we finished the quarter with $54 million of free cash flow YTD before acquisitions versus 25 million for the same period in 2004.

The increase in cash flow from operations was due primarily to an improved working capital position in 2005 compared to 2004.

As you can see, working capital was a source of $11 million of cash in the first half of 2005, compared to a use of $28 million for the same period in 2004.

A reduction in DSOs due in part to strong collections in Europe, combined with increased accounts payable and accrued expenses were the main drivers of the working capital swing.

Looking at the cash base for acquisitions, you will note that the first half 2005 total of $35 million is well below last year’s level.

Remember that 16 million went to acquire six small businesses on YTD, and the remaining 19 million was used to acquire additional equity in our Latin American operations.

We took our ownership of those operations from less than 50% to more than 75%.

Again, while we continue to do acquisitions as an integral part of our overall strategy, our spend will be modest compared to recent prior years.

So, let’s move to slide 14 which shows the current status of several key debt specifics, as well as the progression of our two major leverage ratios since the end of 2001.

Our net debt stands at $2.4 billion, down slightly from the end of Q1.

Our weighted average interest remains stable at 7.6%, and we are currently 87% fixed with respect to interest rates.

Our debt portfolio has a maturity of just under eight years.

We are now seeing the natural de-leveraging characteristics of the business impacting both our bond and consolidated leverage ratio, as each is now below 5 times, with the bond at 4.8 times, and the consolidated leverage ratio at 4.5 times as of June 30, 2005.

Barring extraordinary events, we should continue to de-lever in 2005 and into the future.

Slide 15 is our debt to capitalization as of June 30th, and details the components of our debt structure, where you can see the affects of the last two plus years of refinancing activities.

Of note here is the fact that none of our subordinated notes comes due before 2011.

I’m sure many of you saw that we filed a universal shelf registration statement with the SEC yesterday.

This is business as usual for us, and does not signal any imminent transactions.

We are updating our existing shelf for changes to our legal entity structure and our guarantor lineup.

This filing allows us to efficiently maintain prudent financial flexibility.

From a liquidity perspective, approximately $300 million is undrawn at this time under our revolving credit agreement.

So, we have good access to capital.

Slide 16, 2005 guidance.

Based on our YTD performance we’re now raising our guidance for the full year 2005.

We expect to end the year with internal growth at the top end of our 5% to 8% range.

We expect storage revenue growth rates to remain at the high end of the range in the second half of the year, and expect service internal growth rates to be inherently more variable but to strengthen going forward.

Two things to keep in mind as you think about the second half of the year.

First, we expect to record between $5 million and $10 million of service revenues associated with the new Digital business in the third quarter.

This could have a 3% to 6% impact on service revenue internal growth rate, and a 1 to 2 point impact on overall internal growth in the quarter.

Second, we will likely experience some volatility in the quarterly growth rates based on last year’s Q3 and Q4 results.

Recall, if you would, that last September had weaker than usual service revenue growth, while December had stronger than usual service revenue growth.

Therefore, if those two months behave as we would expect them to we would benefit from a good comparable in Q3 and suffer from a bad comparable in Q4.

The full year, however, should be as expected.

Said differently, the easy comp last year in Q3 combined with this [bolas] of service revenue from the new Digital business, means that in Q3 our internal growth rate could exceed a 10%.

And we want to caution you in terms of extrapolating off of that due to the factors we’ve mentioned.

As regards to the OIBDA margins, the business continues to produce very predictable results quarter over quarter, as the vast majority of gross margin is derived from storage, the revenue and cost characteristics of which cannot change quickly, and that changes in overhead spending are deliberate and evolve over time.

We now expect the OIBDA margins of between 26.5% and 27.5% for the year, with any given quarter’s margin running plus or minus 100 basis points around that range.

These margin outcomes represent the net of productivity improvements, offset by the expected margin swing from bad debt, the YOY increase in sales and marketing, and some margin dilution from our expanded Digital operations.

Our third quarter guidance is for revenue of 512 million to 522 million, and operating income of 94 million to 99 million, with depreciation and amortization coming in at approximately 46 million.

Our full year guidance is for revenue of $2.2 billion to $2.45 billion, and operating income before depreciation and amortization of $540 million to $560 million.

Thank you.

And with that, I’ll now turn it over to Richard.

Thank you, John.

And good morning, everybody.

As John told you, this has been a great quarter, and there’s really not a lot to add to it but I’ll hit a couple of points, and then we’re going to take your questions.

Business performed strongly across the board, internal growth and margins were at the high end of any ranges we were expecting.

And, basically, the business is humming on pretty much all cylinders everywhere.

We see strong demand, we see lots of good opportunity, and people are performing well.

Obviously, John went through the numbers, so I’m not going to review all those again for you, except to point out that our internal growth rates are running at the high end of our ranges, and that we’re seeing strong services, both in comp as well as core services across the businesses.

In addition to that, good product sales in some of our lines add to the incremental margin.

Margins, as he said, we’re doing well.

And he went through all of the details there.

Speak a little bit about our sales force, on a world wide basis as well as the North American basis, for that matter, our sales forces are running ahead of plan and substantially ahead of last year.

And one of our goals of increasing our sales productivity or our sales efficiency, that is yield per dollar costs, we are on target there, and it continues to rise, and we still believe there’s more of that to come as people settle.

As we’ve ramped up a lot of new people, they settle into the jobs, they mature, the education takes affect, and the learning curve, and so forth.

A little about, John spoke about the financial impact coming in the next quarter, so this new Digital win.

Obviously, we don’t talk about specific customers, but I’ll give you a little color on that.

It is the largest deal we’ve ever closed YTD on our new Digital businesses, with a total contract value of somewhere in the range of $20 million, give or take.

And about 60% is in terms of project revenue which will come through services, a good part if not most in the next quarter, but certainly in 2005.

And the balance in recurring storage revenue over the life of the next three years, which is the contract life of the transaction.

The important thing about this, though, is it’s just another step in the validation of the strategy, because this was a large financial services institution, and this is an enormous amount of work.

And basically it’s an institution we have other relationships on the physical side of our business, and we were able to through our longstanding relationship with that business, and the trust built-up in that business, it was Iron Mountain that they were interested in turning to because this is hard work that has to be done in an extremely short period of time.

And they wanted to make sure they had somebody who would be committed to that level of service.

And we’ve shown them over and over that we can reach those kind of commitments, and we’re obviously working hard for them on that behalf.

And it’s another example, many people ask me, ‘why the Digital business, what’s the relationship of the Digital physical business?’ And I’ve told you over and over, that there is a strong relationship because it’s all about information management, it’s all about consistent management information and in order to be compliant.

And compliance is a big issue to everybody today that, frankly, didn’t – it existed in the laws but didn’t exist in reality three or four years ago.

And it is driving what everybody, including Iron Mountain, is where we’re headed and what we’re doing, both on our side of our business as well as on the customer side.

The other thing that this does is it pretty much enhances, makes sure that the Digital business is likely to hit their financial targets for the year, in fact, may exceed those targets.

And, therefore, we’re telling you that we believe that our Digital business at the order line will breakeven or slightly better for the year.

And we have been saying this, that we saw breakeven coming earlier, a little faster; and it might be in the next few quarters or into the mid-half of next year.

And I guess the message we’re telling you now is we see even further acceleration, and it will be breakeven for the year.

On the acquisition front, I think the key message here is, in fact, the key message to everything is the business is performing.

There’s not a lot of change going on right now.

The strategies are set, and we’re playing them out.

And that’s the same in the acquisition front, because we’re back to the normal levels of spending and doing tuck-ins, fold-ins, and small transactions.

You know, with about seven acquisitions and a couple partner buyouts of about $40 million spent this year, and only two actually closed since our last conference call.

We do see constant acquisition activity.

We are in the market and will remain in the market, and we are actively seeking and closing transactions.

But it’s just the average size of the deals are small, and we expect they’ll stay that way by and large.

So, in summary, this was a good quarter for Iron Mountain.

And, as I said just now, I think the key thing for investors to understand is for the last couple of years we’ve been talking you through a change, as we’ve started up a new Digital business and increased our investment in it, some concerns about whether it would breakeven, and some other people’s concerns about whether it was a rational thing to do.

We believe it’s not only a rational thing to do but a very attractive thing to do, which is why we pushed hard on the head.

And I think we’re feeling very good about where it is, and signaling to you what the financial dynamics are looking like.

We have a serious business there that’s doing a good job and going to do an even better job.

And in addition to that the physical businesses are doing well, too.

Our international businesses are getting over their major integration issues and starting to make headway on a lot of fronts.

And, of course, the shredding business continues to be a good winner for us.

So, we’ve laid out the strategy in the last few years.

That strategy called for a significant amount of investment, a significant amount of change, and a broadening in the breadth of the business, and an increasing of the opportunity set.

We’ve been talking you through that for a couple of years.

I think this quarter is a strong representation of what that strategy can do for this business, and we look forward to a lot of these coming in the future.

So, really, we’re about now talking about 2006.

We’re off planning, you know, making sure that’s going to work well, and so forth.

With that, we’ll stop and take your questions.

And then we’ll come back and wrap-up.

Operator?

[OPERATOR INSTRUCTIONS.]

And, sir, our first question is from the line of [Lionel Delovous] with Goldman Sachs.

Good morning.

First, a question on the sales force.

I think at the end of the first quarter the YTD count for the sales force was, I remember was 602 or 603 people.

And you were a little bit beyond budget.

Where are you today in terms of actual headcount?

And where do you expect to be at the end of this year?

That’s the first part of the question.

The second part is I think at the end of last year you were basically saying that you would like to invest a lot more in the sales force in Europe, as well.

Where are you in terms of this investment at this point?

Total sales force we’re around, I think it was about 632 at the end of the quarter; and we’ve had, you know, a little over 20 openings, which is sort of a normal level at any point in time.

And in Europe, I don’t actually have their numbers in front of us.

They continue to make progress.

We’ve invested more, but we’re still, that’s still the place where there’s more to come.

Okay, so we should not see a huge ramp-up in investment in sales and marketing in Europe in the next two quarters?

No.

No, you won’t – I think you’re going to find that our sales and marketing spend is going to run in line, frankly, in line with the last half of last year, maybe up slightly, but not significantly.

Okay, and then looking at the gross margin and looking at it sequentially, and sales were up a little bit sequentially, but [not much].

But, so I look at the gross margin, the gross margin was up pretty significantly between 2Q and Q1.

Why was that?

Was it only the business mix between the two quarters?

I’m sorry, what was the last part of your question?

I mean why was the gross margin up so much sequentially between the second quarter and the first quarter?

We, there was some seasonality on the expense side, so in the first quarter related to heating our buildings, primarily.

Our use of energy, electric, gas, and oil in the first quarter was 310 basis points of revenue, that’s our high quarter.

And this quarter it was only 230, so it was sequentially an 80-basis point pick-up right there.

That’s the biggest factor.

Okay, and the last question, I mean your leverage is coming down and virtually your performance is relatively strong.

You’re still rated [CAA1] at Moody’s.

Did you talk to the rating agencies recently, or have you seen any signs that you might be able to go back to a single B3 rating in the near future?

Yeah, we tend to go talk to rating agencies at least once a year in the absence of any deal, to keep them informed.

We have turnover at one of the two rating agencies in terms of who is covering us, so we’ll probably be down there.

But, no, we haven’t had any significant dialogue lately.

Okay, thank you very much.

And, sir, our next question is from the line of Thatcher Thompson with CIBC World Markets.

Morning, guys.

Hi, Thatcher.

Hi, Thatcher.

You mentioned on the Digital side the largest deal for Iron Mountain, and it seemed to swing your profitability quite a bit for that Digital business.

I would imagine that’s one of the largest deals ever done anywhere?

That would be my guess.

Obviously, we can’t obviously know, but I would almost be certain of that.

Okay, can you describe kind of, for lack of a better word, the factory build to handle the project revenue?

How much CapEx?

How many people?

John mentioned the sale leaseback, and then also the opportunity to fill this with more big deals as you finish the first deal?

Well, without – you know, I’m giving you too much color.

I’m a little afraid.

But, certainly, about the opportunity, for a lot of reasons, competitive as well as for customer confidentiality, I won’t talk too much about it.

But the factories, you say, it’s a combination of buying, our team mobilizing quickly.

And I’m talking, you know, holidays and weekends and staffing.

This is a project that has to be done in 90 days, and we are doing an enormous amount of data restoration work, where you literally had to build systems.

We’ve provisioned, purchased, built, and brought up our infrastructure.

This is going to be, I’ve forgotten the precise number of terabytes, but it’s almost, it’s a significant increase in our total data repository so we had to layer in a lot of infrastructure.

You know, the good news is we had the infrastructure, we had to lay in the incremental capacity of storage devices, and hardware, and so forth.

But, you know, the software we already owned, and it’s process and procedures we’ve developed over the last few years, and the ability to do this work is the ability to run an efficient and accurate process and procedure for data restoration.

And it may sound easy, but as we have learned, our own selves, by spending a lot of money in trials before, it is not at all easy.

It’s very hard.

Which is why, you know, this is a business that people want to go somewhere they can trust.

But we ramped up and hired I think in the neighborhood of 80 people.

The good news is it’s summertime and we were able to take advantage of a lot technology, you know, college students and so forth.

And we leveraged our, you know, we already had through our own Digital business a significant infrastructure of data centers and infrastructure of networks, and people, and knowledge, and so forth.

And then, last is we’ve used some outsource partners on parts of it to do pieces of the work.

So, it’s a very complex project management job, and we have mobilized a lot of people on behalf of this customer because this is a serious problem the customer has to deal with, not a passing, ‘oh, yeah, maybe we will or might or not.’ And you can sense from the timeframe that it’s a serious kind of issue for them.

And, you know, they’re – you know, I’m sure other people in the world could do it, but I have to say with great confidence even we, who we think we’ve gotten pretty good at it, this is a hard project to do, and so far I think we’re doing well at it.

Okay.

And one other question.

Richard, you had mentioned some price rationalization for large customers, to get them all on one contract with escalators.

Maybe it involved some price decreases.

John just mentioned in his comments that price increases actually contributed to revenue this quarter.

What’s – and that strikes me as a fairly dramatic change from what we were hearing six months ago?

Well, I think as we’ve been saying for the last six months, the market is shifting, our strategy and approach to the market is shifting.

And, you know, but there’s still rationalization going on, there’s still lots of things going on.

But our value proposition is getting stronger, and we’re learning to use it better.

And so the net of it is where I think in the prior year we were sort of slightly on the negative side of 0, we think we’re going to be slightly on the positive side of 0.

And, yes, that is a shift.

And I think I’ve been saying for six months, at least, that we are shifting our strategy some.

I think you’re seeing the results of that, and the last thing I want to suggest to you, don’t look for anything ratable.

We will do what’s right for our customers.

But I think in the prior period for awhile the pendulum swing a little too far to the benefit of customers.

You know, the fair balance got a little bit unfair, and we’re trying to take it back to the land of balance and fair.

And that's what we’re going to do.

Thank you.

And, sir, our next question is from the line of [Jeff Embersetz] with Cumberland Associates.

Hi.

I was wondering if you could help me on the CapEx number, to understand what you would refer to as sort of maintenance CapEx versus CapEx required for supporting additional revenue growth?

Yeah, our maintenance CapEx is, runs about, it’s estimated to be about $40 million this year, and is comprised of maintaining our 55 million s.f. of space, so it’s probably about a third of it.

Some portion of our IT spending that relates to the desktop and to infrastructure that we have to refresh from time to time, that’s about a third of it.

And then there’s certain warehouse equipment and furniture and fixtures and other things that make up the remainder of it.

Okay.

Thank you.

Sure.

And, sir, our next question is from the line of Franco Turrinelli with William Blair and Company.

Good morning, gentlemen.

Just a quick piece of housekeeping clarification.

The project revenues from this Digital service fall in complementary services, I assume?

Well, given the compressed timeframe and the magnitude it would be, it certainly is, meets our definition of lumpy and not likely to be routinely recurring.

So, we’ll probably put it in complementary.

And it was in complementary in this quarter?

It’s $1 million this quarter, but it didn’t move the dial.

Oh, John, we estimate things to the nearest million, don’t we?

We’re out of the basis point business.

Richard, just to push a little bit more on this, and we understand I think the sensitivity of it, but this sounds like a sort of e-mail recovery project based on some sort of request, even litigation or some kind of regulatory process, is that fair?

It could be whatever you think it is.

Okay.

And then in the – we haven’t talked about shredding, at all.

I know that you had a very good first quarter, including a lot of activity, though, in terms of new RFPs in the second.

Can you give us a shredding update?

Yeah, it’s still humming.

I mean, you know, and hopefully that’s what we’re going to be telling for a lot of quarters to come.

But it’s still humming north of 20% internal growth, and yeah, we’re landing more than our fair share of good deals.

And we’ve got a very strong, I think, pipeline in deals or contracts to sign to be implemented.

You know, there is a lag time.

Not as long as the storage business lag time.

There’s a long storage business lag time between signing and actually revenue recognition.

But on big shredding contracts there is a bit of a lag time, it takes a while to, and a lot of work and energy to plan and do the logistics of rolling out, you know, a contract may be over 15, 20 cities and 30 or 40 locations.

But another thing going on in shredding which has very hot marketplace, and we’re seeing good sales success.

The recycled paper market is a little weak, and recycled paper is down around $90 a ton versus $100, $110 historical average.

That’s not, recycled paper, because of the inherent volatility, due to the market pricing of it goes into a complementary service revenue.

So, we’ll watch that and report on that quarter to quarter.

Richard, one of the things that seems to be happening on the shredding side a little bit, maybe like, you know, what’s happening on Digital is that not only were you seeing more opportunities, but you were seeing bigger opportunities, in a sense more strategic opportunities.

Is that still the trend?

Any success with those?

Absolutely.

And that’s our real market focus.

Look, like in all of our businesses, we tend to – we’ve got broad coverage over segments in the markets, from small to huge.

But our strength is absolutely in the enterprise, and they’ve got extreme needs, extreme regulation changes, even now pending and coming.

And, you know, there’s a lot going on and that has impact on that business.

You answered the question in terms of sales force investment in Europe, can you just give us an update on the European business, more generally?

Maybe separating out U.K. trends versus Continental Europe?

We have…

Let John talk about it.

75% of our business is U.K., and we have some reasonable longitudinal data, therefore, off of that business.

We, on the Continent we don’t have the benefit since we’re still building the platform, don’t have the benefit of a lot of that kind of data.

We’re…

You know, we’re driving the business in a couple of directions over there.

As we said earlier, there’s an increase in the sales side of the business.

There’s also some rationalization going on in the operational side of the business.

All of which, frankly, has gone well.

The U.K. is doing well.

You know, we’ve talked a lot about the public sector.

And, yes, it had such a great year last year, we’ve said over and over that puts a dent in growth and so for this year because some of that was lumpy revenue, it didn’t come back.

On the other hand, that group has responded to the challenge, has closed some additional new business, and is doing a good job of broadening their expertise skill, and even looking to take some of it to the private sector, which will increase the opportunity set there.

And on the Continent, you know, you see, it’s kind of country by country, okay?

The Continent, as I’ve said over and over, is not one integrated thing.

I’m not sure I can run down each individual country.

But by and large, the trends we see in the Continent are all positive.

That is that there’s more and more M&A going on over there.

M&A drives the consolidation of the large customers, almost none of which are really outsourced.

And that drives them to want to do more efficiency in the operations, which has them looking at outsourcing.

We’re doing some work to expand the footprint and a few other small places, where we see good long-term growth.

But, you know, strategically, I guess what I’d say is that just like frankly pretty much here in the U.S.

We’ve laid out the strategy.

We’ve gotten things pretty much lined up.

And people are performing, and actually doing quite well against this.

So, there’s nothing remarkable to talk about.

And that’s what I hope to say to you for a long time to come.

One point I’d make about Europe is that in the two quarters we’ve reported this year, the pound, which is where most of the revenue comes from has been between $1.85 and $1.90, and now it’s running about $1.75.

So, when 20% of our revenue sees an FX move like that it impacts the magnitude of our results; has no margin impact because they do match revenues and expenses in the local currency.

But embedded in our forward guidance is the full knowledge that, you know, any time we guide we assume that the rates are going to stay right where they are the moment we open our mouth.

And our internal growth rate is not, is normalized for FX movements.

But the dollar strengthening, which means, you know, you may see other income as we mark-to-market some debt, inter-company debt and third-party debt.

And the absolute magnitude of revenues and profits coming will be lower than in the first half due to the exchange rate.

Okay, thanks, guys.

And, sir, our next question is from the line of [Douglas Pratt] with [Mesa Capital Management].

Mr. Pratt, your line is open.

Next?

I guess we lost him.

Let’s go to the next call.

And, sir, our next question is from the line of Mike Schneider with Robert Baird.

Good morning, guys.

Hi, Mike.

Wanted to address just a core services number being up 7% organically in the quarter?

Could you drill down in just [interim]?

6 in interim, and it got drug up to 7 by shredding.

I’m sorry, what was your first comment?

Interim without shredding was 6%.

6%.

So, that means the international business actually in core services was probably lower sequentially?

No, about the same.

About the same?

Well, the reason I ask that question, it looks like you had a nice sequential improvement in interim box services.

But yet the – but the total number for core services, the 7% didn’t go up.

I’m trying to figure out what was, you know, interim box services were better, what was actually sequentially lower to keep the growth rate the same?

International.

Okay.

Any magnitude you can put around that?

No, we’re not going to go to that level of detail.

We’re talking about 30% of our revenue, and a place that’s 20% of our revenue, and it has everything to do with customer behavior around advanced instructions and what-not, and we’re just not drilling that deep.

But what we – no trends or extraordinary things going on that we know of, it’s just natural variations.

But the encouraging trend is that interim box services are up sequentially, right?

After some of the unexplained weakness in the third and fourth quarters of last year?

Yes.

Yes.

And any, you know, in hindsight, any analysis or explanation you can put around that?

Yeah, well, the same one we’ve given you consistently.

It was that the behavior of 10s, not 100s, 10s of just large customers, it seems like there was some confluence of behavioral change four quarters ago, and we’ve come through that trough, and we’re back here.

But we’re increasingly cognizant of the fact that, recall core services is event driven end business as usual factors put together, so it’s just a little more variable than one might think.

Okay.

No, I appreciate that.

And then just a comment on the second half, when you say margins are roughly going to be flat first half to second half, and I realize Digital is taking on a greater portion so I guess that’s somewhat of an adverse mix.

But why with higher organic growth in the second half would you still expect that margin to be flat, first half to second half?

We have some expenses related to consolidating and rationalizing our business operations in the U.S., which will pay off in margin long term, but a little bit of expense coming in the second half.

Bad debt should be higher.

I mean we still think that 20 basis points is not at its natural level, so we assume that will happen.

And general conservatism, I guess.

Okay.

And the consolidation of the U.S. operations, can you give us some color as to what’s going on?

Well, I’ll talk about that.

We’ve talked for oh, I don’t know how long, time flies in my head, but a year or two, about a gradual shift as we’re coming out of our second phase into our third strategic phase, about rationalizing a variety of things.

We’ve started down the path of our sales force and took it out of our operational units, and our business units started to create a national, you know, a country based model, sales force.

And a country based model now on the operational side.

And now we’re moving to the next phase of that of taking a couple of our lines of business, well, actually we started and combined two of our lines of business, shredding and the box storage and services, records management piece, oh, I think a couple of years ago.

We’re now extending to the third one, which is the data protection side and the other two.

And what we’re doing is consolidating the operations, both at the overhead level as, you know, because they were separate units, they still today are separate business units.

But we’ve started the management consolidations at the top and are working our way down, and throughout the rest of the year going into next year we’ll have it pulled together.

And we’re doing it primarily to continue our vision of putting one face to the customer, having instead of two account management teams with different product expertise, calling on customers, the same customer.

What we hear back from customers over and over is just, ‘come on, quit sending so many people in here.

Send one person in, and talk to me about everything.’

And this is the way to accomplish that, and it’s the way to accomplish in doing that, frankly, driving more revenue through our existing customer base because we are, we have been as part of our strategic shift, and if you have followed us very carefully, and not many people have.

And I don’t want to bore you with too many details, but part of our strategy in phase two was to go out and acquire new customers.

We trained, and paid, incentivized, and gave rules to our sales force that they could never call on an existing account.

We only changed that rule about a year-and-a-half ago, and started letting some, but still not all, call on existing accounts.

This is all part of that, as we recognize that we, although there’s plenty of existing accounts we don’t have, we have relationships now where there’s enormous penetration opportunity.

And to do that, we need to put one face to the customer and put the right people in front of them.

And these are all shifts in that direction.

There are some secondary benefits to this.

The primary reasons I said is for the one face to the customer.

The secondary benefit is it will create a more efficient organization which will help enhance margin over time and it’s just part of our continued path to get the 38% [off the working] margins, which we’ve committed to do.

Okay.

And just a final nuance, on the margin guidance for then for the second half, and related to my opening question which is it appears as though the North American box services business is coming back from this lull, in the second half of last year.

Shouldn’t that be a positive benefit to the margins?

As that business comes back in the second half?

Yeah, maybe, but we’re not forecasting anything we don’t know.

There’s also some seasonality in the business in the sense that our two weakest service quarters are the third and fourth quarters, so while we manage labor carefully through that you just, you don’t get as much service gross margin to cover fixed overhead.

So.

Okay.

Thanks very much.

But that’s the natural progression of things is for margins to pop into the first quarter off strong revenue, and then sort of hang in in the second half of the year.

Okay.

Thank you.

You’re welcome.

And, sir, our next question is from the line of Henry Naah with Lehman Brothers.

Hi, guys.

Two questions, if I may.

I was wondering if, you know, it sounds like this shredding business is going pretty well.

Our checks indicate that [inaudible] is doing well, also.

Could you please give us some update as to how that’s progressing?

Well, as you know, we integrated Connected in our additional services businesses, and so we’re not, I guess we have a view on it, but I don’t think we’re willing to talk specifically about one product line versus another.

But the organization is doing well, the Digital business, as we said already has rallied well to the opportunities they see out there.

The sales of the Connected products are going as expected and, frankly, slightly better.

So, you know, any way you add it we feel pretty good about that.

And the last thing is I think the organization integration, you know, this is the first what you would call technology acquisition we’ve ever done, and the integration both the management team that have come in and taken new roles, as well as on the development side and everything else has gone well, so far.

Everybody seems to be pretty excited, and we’re making some real headway.

Okay, great.

And then you guys had also mentioned that on the complementary services the sale of data products was a little better than expected?

Data products are very, very strong.

And, frankly, we’ve mentioned that because we want to talk about good things that may or may not repeat.

It’s just a booming year for data products, which means that by itself in the quarter that data products, the growth contributed 500 basis points.

And we don’t yet know whether it’s because our sales force did a, you know, our organization did a better job of selling it, or whether just the market is up, you know.

But we’re just riding the tide, or whether it’s people did the work.

My guess is that it’s the efficiency of the sales force.

We have a hard stop at noon, and I’m going to have to move it to the next questioner, because we have a little bit of a queue here.

I want to get through as much as we can.

And, sir, our next question is from the line of Andrew Steinerman with Bear Stearns.

Hi, gentlemen.

So, now that we’re expecting internal growth overall at the high end of the range, could you sort of think about maybe what’s driving us to the high end of the range?

Do you think it’s maybe creep inching up?

Do you think it’s price inching up?

Or do you think it’s new sales inching up?

Or is everything heading, you know, sort of in the inching up direction?

I think volume is stable.

Price is probably 50 basis points to the good.

Sales force productivity is probably 50 basis points to the good.

That’s probably what’s happening.

That’s probably what’s happening on the storage side.

And on the service side, you know, better, more intense coverage of big accounts and market trends is driving some business to us, particularly on the special projects side.

So, I think the coverage model will, you know, as we enhance and perfect our coverage model, there’s a lot of business to be done with our customers.

And we’re, you know, we’re encouraged based on exogenous factors that is driving demand for services that our, you know, mid to long-term growth outlook is strong.

When you say ‘more business with existing customers,’ to me that sort of sounds like to me creep is leaning forward.

Is that fair to read it?

It isn’t coming through on the numbers, but, you know, it certainly is the case that with our enterprise customers there’s more mandating the use of one vendor, and so there’s good penetration opportunity.

We’ll stay-tuned on volume.

Thanks.

Much appreciated.

And, sir, our next question is from the line of [Edward Aterino] with the [Benchmark Company].

Hi, good morning.

Did I miss CapEx for the second quarter, John?

74 in the second quarter and 130…

74?

Yeah.

Okay.

I just had a question on margins, you asked –on de-leveraging, if you had to sort of speculate on the trend of interest expense the next two or three years, I’m playing with my model here, it comes down pretty sharply assuming you kept CapEx around 250, 260 million a year.

Yeah, CapEx may, that may be on the low side for CapEx, because it’s running at 12, 13% of revenue.

I don’t, I wouldn’t model it coming down hard from those levels.

Okay.

It does, debt does come down.

There is some Asian expansion and some platform work left in Europe, and we do need to bring to those markets, consistent with our strategy, our other products and services, like Digital and shredding, and so forth.

So, but there’s no question that sticking to our knitting, even with those expansion investments ahead of us that our leverage ratio will come down.

Right.

And that’ll create that capacity that we may tap.

Last question, SG&A has jumped up to sort of a new level here, around 27 or so percent of sales versus the historic level I guess is more like 25, 26.

Is that going to be a new level or is this going to trend down in time?

It’ll trend down in time, I think, unless we choose to invest more in sales and marketing.

Right now, our view is we’ll get productivity and some headcount increase in sales and marketing, but it should not be a huge margin.

Got you.

One of the reasons it’s off from prior periods is that in the last few years, as you know, we’ve had bad debt reversals that have contributed to margin.

I think we’re close to where we need to be in that regard.

The other issue is we’re having a good year and so the incentive compensation plans are probably going to pay better than they have in the recent past.

Last question, do you want to put a timetable on getting the 30% margin?

No way!

Okay, thanks.

Thank you.

We’ve…

We’ve run out of time.

We’ve hit our commitment to try to get out of here in an hour, and so I think we’d like to do that.

So, we’d like to appreciate, first, thank you for coming, and thank you for your support.

We recommend you watch our web site for upcoming events and so forth.

I think as we’ve said over and over, this is a good quarter for the Company.

The engine seems to be humming well.

And I’d like to thank our organization for their continued great performance, and wish you all a good summer for the balance of the summer.

Thank you.

Ladies and gentlemen, we thank you for your participation in today’s conference.

This concludes your presentation, and you may now disconnect.